There is of course a more basic question. Raising tax-GDP ratios requires more than just political will, which is obviously a necessary condition. It also, in today's world, implies a willingness to engage in macroeconomic strategies which may not please potentially mobile capital. It is not an accident that all finance capital dislikes taxation; and recent experience suggests that the competitive pressure to attract other forms of capital also typically generates policies like tax incentives. Indeed, more taxation is probably greater anathema to large capital than the much-maligned large fiscal deficits.
 
The EFC's intentions in this regard are wholly laudable, but there must be an explicit recognition of the implications, which involve a redirection of the basic macroeconomic strategy. Thus, the anticipated increases in income tax and corporation tax, while entirely feasible at one level, are not really compatible with a macroeconomic approach that puts primacy on the need to attract inflows of capital.
 
That the EFC is basically operating in that kind of world is evident from the suggestions on expenditure restraint. The largest element of Central revenue expenditure today is interest payments, which the Report actually describes as one of the items which is "inflexible downwards". The EFC appears to suggest that the only way out of this in future is to reduce public debt by cutting deficits at present. But even changing the pattern of financing the existing deficits can have a major effect on reducing the interest burden of the government.
 
The EFC uncritically accepts the position that the government has to rely only on expensive market borrowing and rules out the possibility of deficit financing altogether, even though this would sharply reduce interest payments at the margin. Similarly it appears to accept that the Statutory Liquidity Ratio cannot possibly be raised, even though this would increase access to slightly cheaper borrowing by the government. All this because the EFC seems to subscribe to the position that public borrowing "crowds out" private investment, even though empirical studies in India and elsewhere suggest that there is if anything a positive correlation between public and private investment.
 
The constraints imposed by this approach mean that the EFC is forced to rely on cuts in other expenditure to move towards fiscal balance. Thus, as shown in Chart 7a, the Centre must makes cuts in the already pitifully small proportions of GDP that are spent on social and economic services, not to mention the declines in expenditure (as share of GDP) slated for pensions and general services.

Chart 7a >> Click to Enlarge

Chart 7b >> Click to Enlarge

Chart 7c >> Click to Enlarge
 
For the States - as described in Chart 7b - there are to be small increases in the per cent of GDP expended on social and general services, especially in some sub-categories, but, alarmingly, a further cut in the proportion spent on economic services. It is hard to imagine the justification for such a cut by both Centre and States, especially now that the myth that the private sector will enter to fill such spending gaps has been well and truly exposed by the Indian experience of the 1990s.
 
Of course, all these considerations, interesting as they are, are of little immediate relevance since these are no more than general policy suggestions which may or may not be taken seriously by the Government, and by the Finance Ministry in particular. But they are important for our purposes because they inform the real bread and butter issues of the EFC, that is the questions of sharing tax revenues between Centre and States and allocating across States. Thus, the EFC appears to be so concerned with its own prescription of fiscal health of the Centre that it has tailored the need for revenue sharing with the States accordingly, despite the requirements of greater fiscal federalism.
 
This is where the real disappointment with the Report comes. Despite the crying need to devolve more resources to the State level, which many would argue to be self-evident, the EFC has actually set the clock backwards and moved away from greater devolution, notwithstanding its statements to the contrary.
 
At first sight, it appears that the EFC has actually provided more resources from the Central pool. Thus it has made provision for about 37.5 per cent of all Union taxes and duties to be shared with State governments. However, some of this relates to direct grants and support by the Centre rather than the amounts which must be statutorily shared, and therefore depends upon the discretion of the Central government.
 
In terms of the statutory requirement, the EFC has been much more restrained, and has ended up providing to the States even less (as a proportion of total tax revenues) than they have received at several points over the past twenty years. This is clarified below.
 
One important respect in which a major demand of the States has been neglected (again, because of the wording of the Eightieth Amendment Act) has been in terms of the sharing of net proceeds versus the gross tax revenues of the Central government. The difference is not large, and many would argue it to be inconsequential were it not for the fact that the discrepancy has grown substantially in the past few years, as plotted in Chart 9. Not only does it mean that there is no incentive for the Centre to be more efficient in terms of collecting its taxes, but it effectively reduces the pool of resources for the States.

Chart 8 >> Click to Enlarge

Chart 9 >> Click to Enlarge
 
The EFC has proposed that 28 per cent of the net tax revenues of the Centre must be shared with the States. As would be clear from an examination of Chart 8, this is lower than the previous year and even lower than the average for the entire decade. Of course, in addition the EFC has also recommended that another 1.5 per cent of the net proceeds be shared in lieu of the additional excise duties which were effectively foregone after the Eightieth Amendment Act.