India’s fiscal dilemma

Source– The post is based on the article “India’s fiscal dilemma” published in The Indian Express on 13th February 2023.

Syllabus: GS3- Government budgeting

Relevance– Fiscal situation of economy

News– The recently announced budget provides a good opportunity to study the fiscal situation of the country.

What is the good news for the fiscal scenario of the country?

The fiscal situation has proved resilient to the successive shocks.

Tax collections as a percent of GDP are actually marginally higher than they were in 2018-19. On the spending side, the composition has improved. Capital expenditure has increased from 1.5% of GDP to a budgeted 3.5% of GDP.

Sizable amount of off-budget expenditures were brought back onto the budget.

The fiscal deficit is now on a downward trajectory. It is budgeted to fall to about 6% of GDP next year from a Covid peak of more than 9%.

What are the mixed developments related to the fiscal situation?

Personal income taxes have shown an encouraging rise. But, this is accompanied by increases in exemption limits. It means that taxation is now resting on a narrower base of taxpayers.

The GST’s promise has not yet been realised. The collection ratio has remained essentially the same as it was five years ago. It is because efficiency gains have been offset by repeated reductions in rates.

Furthermore, corporate tax revenues have declined significantly, because tax rates have been reduced.

What are bad signals for the fiscal situation?

There has been a notable increase in expenditures over the past five years. The true increase in expenditure remains substantial, exceeding 1.5%of GDP.

The structural fiscal deficit is budgeted to 6% of GDP next fiscal due to high expenditure.

The large deficits since 2018-19 have necessitated large amounts of borrowing. It has led to an increase in interest obligations. They now absorb nearly half of the centre’s tax revenues.

The second issue is centralisation. The states will receive just 31% of gross tax revenues next fiscal, compared with 37% in 2018-19. This reflects the centre’s increasing use of cesses, which are not shared with the states.

A subtler form of centralisation is taking place on the expenditure side. Non-interest, non-subsidy current expenditure is being compressed by 1% of GDP in 2022-23 and  0.5 % of GDP next year.

The centre is scaling back its transfers to states for various centrally sponsored schemes. Some of the reduction can be justified because it is aimed at forcing the states to improve their efficiency in their spending and managing their funds.

What are the limitations of centralisation for fiscal consolidation?

In an optimistic scenario, Centralisation can lead to improvement in state government efficiency. But,the centre will need to find other ways to reduce the deficit to its target of 4.5% of GDP.

Centralisation may not succeed in improving efficiency. In that case, states would either need to reduce the services provided to their people or increase their borrowing. The overall fiscal position might not improve at all.