MacroScan (Printable Version) - The Central Government's Finances

Some newspapers have already made much of the recent data released by the Finance Ministry on the central government's finances for this year. These suggest that the revenue deficit is already much higher than it should be given the target for the full fiscal year - indeed, for the first five months of the year, from April to September, the revenue deficit has already reached 83 per cent of the budget target of Rs. 76,171 crores for the full year.

This means that unless the central government is able to increase receipts quickly, or cut down on its expenditure, the revenue deficit is likely to be well over its target in the current fiscal year. This has already given rise to fears of new taxes being imposed upon common people in the immediate term, and of inflationary pressures.

But there are reasons to be much more cautious in interpreting these recently released figures. First of all, it was only to be expected that the revenue deficit would be larger than projected, because the budget itself had what is generally accepted to be an excessively optimistic perception of the likely deficit. This was made through very large (and generally unwarranted) expectations of increases in tax revenues.

During the presentation of the Budget, the Finance Minister had justified these exceptionally large expectations of tax buoyancy (to the tune of more than 20 per cent increases in some direct taxes) on the grounds of greater enforcement, collection of corporate tax arrears (some of which have remained unpaid for decades) and the like. It was fairly obvious to most observers that these Candide-like expectations were most unlikely to be met.

And this is more or less what has happened, thus far at least. Tax revenues thus far are less than 24 per cent of the budgeted annual total, and the net tax revenues of the Centre are less than 20 per cent of the budget amount. In such a context, it is hardly surprising that the revenue deficit is already much higher than anticipated.

In fact, revenue expenditures have been restrained - some would say overly restrained given the requirements created by poor early monsoon rainfall and the many commitments of the new government. Total revenue expenditure has been around 34 per cent of the total amount budget for the year, and of this the major element has been for subsidies. (Incidentally, capital expenditure has been even lower, and thus far only 28 per cent of the budgeted amount has been spent.)

So, the current inability to meet budget projections does not stem from any fiscal profligacy on the part of the government - rather, it reflects the excessive optimism and lack of realism of the budget estimates themselves.

That being said, what are the implications of a larger revenue deficit? Under normal conditions, it would not really matter very much, and if it were the case that such a deficit reflected increased expenditure directed towards the poor or towards revising the rural economy, it would even be welcome. But we have already seen that it does not reflect increased expenditure, but rather the inability to meet the inflated tax revenue targets.

This is a problem in the current situation because of the government's commitment to the Fiscal Responsibility and Budget Management (FRBM) Act, an extraordinarily foolish piece of legislation which the new UPA government chose to notify as one of its first actions. The FRBM Act not only announces very rigid targets for the revenue and capital account deficits of the government, it also specifies conditions that have to be met within the fiscal year.

The notification spells out that in case the central government does not meet 40 per cent of its revenue target within the first six months of the year, it must start cutting back on expenditure to ensure that the overall deficit is contained. The Act also prohibits the use of deficit financing, or the printing of money, to meet the deficit. This prevents the government from increasing necessary and important expenditures (for example on rural employment schemes, on agriculture, on health and education).

So the current fiscal situation is a source of concern only because it is likely to prevent the central government from undertaking expenditures which are necessary to fulfil its own promises, and may even cause it to cut back on some expenditure. In the current context, this in itself is not a source of inflation, which is currently being driven by cost-push factors that are both national and international in origin.

What can the government do about this situation? The most obvious answer is that it needs to increase tax revenues. This does not necessarily imply - as had been implied in some newspapers - that tax rates have to be increased or that new taxes have to be imposed on the common people. Rather, the government should actually get serious about recovering the tax arrears and enforcing greater compliance, as it has promised.

And there are other taxes, including some which were originally proposed in the budget, which should still be reconsidered. The most blatant example is the stock markets transactions tax, which was an extremely small but important measure (involving a tax rate of only 0.15 per cent on turnover). Even this small tax has been substantially diluted as the government caved in to the pressure imposed by a handful of Dalal Street brokers, and it is estimated that more than Rs. 3,000 crores of potential tax revenues were foregone in the process.

At the same time, the capital gains tax was removed, so that effectively financial speculators are today taxed less than they were before, which is completely unjustifiable. Now that there is a sense of fiscal stringency, such taxes must immediately be re-imposed. In addition, other taxes can be considered, such as a Tobin tax on cross-border transactions, which would operate to curb the openly speculative movements of finance that have become so marked in India especially in the recent months.

All these are eminently possible, but only if the central government is serious about fulfilling the promises that it made to the people in the aftermath of the electoral mandate.



