Beyond the pandemic: The crisis of revenues

The Covid-19 pandemic has cost us dear in not only lives and livelihoods, but also lower revenues and higher expenditure, both for the Union and the states. The ongoing pandemic is not the time to mobilise higher revenues. But I am sure that soon there will be life after the pandemic. So, it is useful to look at the finances of both the Union and the states before the pandemic between 2011-12 and 2017-18.

Even before the pandemic, there was insufficiency of revenues at both the Union and the state levels. For example, in 2017, India’s general government tax revenue — that is, the consolidated tax revenue of the Union and states — as a proportion of Gross Domestic Product (GDP) at 17 per cent (all percentages are as a proportion of GDP henceforth) was lower than that in all other G-20 countries, except Indonesia, and the lowest among the BRICS (Brazil, Russia, India, China and South Africa).

There is near unanimity that our general government needs to spend more on education (6 per cent), health (2.5 per cent), infrastructure (7-8 per cent), and law and order (5-7 per cent). Factor in 4-5 per cent for interest payments on the public debt that exists from the past, and what we should spend on poverty alleviation and subsidies, and you will get a number that is far more than 20 per cent, which is the general government revenue (tax and non-tax combined) resulting in a general government deficit close to double digits. Unless you believe that fiscal deficit is all maya, we can spend enough on these meritorious heads only if we have enough revenues.

Let us look at the problem disaggregated between the states and the Union. The Constitution has rightly assigned some important taxes, such as on income and imports, to the Union, and those on property or sale of liquor to the states. On the expenditure side, it has assigned defence and external relations to the Union, and those on primary education, health and law and order to the states. The compelling logic of such assignment is fairly obvious. Imagine filing income tax returns in different states for what you have earned in them! Or Delhi trying to decide where to locate a police station or primary school in Jhumri Telaiya!

Our founding fathers foresaw that the constitutionally stipulated assignment of taxes and expenditure would result in “own revenues” of the states falling short of their expenditure and creating the so-called “vertical gap”. Thus, they provided for a Finance Commission every five years primarily to reallocate a portion of the Union’s tax revenues among the states. The latest in the series, the Fifteenth Finance Commission, has recently given its report with recommendations for the five years, 2021-26. Let us use the data in this report for guiding us on the way forward, beyond the pandemic.

For our states in the aggregate, the vertical gap was 58 per cent in 2017-18, compared to the OECD average of 40 per cent. A part of this imbalance is by design, but a part is also because of inadeq­uate own revenues. Own tax revenues of the states declined from 6.4 per cent in 2011-12 to 6 per cent in 2017-18. The corresponding decline in their non-tax revenue was from 1.1 per cent to 1 per cent. With such a decline in own revenues, and their revenue and capital expenditures increasing from 12.3 per cent to 13.5 per cent, and from 2.4 per cent to 2.5 per cent, respectively, this vertical gap increased in the six years ending 2017-18. The question is not whether the states should have a vertical gap, but how much it should be. Once the pandemic is over, the states need to garner more own revenues to spend more on meritorious heads such as education, health and infrastructure.

Unfortunately, even before the pandemic, between 2011-12 and 2017-18, the Union’s finances also remained under severe pressure. In 2011-12, with its revenue expenditure at 13.1 per cent and capital expenditure at 1.8 per cent, its total expenditure, even before any devolution of tax revenue to states, was more than its gross revenues by 3.3 per cent. In 2017-18, with the abolition of the Planning Commission and the plan grants to states, the situation improved but not enough. The Union’s gross tax revenues — that is, its tax revenues before devolving the states’ share under Finance Commission awards — increased from 10.2 per cent in 2011-12 to 11.2 per cent. With a corresponding decline in non-tax revenue from 1.4 per cent to 1.1 per cent, in 2017-18, the Union’s gross revenue was up 0.7 per cent from 2011-12. Its revenue and capital expenditure were down to 11 per cent and 1.5 per cent, respectively. But in 2017-18, despite the expenditure compression (2.4 per cent) and revenue enhancement (0.7 per cent), the Union government, even before devolving any of its tax revenue to the states, was already in deficit (0.2 per cent)! There are limits to expenditure compression and revenue enhancement is the only way forward.

Once the pandemic is over, there needs to be a concerted fight against the crisis of revenues by both the Union and the states. Hopefully, this will happen, and Finance Comm­i­ssions of the future will not have to struggle to redistribute a large general government deficit between the Union and the states.

The writer is an economist and member of the Fifteenth Finance Commission