The Hindu Business Line : Rising deficit demands attack on revenue spending

The ballooning deficit is a cause for serious concern that is nullifying the buoyancy in tax collections. This requires a quick, multi-pronged response to curb revenue expenditure. Besides widening the tax base, it may also be a good time for the Government to look at downsizing the executive and the legislature.

Fiscal policy has played a great role in assisting the economic growth. Fiscal tightening, by reducing non-developmental expenditure, produces a positive growth effect. Therefore, there is a negative relationship between fiscal deficit and growth. Encouraged by this hypothesis, Budget 2006 set a fiscal deficit target of 3.8 per cent of GDP, and for revenue deficit at 2.1 per cent.

Despite the best attempts by the Government, even these none-too-stringent targets remain unattained. Indeed, in real terms, the revenue deficit rose to Rs 69,277 crore in April-September 2006 compared to Rs 65,000 crore during corresponding previous period. The same was the case with the gross fiscal deficit, the figures being, respectively, Rs 86,461 crore and Rs 83,843 crore. The rising revenue expenditure — mainly, interest payments, food and fertiliser subsidies and defence spending — has nullified the buoyancy in tax collections. Grants to States also worsened the Centre's finances this fiscal. Interest payments took away nearly 36 per cent of non-developmental expenditure; this can be reduced only by containing the borrowing of Union government.

The Government has to post-haste drastically cut non-developmental expenditures that have reached a level of 70 per cent of total estimated expenditure for 2006-07 compared to 57 per cent in 2000-01. There is also a need to broaden tax base and increase in the tax rates on conspicuous consumption, such as luxury goods and entertainment services.

The last Budget had estimated tax revenues at Rs 3,27,205 crore or 8.16 per cent of GDP at current market prices (base: 1999-2000). This figure is low and the government must think of raising the tax-GDP ratio to at least 10 per cent. Given the GDP growth of 13.5 per cent at current market prices, (the inflation rate is assumed at 5 per cent and the GDP growth at 8.5 per cent in real terms), the Government can increase the tax revenue by Rs 73,614 crore for this fiscal. This is the least the government must do to reduce fiscal deficit.

If the tax-GDP ratio can be maintained at 10 per cent for 2007-08, tax collections can be augmented by more than Rs 80,000 crore over the amount garnered at a tax-GDP ratio of 8.16 per cent arrived for 2006-07, given a GDP growth of 14 per cent at current market prices (the inflation rate is assumed at 5.5 per cent and GDP growth in real terms at 9 per cent).

The 2007-08 Budget should try to equalise the tax incidence so that each and every one bears equal burden of government finances. It must also be ensured that the tax regime does not lead to a deflationary impact on the economy; it must not kill the productive efforts in the economy.

The incomes of certain groups, particularly the less privileged and the senior citizens, should not be unduly affected, especially in the absence of a robust social-security system. The equity and justice principle cannot be thrown to the wind in pursuit of funds for growth.

There is room to bring a number of economic activities into the tax bracket particularly in the rural areas, for instance, such activities as dairy farming or handicrafts. The Government must also think of introducing agriculture income-tax on cash crops where the annual earnings exceed Rs 1 lakh. Subsidies on production, investment and exports should be removed once these activities have reached the viability threshold.

The capital gains exemption on equity shares should be capped at return of 20 per cent per annum on the actual purchase value. Instead of wasting considerable time and energies of collecting taxes from small tax payers, and business establishments, the Government must go after people and business establishments with large incomes who evade tax with professional help; the huge amount of unaccounted income lying with this class must be unearthed and taxed. The Government must also tighten up on indirect tax collection, such as of excise and other duties. Factories are known to indulge in under-reporting production.

Disinvestment of public sector undertakings has all but come to a halt. The Government must get down to selling off at least the loss-making PSUs, to reduce its financial burden.

It is also a good time to look at the size of the government itself, starting from the size of the legislatures. Perhaps, it is time for a cost-benefit analysis of the members of legislatures.

The expenditure on the members, in the form of their upkeep and travels within and outside the country, and on the administration of such large bodies needs to be reduced drastically. Ministry size can also be reduced. The size of the ministries and other government organisations should be consistent with their functions so that the revenue expenditure can be cut down.

(The author is a former Economic Advisor to SEBI.)