Themes > Current Issues	15.10.2004


The Central Government’s Finances

Jayati Ghosh

Some newspapers have already made much of the recent data released by the Finance Ministry on the central government's finances for this year. These suggest that the revenue deficit is already much higher than it should be given the target for the full fiscal year - indeed, for the first five months of the year, from April to September, the revenue deficit has already reached 83 per cent of the budget target of Rs. 76,171 crores for the full year. This means that unless the central government is able to increase receipts quickly, or cut down on its expenditure, the revenue deficit is likely to be well over its target in the current fiscal year. This has already given rise to fears of new taxes being imposed upon common people in the immediate term, and of inflationary pressures. But there are reasons to be much more cautious in interpreting these recently released figures. First of all, it was only to be expected that the revenue deficit would be larger than projected, because the budget itself had what is generally accepted to be an excessively optimistic perception of the likely deficit. This was made through very large (and generally unwarranted) expectations of increases in tax revenues. During the presentation of the Budget, the Finance Minister had justified these exceptionally large expectations of tax buoyancy (to the tune of more than 20 per cent increases in some direct taxes) on the grounds of greater enforcement, collection of corporate tax arrears (some of which have remained unpaid for decades) and the like. It was fairly obvious to most observers that these Candide-like expectations were most unlikely to be met. And this is more or less what has happened, thus far at least. Tax revenues thus far are less than 24 per cent of the budgeted annual total, and the net tax revenues of the Centre are less than 20 per cent of the budget amount. In such a context, it is hardly surprising that the revenue deficit is already much higher than anticipated. In fact, revenue expenditures have been restrained - some would say overly restrained given the requirements created by poor early monsoon rainfall and the many commitments of the new government. Total revenue expenditure has been around 34 per cent of the total amount budget for the year, and of this the major element has been for subsidies. (Incidentally, capital expenditure has been even lower, and thus far only 28 per cent of the budgeted amount has been spent.) So, the current inability to meet budget projections does not stem from any fiscal profligacy on the part of the government - rather, it reflects the excessive optimism and lack of realism of the budget estimates themselves. That being said, what are the implications of a larger revenue deficit? Under normal conditions, it would not really matter very much, and if it were the case that such a deficit reflected increased expenditure directed towards the poor or towards revising the rural economy, it would even be welcome. But we have already seen that it does not reflect increased expenditure, but rather the inability to meet the inflated tax revenue targets. This is a problem in the current situation because of the government's commitment to the Fiscal Responsibility and Budget Management (FRBM) Act, an extraordinarily foolish piece of legislation which the new UPA government chose to notify as one of its first actions. The FRBM Act not only announces very rigid targets for the revenue and capital account deficits of the government, it also specifies conditions that have to be met within the fiscal year. The notification spells out that in case the central government does not meet 40 per cent of its revenue target within the first six months of the year, it must start cutting back on expenditure to ensure that the overall deficit is contained. The Act also prohibits the use of deficit financing, or the printing of money, to meet the deficit. This prevents the government from increasing necessary and important expenditures (for example on rural employment schemes, on agriculture, on health and education). So the current fiscal situation is a source of concern only because it is likely to prevent the central government from undertaking expenditures which are necessary to fulfil its own promises, and may even cause it to cut back on some expenditure. In the current context, this in itself is not a source of inflation, which is currently being driven by cost-push factors that are both national and international in origin. What can the government do about this situation? The most obvious answer is that it needs to increase tax revenues. This does not necessarily imply - as had been implied in some newspapers - that tax rates have to be increased or that new taxes have to be imposed on the common people. Rather, the government should actually get serious about recovering the tax arrears and enforcing greater compliance, as it has promised. And there are other taxes, including some which were originally proposed in the budget, which should still be reconsidered. The most blatant example is the stock markets transactions tax, which was an extremely small but important measure (involving a tax rate of only 0.15 per cent on turnover). Even this small tax has been substantially diluted as the government caved in to the pressure imposed by a handful of Dalal Street brokers, and it is estimated that more than Rs. 3,000 crores of potential tax revenues were foregone in the process. At the same time, the capital gains tax was removed, so that effectively financial speculators are today taxed less than they were before, which is completely unjustifiable. Now that there is a sense of fiscal stringency, such taxes must immediately be re-imposed. In addition, other taxes can be considered, such as a Tobin tax on cross-border transactions, which would operate to curb the openly speculative movements of finance that have become so marked in India especially in the recent months. All these are eminently possible, but only if the central government is serious about fulfilling the promises that it made to the people in the aftermath of the electoral mandate.



© MACROSCAN 2004