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Saturday, Feb 16, 2002

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Taming revenue deficit: The acid test

M. Y. Khan

BRINGING the economy on to a 7-8 per cent growth trajectory and reviving the economy will prove a tough task for Budget 2003. This target would warrant the ruthless direction of resources from undesirable revenue expenditures to capital expenditure. Thus, reducing revenue expenditures would be the acid test for the Government.

The Finance Ministry has been highlighting issues relating to revenue deficit of Union and State governments. According to the latest data available, the gross fiscal deficit of the Centre and State as a proportion of Gross Domestic Product (GDP) has been estimated at 9.4 per cent for 1999-2000 and 9.1 per cent for 2000-01.

Revenue expenditure as a percentage of GDP rose from 11. 6 per cent in 1996-97 to 12.98 per cent in 2000-01 whereas revenue receipts rose from 9.23 per cent of GDP to 9.44 per cent of GDP and non-tax revenue from 2.38 per cent to 2.83 per cent. As such revenue expenditure has shown higher growth than the revenue receipt. Due to this, the revenue gap has been rising. It rose from 2.39 per cent of GDP in 1996-97 to 3.54 per cent in 2000-01.

The revenue deficit at 6.2 per cent in 1999-2000 was estimated to decline to 5.9 per cent in 2000-01. The revenue deficit, which forms nearly 50 per cent of the gross fiscal deficit, has been eating into the Government's borrowed funds. These funds were expected to be utilised for capital formation. Since the borrowed funds are used for current consumption of the government, essential expenditure on investment is deprived of these resources and, as a result, the government's slack investment activity will lead to a fall in its demand for investment goods.

As a matter of fact, there has been a shift in the pattern of aggregate demand from investment to consumption in the government sector, which has slowed gross domestic investment and growth in gross domestic product (GDP). So far these observations are excellent. When we come to solutions and remedies for squeezing the revenue deficit it is generally recommended that there is an "improvement in setting and collection of user charges, extension of user charges to non-merit goods and improvement in the contribution of non-tax revenues and the elimination of the revenue deficit which emerges as the medium term objective. The issue with regard to PSEs is not merely their profit or loss, but also return on investments made by Government to cover the cost of capital after meeting the maintenance cost. The adequacy of return on investment already made by the Government is a key to fiscal empowerment. There are hanging issues relating to the accumulated burden of expenditure commitments on power and other infrastructure sectors such as road, highways, ship ports, airports, railways, shipping and irrigation projects, etc, public enterprises, the financial sector and the carrying costs of food stocks" (Reserve Bank of India Annual Report 2000-01).

These recommendations open up a Pandora's box. The return on investment has been a long drawn issue. The adequacy of return on public sector investment involves pricing government goods and services on a cost plus basis. The question is whether the demand for public sector goods and services such as power, transport, and non-merit goods will match their supply on a cost plus basis. A number of goods and services is subsidised or underpriced and thus an unsustainable demand for them is created. If prices of these goods are raised to earn adequate return, there may be no matching demand.

Even at the existing production capacity, government enterprises may not be able to run operations at full scale. Even services and social goods may not get full demand. The solution lies in increasing productivity and reaching the optimum input-output relationship so that the production cost is lower and the activity efficient. Even the Railways cannot run at full capacity without being subsidised.

These are important issues in a country where the purchasing power of 60 per cent of the population is not adequate even to buy the subsidised foodgrains supplied by the government. Thus, there is a high level of foodstocks in the market and a large segment of population goes without food. So we have not only to produce goods and services in public sector at lower cost but also think of increasing the purchasing power of the low-income.

According to an NCAER-SEBI Survey of Indian Investors, 43 per cent households earned Rs 2,500 or less per month and another 34 per cent Rs 2,500-5,000. Thus, considering an average of five persons to a household, a very large number of people exist on very low per capita income. Policy changes cannot be made without augmenting effective demand, or making public sector enterprises profitable so that the government's non-tax revenue is increased.

The second question relates to the method of costing the government sector's goods and services. The cost-plus method used for pricing goods and services is not rational because it does not take into account the optimum-cost-component aspect. The cost includes, in the case of government goods, much inefficiency, cost over-runs and the absence of optimum input-output relationship. Consequently, costs are generally higher.

The users of government services and consumers of public sector goods may be subsidising such excess costs. So raising the prices of government services and goods will be an injustice to the people unless normative cost compilation practices are adopted for pricing. The pricing methodology has to be rationalised.

Suggestions have been made to reduce the work force of public sector undertakings. If the government is to reach sustainable employment levels, it will have to retire employees offering no value-addition and some productive ones too. Effective demand in India, or elsewhere, is determined by gainful employment and, therefore, retrenchment may affect consumer demand. If they are retrenched under the voluntary retirement scheme, the revenue expenditure of the PSUs will increase which may increase the revenue deficit.

An equally important concern is raised regarding restructuring and arresting the declining trend of the tax-GDP ratio. This ratio has declined from 16 per cent in the late 1980s to 14 per cent in 1999-2000. The RBI Annual Report suggests raising this ratio by the expanding of the tax base. However, no thought has gone into the efficiency in the cost of collection of taxes. There is a big gap between the desired and the actual collection of taxes due to defaults and tax evasions. Much of the unorganised sector also goes untaxed. This sector, which includes agriculture, generates more than 50 per cent of GDP. There is scope to widen the tax net to cover this sector.

There are other ways of reducing the revenue expenditure. The government's administrative expenditure can be cut by controlling the growth of legislative Assemblies, limiting the perks' of legislative members and checking the default on the repayment of their various dues. The government has been pumping money to revive the health of weak public sector banks without attributing responsibility to those responsible for the institutions' sorry states. Auctioning the properties of big defaulters would result in the Government getting more revenues. Export subsidies and the costs of buffer stocks of foodgrains should also be lowered. Only specific programmes should be allowed subsidies and excess of foodgrains should be depleted by resorting to programmes such as food-for-work to create genuine and real assets such as improved infrastructure and the development of government land to make it cultivable and marketable. This will create savings in interest costs relating to the financing of buffer stocks and more non-tax revenue by selling newly-developed marketable lands. Toll taxes can also be levied on the new roads or projects built under the food-for-work programmes.

Economy in cost of collection of taxes is also an issue that has to be considered seriously. The cost of tax collection should not form a high proportion of total collection. Further, collection from taxpayers with incomes of Rs 5 lakh should be assessed on the basis of a declaration and can be finalised automatically. For those with incomes of above Rs 5 lakh, follow-up in details and compliance should be strict and speedy so that the payment of taxes becomes faster. Thus, there should be an increase in the number of taxpayers, administrative costs should not be allowed to rise, and the Government needs to have sufficient will to cut revenue expenditures.

(The author is Economic Advisor to the Securities and Exchange Board of India. The views expressed are personal.)

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