How not to contain the fiscal deficit

India is in a precarious situation. More than eight months into the current fiscal, fiscal deficit is almost breaching the annual target; revenue receipts are not reaching even half the yearly target; and over ₹8 lakh crore are pending in direct tax recoveries. Future steps would demonstrate if the government has a long-term strategy in place for fiscal governance.

High levels of deficit give rise to structural weaknesses and are unsustainable for any economy. They not only cause sharp increases in the debt-GDP ratio, but also adversely affect savings and investment, and consequently growth.

Therefore, containing deficits is important. However, it must be noted that in doing so means are as important as ends. Use of unsuitable means, while providing short-term relief, compromises the ability of a country to develop a long-term fix.

While India has managed to contain deficits to budgeted levels, this has been achieved through incessant cuts in budgeted Plan expenditures, or through generation of non-tax revenues. This strategy is not sustainable.

Diversions of up to 20 per cent on either side as against the budgeted figures for revenue and expenditures have increasingly being noticed in recent years. Private sector investment plans are inextricably linked to priority areas set by the government. As a result of large scale expenditure cuts without really differentiating between important and unimportant sectors, the private sector is forced to alter its investment strategies midway, which is not a healthy sign.

Similarly, using non-tax revenues, in the form of disinvestment receipts and sale of natural resources to make up the shortfall in tax revenues, demonstrates a short-term mindset. Such revenues are not an annual fixture, and they provide a false sense of respite about the government’s ability to meet deficit targets.

India needs a long-term policy on fiscal governance and an independent budget office to aid its implementation.

The policy must have a long-term objective to achieve sustainable levels of deficits by achieving a balance between expenditure and tax revenues, taking into account the unavoidable phases of growth and contraction in the economy.

The objectives must be set up, and periodically reviewed, in accordance with performances of central, state and local-level actors. The policy must prescribe for clear accountability mechanisms, and must not allow diversions from budgeted figures of expenditure and revenue beyond a prescribed ‘safe harbour’.

To augment tax revenues, the policy must set out a time-bound and focused roadmap to realise outstanding revenues. It must undertake a honest assessment of costs incurred in contesting the pending claims; drop the cases in which cost to contest is more than the amount claimed; engage with litigants in relation to other claims; and ensure receipts within a time-bound manner.

The policy must also initiate reforms in the revenue foregone regime. It must revisit unnecessary exemptions, deductions and rebates that do not serve any purpose today, suggest simplification and rationalisation required, and provide a transition path to implement its suggestions within a specified time.

The policy must avoid insalubrious reliance on non-tax revenues and a separate disinvestment strategy must be developed for generating and utilising revenues from sale of assets and natural resources.

The long-term fiscal policy must take into account State-level considerations while setting out broad contours of expenditure planning, implementation, monitoring and evaluation.

It must put in place evidence-based expenditure regime, and the short and medium term plans of the Centre and States must be compliant with the policy. The policy must aim to build capacity of local level actors to facilitate execution, which would also aid in fixing accountability. The policy must make a clear distinction between merit and non-merit subsidies, with a roadmap to gradually reduce the latter.

A successful adoption and implementation of a long-term fiscal policy for India will need to be supported by setting up an independent budget office.

The office should have expert staff to provide research, review and technical support for planning, execution, monitoring and evaluation of short and medium term revenue and expenditure targets.

This would ensure their consonance with the long-term fiscal policy. In line with the fiscal policy, the budget office must aim to build capacity of actors to better understand, develop and implement plans at the central, state and local levels. The advice of the budget office must be guided by ground level experience.

The budget office must coordinate with other central level institutions, such as the NITI Aayog, to take a holistic view in relation to optimal long-term fiscal governance strategy.

Consequently, we must not repeat mistakes of getting enamoured by annual budgetary exercise of setting and meeting deficit targets, which must be nothing but short-term targets in process of achieving the objectives set out by long term fiscal policy. The IBO would aid in development and achievement of such targets.

While a long-term fiscal policy was laid down in 1985-86, the time is ripe now to modify it to suit the current times. A long-term vision for fiscal governance, with clear mid-term targets, aided by an independent budget office to ensure implementation, will make much-needed contribution to revitalise India’s growth story.

The writer is the secretary general of CUTS International. This article is co-authored by senior policy analyst Amol Kulkarni

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