The Hindu Business Line : Educational cess: Feasible alternative

IN THE final leg of their political and economic journey (1991-96), the P. V. Narasimha Rao-Manmohan Singh combine made an effort to put a human face on the economic reforms, albeit in a symbolical gesture in keeping with electoral concerns in a pre-election year.

Nine years later, the Congress-led United Progressive Alliance, headed by Dr Manmohan Singh as Prime Minister, is keen to demonstrate that same seriousness right from the start of the new innings, which is set to usher in a shift in the structure of economic policies.

The sharper focus on agriculture and the plight of the rural poor articulated in the Common Minimum Programme (CMP) is a pointer to a `New Deal' for India.

Another crucial component of the CMP is the proposal to levy a cess on all Central taxes to fund public expenditure on primary education. What do principles of public finance say about the funding and provisioning for primary education? The answer is common sense: they should be met by the state via tax revenues. This, in essence, means it should be provided free of cost to the general public, while the cost is appropriately recovered from those segments of the community that are able to pay.

In 1776, the moral philosopher and `Father of Economics', Adam Smith, articulated the rationale for enhanced public investment on education in his Wealth of Nations. "The expenses of the institution for education (are), no doubt, beneficial to the whole society and may, therefore, without injustice be defrayed by the contribution of the whole society".

The central message of Adam Smith revolves around the issue of tax funding of education, placing emphasis on `publicness' of education. This viewpoint was also more forcefully expressed by Alfred Marshall in his Principles of Economics (1890): "... living economists with one consent maintain that such expenditure (on the education of the masses of the people) is a true economy, and that to refuse it is both wrong and bad business from the national point of view."

Expenditure on education

Primary education can be considered a pure public good, as it imparts functional literacy. This literacy is essential, not only for an individual for its intrinsic value, but also to develop a responsible civil society in a democratic country. Thus, given the publicness of the good in question, expenditure on it should be funded primarily from tax revenue.

In 1966, the report of the Education Commission (1964-66) stipulated that 6 per cent of Gross National Product (GNP) should be allocated for education; this was reiterated by the Majumdar Committee in 1999 in the context of making elementary education a fundamental right. But alas, the provision of that vital good — a basic social input — is still not satisfactory. The education sector has been overwhelmingly state-funded, though since the 1980s, the private sector has penetrated all levels of education. For the latter, however, it was always the profit maximisation objective that was paramount, and this has only been on the rise.

The educational expenditure by the government edged up only marginally from 3.84 per cent of GNP in 1990-91 to 4.3 per cent in 2000-01. Of this meagre public expenditure, a little less than one-third, or 1.5 per cent of GNP is spent on primary education. This is the prime reason for the non-attainment of the goal of universal primary education by 1990, as visualised in the New Educational Policy of 1986. The CMP's proposed levy of educational cess on all Central taxes, to mobilise around Rs 6,000 crore to be spent on primary education needs to be examined against this historical backdrop, as it is rife with problems peculiar to the federal context.

Unsuitable tax structure

In a country where a little less than half the population is illiterate and about one-fourth live below the poverty line, the publicness of primary education is well-established. Therefore, a progressive tax structure (which takes away more from those who have the ability to pay) is the appropriate route to fund expenditure on basic necessities such as public education, health, drinking water, roads and sanitation.

The suitability of the tax structure to fund the provision of public goods is debatable for two reasons. One, only a third of the Central tax revenue comes from direct taxes.

The progressivity of direct taxes has been reduced to a great extent during the reforms decade of 1990s; the erosion of progressive character has been further facilitated by a host of exemptions and concessions in the direct taxes. Two, the tax reform measures also further reduced both the number of slabs and tax rates of central excise and Customs duty and made indirect taxes absolutely proportional in character. The entire tax reform exercise has been based on the Laffer Curve logic that a reduction in rates would vastly increase tax compliance and thus enhance tax revenue.

The fallout of tax reform however, was that not only was progressivity of the tax structure lost but hardly was there any tax buoyancy; this is evident from the declining tax-GDP ratio in the 1990s through early 2000, when the economy was said to have grown at an unprecedented rate. Thus, the overall Indian tax system is quite regressive in character.

Further, given the preponderant role played by indirect taxes in our tax collection effort, any attempt to levy educational cess on all Central taxes will only succeed in intensifying the regressivity of the tax structure and, hence, make it unsuitable to fund the provision of basic public goods and services, such as education, health, etc.

Instead, removing a host of exemptions and concessions in direct taxes as well as increasing marginal tax rates on higher tax bases will go a long way not only in augmenting revenue via the direct tax route, but also in providing adequate funds to finance the expansion of primary education.

Besides being regressive in character, the levy of cess might also tempt the State governments (which have mainly indirect tax sources) to resort to a cess of this kind; in which case the overall tax system will become quite unsuitable and lose its relevance and credibility to take care of the growing requisites of an unstable and equal economy.

Many studies on economic reform point out that social sector expenditures have been the first casualty of the downsizing of public sector in the 1990s.

Therefore, more than levying a cess on all Central taxes, a judicious reprioritising of public expenditure — that is, making a welcome shuffle towards goods and services needed by the poor — will facilitate a better flow of funds automatically into the educational and other social sectors, in a properly redirected circular system.

The federal context

The States, more so the local governments, are well-positioned to allocate educational expenditure spatially and also design its structure. As per Article 42 of the Constitution, education was in the State List, but was brought to the Concurrent List by an amendment in 1976. By this encroachment into the States' functions, the Central Government has gained a predominant position in funding education in the country.

This anti-federal spirit is also seen in the educational cess that has been mooted, and it must be noted that it is a non-shareable revenue source for the Centre. As such the Centre shall arbitrarily decide the distribution of revenue from cess across the States, affecting horizontal equity. If the distribution of this revenue is not done taking into account the unequal educational attainments across the States, it will not only affect regional imbalance, but also create horizontal fiscal imbalances.

For instance, if additional financial transfer were made to the States that already spend substantial amounts on primary education, they may resort to revenue substitution and diversion through cutting their tax-effort and/or increasing public spending on other items. Both these would aggravate horizontal fiscal imbalances across States. This is the additional nuisance value of the cess, though it is well-intended.

The alternative

For the effective spread of primary education in the country, the revenue raised through additional resource mobilisation, desirably through enhanced direct tax revenue collection, ought to be given to the States as a conditional grant, leaving the design of educational programmes and pattern of expenditure exclusively to the States.

The conditional grant could stipulate attainment of preconceived targets, such as enrollment, teacher-student ratio and other infrastructure facilities for sustained educational progress.

Thus, to restore sound public finance fundamentals in a developing economy, the educational cess should give way to a well-designed and truly progressive tax structure. A system of non-arbitrary transfer of conditional grants to the States, respecting their functional autonomy in primary education, combined with a reprioritisation of public expenditure, should be put in place. This will ensure the expansion of primary education in the foreseeable future.

(The authors are academicians and can be contacted at sri_ni@vsnl.net)

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