The Hindu Business Line : Why not a national fiscal commission?

India faces the challenge of achieving fiscal sustainability within a decentralised federal system. In the Budget Estimates, for instance, revenues are generally overstated and expenditures reclassified `conveniently'. For the Fiscal Responsibility and Budget Management Act to succeed, the transparency of the Budget process has to be enhanced by empowering an independent scorekeeper to ensure that the Budget procedure is not distorted, says T. C. A. Ramanujam.

INDIA'S economist-Prime Minister, Dr Manmohan Singh, was unduly pessimistic when he told the Planning Commission that many important targets were not likely to be achieved and that GDP is not even likely to cross the 7 per cent-mark, much less reach the target of 8.1 per cent per annum. GDP growth is a function of Government expenditure, which in turn depends heavily on its ability to raise resources.

No wonder, the Planning Commission has called for raising the tax-GDP ratio, both at the Centre and in the States, to meet the requirements of public expenditure.

The composition of tax revenues at the Centre has changed significantly, with direct tax as a proportion of total tax revenues rising from 19.1 per cent in 1991 to 41.4 per cent in 2003-04, resulting in a corresponding decline in the proportion of indirect tax revenue from 78.4 per cent in 1991 to 57.9 per cent in 2003-04.

At the same time, tax revenue as a percentage of GDP is almost stagnant; in fact, it is declining, the figure being 10.1 per cent in 1991 and 9.2 per cent in 2003-04. This is in spite of the addition of service tax to Government revenue at 0.3 per cent in 2003-04.

Taxable capacity

Is there scope for raising fresh taxes in India when the Centre and the States seem disinclined to go anywhere near agricultural taxation? Even aside from taxing the farm sector, there is a large area to be covered by strengthening the compliance machinery and by universalising the VAT and the general goods and services tax as recommended by Dr Vijay Kelkar.

Prof Indira Rajaraman, RBI Chair Professor at NIPFP, comments: "At present rates of taxation, which are far lower than they were before reform, there continue to remain large areas of non-compliance. With fuller compliance, the taxation system will become more equitable, and revenues will be higher. If the barrier to better compliance is a rate structure that is still too high, lowering rates to the compliance-maximising level will generate higher tax revenues. Whichever way it is looked at, a rise in the tax-GDP ratio is both possible and necessary, for more than just a revenue consideration".

It is not merely the tax-GDP ratio that is crucial to growth. The saving-investment ratio should set us thinking. In the past decade, we have invested an average of 23 per cent of GDP and this saw economic growth of 6 per cent per year in real terms. India is grappling with the fundamental difficulty of solving the riddle of raising the investment rate.

To emulate China's growth, India needs to increase its investment to 30-35 per cent of GDP, and there is little sign it can do that. As the Economist jokes, China's trouble is capital that costs zero, India's is zero capital. Both countries face the same challenge: A failure of financial intermediation. High rates of private savings are not being translated into productive investment. The consequence in India has been under-investment and a big fiscal deficit.

Problem of public debt

Ricardo Hausmann and Catriona Purifield of Harvard University have expressed concern about India's large fiscal imbalances, what with the general government deficit exceeding 10 per cent of GDP and public debt representing about four-and-a-half years of revenue (IMF Working Paper: The Challenge of Fiscal Adjustment in a Democracy: The Case of India, September, 2004-WP/04/168.)

They point out that elsewhere, the magnitude of fiscal imbalances in India would presage a fiscal crisis. Yet, this is not happening. India has a small foreign currency public debt, implying that exchange rate movements per se do not have a significant fiscal impact.

Moreover, the long duration of its domestic debt implies that shocks to the interest rate take a long time in affecting the fiscal deficit. IMF economists warn that complacency on this ground may be misguided. A jump in long-term interest rates caused by the American Fed gradually raising the rates of interest may precipitate difficulties in the banking system.

India's tolerance for debt makes the political system and society as a whole less responsive to debt accumulation. It is in the interest of Government to keep inflation low so that the public is willing to buy debt at a low interest rate. Budget institutions are being reformed in India over the past three years, thanks to the passing of the FRBM Act.

The IMF points out: "The creditability of the FRBM Act would be greatly enhanced if the medium-term fiscal policy statement elaborated a plan of measures that support its annual targets. The statement is candid in saying that most of the planned adjustment will come from an increase in the tax-GDP ratio and correspondingly sets an ambitious target for tax revenue growth".

The problem lies with the Budget estimates. India's track record suggests that the Budget estimates have not been unbiased. Over the past ten years, the actual Central deficit overshot its Budget target by 0.8 per cent of GDP, with nominal overruns in eight years."

Need for National Fiscal Commission

India faces the challenge of achieving fiscal sustainability within a decentralised federal system. As the IMF points out, India is one of the most decentralised countries. Using as a criterion the proportion of general government expenditure spent by the States, only China has a greater degree of decentralisation.

Over the 1990s, State governments in India increased their share of general government spending without taking on additional expenditure responsibilities. However, the States' revenue-raising powers do not match their expenditure responsibilities. The share of total taxes collected by States is low. States do not have the mechanism of the FRBM Act.

Even in respect of the Central Budget estimates, it has been the experience that revenues are generally overstated and expenditures reclassified in an opportunistic manner. This reduces the credibility of the Budget figures. For the FRBM Act to succeed, transparency of the Budget process has to be enhanced by empowering an independent scorekeeper to ensure that the process is not distorted by the strategic use of Budget estimates.

Such an independent body will be empowered to prepare Budget estimates, provide accounting standards and verify the compliance with the FRBM Act and other budgetary rules and targets. The US Government found that the Gramm-Rudman-Hollings Act was subject to abuse and therefore transferred the responsibility for Budget estimates to the Congressional Budget Office.

Creating a similar independent entity within the limits of our Constitution — along the lines of the Electoral Commission, or by expanding the role of existing independent agencies charged with monitoring government funds and assessing policy (like the CAG) — with the function of signing off on the quality of Budget estimates and the appropriateness of its classification may increase the effectiveness of the FRBM Act while making deviations at the time of Budget execution more justifiable.

(The author is a former Chief Commissioner of Income-Tax.)

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