Subhash Garg: Expenditure reforms agenda for states
Subhash Garg / New Delhi December 17, 2005
Pension reforms, better debt management and increasing user charges lie at the heart of any reforms strategy
States have been assigned a significant responsibility for delivering public goods (goods and services such as law and order, which cannot be produced, priced and sold by private sector on account of their very nature as their consumption cannot be specified to an individual/s only) and merit goods (goods and services like education and public health with desirable positive and negative externalities). India is one of the most federally decentralised countries, with states spending around 20 per cent of gross domestic product or over 50 per cent of total public expenditures. These public expenditures need to be productive and efficient, besides being rightly focussed, for delivering best value for public funds spent. If the states’ expenditures get atrophied on account of structural rigidities or are misdirected for production of private goods or non-merit goods, the cause of public welfare will suffer badly.
A study of state finances, for the period 1990-91 to 2002-03, currently underway at the National Institute of Public Finance and Policy, has thrown up major insights in structural changes in the composition of states’ expenditures. Unfortunately, the changes are quite undesirable. The states’ total expenditure at 19.26 per cent, went up by close to 0.7 per cent of GSDP (gross state domestic product) during this period, but all desirable kinds of expenditures declined. Capital expenditure steadily declined. By 2002-03, capital expenditure was lower by 0.8 per cent of GSDP, or by over one-third. Public goods expenditure (general services expenditure minus interest and pension) barely managed to stay unchanged at the level of 2.18 per cent of GSDP (against 2.22 per cent in 1990-91), but merit goods expenditure declined substantially from 6.51 per cent of GSDP to 5.87 per cent of GSDP, registering a substantial decline of over 0.64 per cent of GSDP. At 2002-03 GSDP of over Rs 19,00,000 crore, such reduction in capital expenditure and merit goods deprived people of desirable type of expenditure by over Rs 15,000 crore and Rs 12,000 crore, respectively, — Rs 27,000 crore in aggregate.
Quite regrettably, states’ interest expenditure rose by a whopping 1.78 per cent of GSDP and pension expenditure by 0.94 per cent of GSDP or 2.72 per cent of GSDP or over Rs 53,000 crore, which amounted to more than 350 per cent of the entire rise in public expenditures. Increase in pension payments alone was higher than entire compression in capital expenditure or entire increase in states’ expenditure. The states revenue expenditures actually fell by 1.25 per cent and total expenditure (revenue plus capital) by as much as 2.06 per cent of GSDP if we exclude the increase in interest and pensions.
Given the states’ inability to raise the overall level of public expenditure, an expenditure reform strategy can be built around four key reforms. First, the states need to eliminate or reduce substantially expenditure such as the user charges gap for non-merit social and economic services. The study estimated that states are spending over 3.35 per cent of their GSDP on non-merit goods. This expenditure is concentrated in secondary and tertiary education (Rs 27,174 crore), power subsidies (Rs 14,856 crore) and maintenance of large and medium irrigation dams (Rs 8,721 crore). Together, these three sectors accounted for 2.66 per cent of the GSDP during 2002-03. States’ total recoveries of user charges are estimated to be not more than 0.25- 0.5 per cent of GSDP. The states need to examine all non-merit social and economic services, especially these three sectors, for evolving a criterion for discontinuing non-merit goods and services and levying appropriate user charges for whatever services are felt necessary to be continued for short, medium or long term.
Second, there is a serious need to restructure and manage expenditure on pension and retirement benefits to bring it down to less than 1 per cent of GSDP. Switching over to a defined contribution-based pension scheme for new employees, bringing parametric changes to existing pension schemes for making commutation a non-subsidised option, not extending any further rank indexation at least, if not wage indexation, reforming survivor pensions, and reforming other retirement related benefits like leave encashment are some options available for achieving this objective. The states also need to examine whether the new pension scheme should be extended to relatively younger employees with less than 10-15 years of service by converting their vested rights into bond-based pension payments. States need to also unwind the defined benefit pension based systems for non-core civil service and set up pension funds for existing defined benefits employees to make government’s implied obligations transparently clear.
Third, states’ entire debt management needs to be professionalised to limit and manage new borrowings and restructure existing borrowings in such a way that interest burden on states is brought down to less than 25 per cent of their own revenues as against the present level of 41.48 per cent. States paid 3.63 per cent of their GSDP in interest payments and their own revenues as a proportion of GSDP was 8.75 per cent in 2002-03.
Fourth, states need to restructure and re-prioritise the rest of the expenditure (nearly 8 per cent of GSDP, comprising of 5.87 per cent of merit goods expenditure and 2.18 per cent of public goods expenditure in 2002-03) for better relevance, targeting, productivity and efficiency. Public goods like law and order, criminal and civil justice, protection of life and liberty, taxation services and so on, classified as non-plan, have suffered enormously because of fund constraints, thus leading to weaker governance in the country. These expenditures need to go up. The primary challenge in the merit goods sector such as education and health, is poor productivity of such expenditures rather than the level of expenditures. A contract teacher, at one-third of the cost of a regular teacher, can deliver better educational service because of the right incentives. The states also require to invest in acquiring the right kind of skills and developing the right kind of institutional arrangements for planning, appraising and executing a capital expenditure budget as their capital expenditure is likely to go up to 3 per cent of GSDP.
Finally, it is also necessary that states undertake key non-fiscal reforms for better expenditure management like transparency of public expenditures, sound and efficient procurement practices (including contracting out delivery of services), better design and appraisal of expenditures and extensive monitoring and analysis of public expenditure.
The writer is an IAS officer serving in the National Institute of Public Finance and Policy. Views expressed here are personal
Subhash Garg: Expenditure reforms agenda for states
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