<b>Rathin Roy:</b> Numbers need to back the politics better

Enhanced tax devolution moderated to maintain resource allocation for central priorities


Rathin Roy
I looked for answers to three important questions in Budget 2015. First: how would the increased devolution to the states recommended by the 14th Finance Commission (FFC) impact the finances of the central and state governments?

Second: would the government adopt a fiscal stance that met the national commitment to fiscal consolidation while addressing the declared policy imperative of raising public investment?
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Third: would this Budget deliver the coherence and credibility required for a $3-trillion-plus economy?

The answer to the first question is clear from the fiscal arithmetic, expressed as percentages of GDP. Comparing the 2015-16 Budget estimates with the 2014-15 revised estimates, the government has reduced total expenditure by 0.7 per cent while increasing central Plan expenditure by 0.35 per cent. Expenditure reduction has been achieved by reducing total non-Plan expenditure by 0.35 per cent and reducing total central assistance for state Plans by 0.75 per cent. Central contributions to four major legacy flagship schemes - Mahatma Gandhi National Rural Employment Guarantee Act, Sarva Shiksha Abhiyan, Integrated Child Development Services and National Health Mission - have been reduced by 0.14 percent. Thus, states have had to "pay" for the generous increase in the devolution. Did they pay more than they receive? Not quite. The state's share in tax revenues has risen by 1.05 per cent of GDP. The net gain to states is, therefore, 0.3 per cent of GDP.

This, while positive, it is less than the increase in the central Plan outlays. Thus, a lot of the generosity shown by the government in accepting the enhanced tax devolution has been reclaimed in this Budget to maintain resource allocation for central priorities.

On the revenue front, the FFC assumed that tax revenues would be slightly less than forecasted in the 2014-15 Budget. However, revenues have fallen considerably in the revised estimate, by 0.9 per cent of GDP. As a consequence, states' share in the divisible pool is 2.67 per cent against a forecast of three per cent of GDP. With the new devolution, states' share is forecasted to increase to 3.7 per cent as opposed to 3.97 per cent forecast by the FFC. Thus, states will also lose from a lower total tax collection compared with what they could have expected from the FFC award. This situation will not change in 2016-17 since the medium term fiscal policy statement (MTFP) predicts gross tax revenues to be 10.5 per cent and 10.7 per cent respectively as opposed to 10.9 per cent and 11 per cent forecast by the FFC.

I felt that the FFC estimates of the potential for raising tax revenue were unduly pessimistic. I find the Centre to be even more pessimistic about our revenue buoyancy, notwithstanding all the optimistic talk about future economic growth.

I also find it as free with tax expenditures as the previous regime. For example, the Budget announced the government's intention to streamline exemptions and reduce corporate tax rates, which is excellent. But these announcements will not be credible unless backed by demonstrable actions - there are 32 incentives to corporate taxpayers in 2014-15, and their combined revenue impact is eight per cent higher than the previous year.

This leads neatly to my second question about the government's fiscal stance. The government needs to be congratulated for meeting its fiscal and revenue targets in 2014-15. However, it seems to have fallen prey to the temptation that cost previous regimes dearly: to postpone fiscal consolidation to the next year. This would be understandable if countercyclical fiscal measures were required; but if future growth prospects are as optimistic as the government has projected in this Budget, then the logic for being lax on fiscal consolidation escapes me.

The MTFP says that "with economy poised for cyclical upturn ... public spending needs to be stepped up ... in core sectors to tap the growth potential". In 2014-15, the fiscal space for public investment - the difference between the fiscal and revenue deficits - was 1.2 per cent of GDP. The projected 2015-16 fiscal deficit is 3.9 per cent and revenue deficit is 2.8 per cent, leaving 1.1 per cent as fiscal space for public investment - which is exactly the figure for 2016-17. In 2017-18, things get worse - the fiscal space for public investment shrinks to one per cent of GDP!

This does not bode well for the answer to my question about coherence and credibility. In my view, the Budget continues to reflect strategic incoherence on how to achieve two competing aims: to increase resources devoted to public investment and measures to foster inclusion, while maintaining a stable macro-fiscal framework with sufficient fiscal space for enhancing public investment.

At the root of this incoherence is the lack of an effective strategic policymaking structure within the government, which is reflected in the fragmented institutional structure and business processes of the finance ministry. Without reforms on this front, the government will not be able to deliver more effective transparent and predictable fiscal policies.

Yet (or perhaps despite this) it must be acknowledged that this Budget reflects a strong sense of political will and urgency. It is remarkably coherent in specifying the aims of specific public investment proposals. For the first time, it specifies the principles under which different changes have been made in tax laws, rates and exemptions. Annexures to the Budget documents specify precisely how different central initiatives are impacted by reductions in central assistance to states. It has also announced a series of important time-bound reforms that will make doing business in India easier - though a little parsimony in what is covered in the Budget would not go amiss. For instance, the Budget is hardly a place to announce a change in the visas-on-arrival policy.

There are some regrettable omission. There is no evidence that the (unpublished) interim report of the Expenditure Management Commission has made any difference. Some more specificity about long-awaited reforms in direct taxation, and in streamlining the tax administration, would have been welcome. In view of the constitution of the NITI Aayog, this would have been the Budget in which to commence moving to a medium-term budgetary exercise that would replace annual budgeting.

With these caveats, the Budget contains enough evidence of a purposive, reform-minded Centre that is making progress on its desired policy objectives.

The writer is director, National Institute of Public Finance and Policy
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper

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First Published: Feb 28 2015 | 10:47 PM IST

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