States should focus on the quality of public expenditure

News: States were guaranteed bi-monthly compensation for any loss of revenue in the first 5 years of GST implementation from 1 July 2017. The 5-year period will end on 30 June and there is a growing demand from many states to extend the GST compensation mechanism beyond that.

Given this uncertainty over the extension of GST compensation and the possibility of it tapering off at least in the medium term, it is imperative for states to devise strategies towards prudent public expenditure management.

How can states create additional fiscal space?

Additional fiscal space can only be created through two routes:

– either by enhancing both tax and non-tax revenues, or

– by careful expenditure management.

As possibilities for the first route are constrained within the federal system, the second route could be a pragmatic approach.

In this context, getting expenditure priorities right and efficiently utilizing funds is of paramount importance.

The 13th Finance Commission had also suggested that due weightage be given to “the need to improve the quality of public expenditure to obtain better outputs and outcomes” from fiscal transfers.

What is the key constituent of prudent public expenditure management?

An important constituent of the quality of public expenditure is reducing committed expenditures in budgets and focusing on outlays that are “future-” and “growth-oriented”.

– This entails an assessment of the institutional arrangements relevant to the fiscal rules and budgetary procedures in states.

Steps already taken

– As a first step, a system of performance budgeting was introduced to assess performance against set goals/objectives. However, this was not able to establish a clear one-to-one relationship between financial budgets and performance.

– Outcome budgeting was introduced in 2006-07, which also recognized that outlays do not necessarily mean outcomes.

What is the RBI’s triple E framework?

A framework was suggested by the RBI study in 2009. This study proposes a “triple E framework” to assess expenditure quality, which has constituents of expenditure adequacy, effectiveness and efficiency.

– Expenditure adequacy is in terms of focusing on the government’s primary role.

– effectiveness is about assessing performance, and

– efficiency involves an assessment of the output-input ratio.

What are the present trends wrt public expenditure of states?

Present patterns of public expenditure in many states are unlikely to pass the test set out by the RBI study’s ‘triple E’ framework.

Expenditure adequacy: The classic case of new welfarism has been the proliferation of subsidies and freebies. Increased allocations for these have often resulted in inadequate allocations for public goods, and hence, low provisioning levels.

Once expenditure adequacy is undermined with expanded subsidies and freebies, the scope for assessing effectiveness and efficiency gets narrower and is limited to expanding the coverage of such schemes.

Even though freebies and subsidies increase private consumption and could generate growth in the short term, these reduce fiscal space in the long term.

Way forward

States need to rationalize expenditure, which includes reassessing the continued desirability of specific expenditure programmes, such as unbridled subsidy expansion. Such an approach would also help in realizing possible efficiency gains in the provision of public goods and services, and thus create fiscal space.

States need to look beyond GST compensation and adopt a long-term view to manage finances. The long-term solution rests on state efforts at revenue raising, expenditure re-prioritization or rationalization and judicious borrowings.

State finance commissions (SFCs) – In most states, state governments are either apathetic towards the institution of SFCs, or, in certain cases, poor implementers of the recommendations made. For the sake of their own finances, states must change this.

Source: This post is based on the article “States should focus on the quality of public expenditure” published in Livemint on 3rd June 22.