Perils of overestimates: Balancing deficit targets with accurate estimates

Is there a sense of déjà vu in the recently released provisional actual numbers for the Union Budget for 2024-25? These numbers were made public at the end of last month. A quick comparison of these provisional actual numbers with the revised estimate (RE) for 2024-25 shows that the problem of revenue overestimation has resurfaced — after a welcome break of four years.

 

Note that the RE of the Union Budget for a financial year is released about two months before that year ends. This release coincides with the presentation of the following year’s Budget. Thus, the RE of the Budget for 2024-25 was available on February 1, 2025, when the Budget for 2025-26 was presented by Finance Minister Nirmala Sitharaman. Even though the RE is an estimate for the year, it should not vary by a large margin from the provisional actual numbers made available by the end of May later that year. Ideally, an overestimation of revenue collections should be avoided, just as an underestimation of expenditure could cause problems for managing government finances. 

 

Among the Budgets Ms Sitharaman has presented over the past six years, revenue overestimation was a big problem in the Budget for 2019-20, her maiden exercise. The magnitude of this problem was much smaller than what was seen in the previous year’s Budget, but it nevertheless troubled her first Budget. Thus, the actual collection of net tax revenue in 2019-20 (the Covid lockdown was declared only in the third week of March 2020) turned out to be 13.6 per cent lower than what was given out in the RE. With non-tax revenues as per actuals also falling by over 5 per cent over the RE, and with only a marginal change in expenditure, the actual fiscal deficit in 2019-20 widened to 4.6 per cent of gross domestic product (GDP), compared to 3.8 per cent mentioned in the RE. Covid must have been a factor, but the finance ministry’s tendency towards revenue overestimation was equally responsible for the huge variance.

 

Commendable restraint in preparing the RE was shown by Ms Sitharaman and her team at the finance ministry in the following four years. Instead of the problem of revenue overestimation, there was revenue underestimation! The actual numbers in those four years — from 2020-21 to 2023-24 — turned out to be higher than the RE provided earlier. The extent of increase in net tax revenue ranged from 0.13 per cent to over 6 per cent during this period. With expenditure broadly under control, the actual amount of fiscal deficit was lower than what was given out in the RE for these four years.

 

That trend has changed, as last month’s numbers revealed. The provisional actual number for net tax revenue in 2024-25 was 2.3 per cent lower than the RE. Interestingly, the biggest change was seen in personal income-tax collections, where the provisional actual numbers were about 6 per cent lower than the RE for 2024-25. In the last six years, the share of personal income-tax receipts in gross tax collections has risen from about a fourth to just under a third. Why personal income-tax collections would have to be revised downwards by about ₹74,000 crore in just four months is a cause for concern, and the reasons behind this should be investigated. Was that a blip or does that have a message for the pattern of personal income-tax collections growth that the government can expect in the current financial year?

 

The sharp downward revision in personal income-tax collections for 2024-25 was perhaps one of the main reasons for the government applying the brakes on its revenue expenditure. Against the budget estimate (BE) of ₹37.1 trillion for 2024-25, the RE for revenue expenditure placed it at ₹36.98 trillion. But four months later, the provisional actual number for revenue expenditure last year is placed lower at ₹36.03 trillion.

 

The only silver lining in these changed numbers is an improvement in the quality of expenditure — the provisional actual number for capital expenditure showed a rise, just as that for revenue expenditure was lower. And if the fiscal deficit as a percentage of GDP remained largely unchanged, it was because the nominal size of the Indian economy was revised upwards during this period. As a result, the deficit stayed at 4.8 per cent of GDP.

 

Why should the finance ministry try to keep the changes between the RE and the provisional actual numbers to a minimum? Apart from sending out misleading signals on the state of government finances, large variations force the central ministries to go in for undesirable options. Since the government is committed to the idea of bringing down the fiscal deficit to a targeted level, any overestimation of revenue numbers in the RE forces the central ministries to curtail their expenditure in the final months of the year in a bid to stick to the deficit target. Such last-minute expenditure chopping often leads to fiscally unhealthy outcomes. This may also lead to imaginative expenditure budgeting, resulting in the transfer of spending liabilities to state-owned entities or seeking recourse to off-Budget borrowings — a practice that was ended a few years ago.

 

There is yet another reason why such revenue overestimation should be examined closely. Actual numbers falling short of the revenue mentioned in the RE is also an early sign of weaknesses in the pace of economic activity. The sharp overestimation of revenue in 2019-20 was an indication of slowing economic growth. Similarly, the underestimation of revenue in the RE for the four years from 2020-21 to 2023-24 coincided with a gradual but smart recovery in the pace of GDP growth.

 

India’s economic growth slowed to 6.5 per cent in 2024-25, compared to 9.2 per cent in 2023-24. The resurfacing of the problem of revenue overestimation in the RE for 2024-25 could therefore be a sign of weakening growth impulses in the Indian economy. Shortfalls in provisional actual revenue collections for personal-income tax, excise and Customs, compared to the numbers mentioned in the RE for 2024-25, should be a wake-up call for those managing the Indian economy.

 

With external sector uncertainties rising, the challenges before the Indian economy and government finances will only become more formidable. Moreover, fiscal discipline is not just about meeting deficit targets but also about getting the revenue and expenditure estimates right. To begin with, therefore, government efforts should now be focused on examining the reasons behind the slowing actual revenue collections compared with those in the RE.