Fiscal constraints

India needs to boost tax-to-GDP ratio

The increase in allocation for capital expenditure in the Union Budget has been welcomed across the board. Given that the economy is recovering from a pandemic-induced disruption and the private sector is reluctant to invest because of weak demand, it is expected that capital expenditure by the government will help augment growth and crowd in private investment over time. Higher capital expenditure by the government and improvement in infrastructure will also help increase medium-term potential growth. Although India needs massive investments in infrastructure, the fiscal situation may not allow the government to spend consistently in this area. Even for the next fiscal year, the government intends to increase capital expenditure by suppressing revenue expenditure, which may not be viable. The government has budgeted for an under 1 per cent increase in revenue expenditure, which is not in line with recent history. It is being argued that the government has not made adequate allocations for subsidies and the rural job scheme. Also, the pandemic can impose additional demands on the budget.
 

At the aggregate level, the total government expenditure is budgeted to increase by only about 4.6 per cent when the government expects the economy to grow by 11.1 per cent in nominal terms, which itself is said to be an underestimation. In other words, compared to the current fiscal year, government spending as a percentage of gross domestic product (GDP) will decline next year. This shows the kind of fiscal constraints the government faces. While it did increase allocation for capital expenditure, interest payments on the accumulated debt is also expected to go up by 15 per cent compared to the current year. The outgo on interest payments in the next fiscal year would be 38 per cent higher compared to 2020-21. It would also account for over 48 per cent of the Union government’s net tax revenue. Sustained higher borrowing will add to the interest burden. The central government’s debt stock is expected to increase to 60.2 per cent of GDP by the next fiscal year and would be materially higher than the medium-term target of 40 per cent of GDP. Thus, in order to sustain the expenditure to augment growth and progressively bring down the debt-to-GDP ratio, the government will have to increase the tax-to-GDP ratio. Non-tax revenues can help to some extent but have limitations.

The central government’s gross tax-to-GDP ratio is expected to decline to 10.7 per cent in the next fiscal year compared to the level of 10.8 per cent in the current year. The ratio has largely been stagnant over the years and the Budget has not done anything in this context. It was suggested, for instance, to increase tax on capital gains along with rationalisation of exemptions and deductions in the area of personal income tax. The underperformance of the goods and services tax over the years has also affected tax collection. Although the collection has improved, the issue of rate rationalisation remains unaddressed. With the general government debt hovering at about 90 per cent of GDP, without a significant increase in tax-to-GDP ratio, government finances would remain under stress and impede growth. Thus, both the direct and indirect tax systems need comprehensive review. Rationalisation of rates and improvement in compliance will help create the much-needed fiscal space.