Fiscal constraints – On Capital Expenditure of Government

News: Recently released Union Budget 2022-23 has increased capital expenditure.

Why increasing CAPEX is a significant step?

The economy is recovering from a pandemic-induced disruption, and the private sector is not investing because of weak demand. Hence, increased capital expenditure will help in increasing growth and crowd in private investment. It will also increase medium-term potential growth.

What are the fiscal constraints in front of the government?

First, the fiscal situation may not allow the government to spend consistently. Also, the government has the intention of increasing capital expenditure in the next fiscal year as well, but reducing revenue expenditure for this is not a viable solution.

Two, another issue is that the government has not made adequate allocations for subsidies and the rural job scheme.

Three, the government has budgeted for less than 1 percent increase in revenue, but the total government expenditure is budgeted to increase by only about 4.6 per. On the other hand, the government expects the economy to grow by 11.1 percent in nominal terms. Hence, it is an underestimation which says that government spending as a percentage of gross domestic product (GDP) will decline next year.

Four, the government has increased allocation for capital expenditure, but it has to pay interest payments on the accumulated debt. It will grow up by 15 percent compared to the current year, which will account for over 48 percent of the Union government’s net tax revenue. Further borrowing will add to the interest burden.

Five, the center’s debt is also rising. For instance, it will increase to 60.2 per cent of GDP by the next fiscal year, which is higher than the medium-term target of 40 per cent of GDP. Hence, to sustain the expenditure and bring down the debt-to-GDP ratio, the government will have to increase the tax-to-GDP ratio, but non-tax revenues can only help to some extent.

What is the way forward?

First, the central government’s gross tax-to-GDP ratio is expected to decline to 10.7 percent in the next fiscal year. Hence, the government should increase tax on capital gains along with rationalization of exemptions and deductions in the area of personal income tax to improve the tax to GDP ratio.

Second, address the issue of tax rate rationalization to improve the tax collections under GST.

Third, the government needs to review both the direct and indirect tax systems to improve compliance and increase fiscal space.

Source: This post is based on the article “Fiscal constraints” published in Business Standard on 3^rd Feb 2022.