Trends in Indian Public Finance 2016

The Economic survey concomitantly admonishes the previous UPA government for its generous tax policy. While citing that number of taxpayers is key indicator of fiscal capacity, the survey says that the country could have gained as many as 1.65 Lakh additional tax payers if the UPA government had kept the threshold at 1.5 Lakh in 2012-13. This would have resulted in additional tax collection of Rs. 31500 crore; and this would have raised India’s tax-GDP ratio by 0.32%.

Trends in Tax-GDP Ratio

India is very far from being a full tax-paying democracy. The survey notes that only 5.5% of earning people in India pay tax while only 15.5% of the Net National Income is reported to the tax authorities. Further, only 4% of India’s voters are tax payers. Ideally, this number should be close to 23%. Due to under-tax compliance and narrow tax net, the tax-to-GDP ratio of the country stands at 16.6%. This is much below the developed countries for example; the tax-GDP ratio in OECD countries is around 34%. We note here that the highest tax-GDP ratio in the world is of Denmark.

It’s worth note that India’s tax-GDP ratio has increased by about 10 percentage points over past six decades from 6 per cent in 1950-51 to 16.6 per cent in 2013-14. In 2010-11, the tax-GDP ratio was around 10%. In five years or so, we find that the tax-GDP ratio has increased by a great margin, but survey still finds it uncomfortable. There are several reasons for low-tax-GDP ratio.

Firstly, as mentioned above, India has a low population of tax payers. Low per capita income, low average income and high poverty are key reasons for this.

Secondly, those who pay tax either pay less due to exemptions or under-report the income. One example is unorganized sector and MSMEs. MSMEs have strong profitability but government is generally not able to capture their earnings in tax revenues due to variety of exemptions, compliance issues etc.

Thirdly, service tax in India was imposed late and imposed only on few sectors. Its share has been traditionally low in gross tax revenues of the government. Currently, services comprise about 60% of the GDP, yet the service tax collected is 15% of the Gross Tax Revenue as shown by below graphics:

Fourthly, the tax collections are always sensitive to growth trends. The corporate taxes are hit by recession, decreasing domestic demand etc.

There are several ways to increase tax-GDP ratio. These include raising the taxes, lowering the tax exemption slabs, imposition of new taxes or cesses or surcharges, boosting the demand etc. Out of these, the easiest method in the hand of the government is to hike taxes. The survey recommendations for increasing tax-GDP ratio are:

• Don’t go with a populist measure of raising tax exemptions limits
• Try to impose some new small taxes or cesses
• Stick on fiscal consolidation path while taking measure to sustain growth

Here, the Survey cautions that the democracies which have higher tax-GDP ratios have taken a lot of time to reach to those figures and it would be wiser to not to reach any harsh judgment of India’s performance because there is much difference between the evolution of Indian economy and economies of those countries.

Trends in Government Expenditure

India is behind many other economies in Government spending. India’s government spending is lowest among BRICS, and lower than the OECD and emerging market economies. They are in fact, lower than those of comparable per-capita GDP economies such as Vietnam, Bolivia and Uzbekistan.

We note here that it is not good to make cross country comparisons because there is a strong relationship between taxing capacity and government spending. India has a low tax-GDP ratio so obviously, government spending will also be low. Government spending is also dependent on level of economic development. Further, survey says that the big increase in public spending in most of the advanced economies we see today happened to crises of extreme magnitude such as world wars and great depression, which led to sharp expansion of the welfare state. Independent India did not suffer any such crises. In this context, the survey notes that:

• To boost public spending, government needs more revenues in the form of taxes. That can be done by increasing tax-GDP ratio.
• Indian elite should pay more taxes to provide for greater spending. There should be more tax imposed on those who are rich and better placed regardless of whether their income comes from industry, services, real estate or even agriculture. The Government should phase-out of the tax exemption raj that benefited the richer private sector.
• The survey also recommends removing tax incentives for small savings, as mostly the rich benefit from them; imposing tax on gold since it is hoarded by the rich; imposing wider property tax in the context of smart cities.

Trends in Fiscal Deficit

Fiscal deficit is the difference between total expenditure and total revenue receipts including recoveries of loans and other receipts.

The UPA government had appointed the Vijay Kelkar committee to chalk out a roadmap for fiscal consolidation. On the basis of recommendations of that committee; the UPA-II government had unveiled a revised fiscal consolidation roadmap in October 2012. It targeted a fiscal deficit of 4.8 per cent of GDP for 2013-14 and through a correction of 0.6 percentage point each year thereafter, a fiscal deficit of 3.0 per cent of GDP in 2016-17. In 2014-15, government was able to contain fiscal deficit at 4.1 per cent of GDP; and the budget 2015-16 sought to contain the fiscal deficit to 3.9 per cent.

In summary, whoever is in power at the centre, they have not diverted the focus from fiscal consolidation path.  The economic survey lauds the efforts of the governments in this direction.

However, for the future, the survey has given a cautious note. It says that containing the fiscal deficit at 3.5% in 2016-17 is a challenging task because of two reasons. First is the increased outgo due to 7th Pay commission and OROP. Second is that global economic slowdown is expected to persist. Again, the government has been advised to improve tax compliance through better tax administration, tapping new resources of government revenue and keep the subsidies in control.

Further, Survey also suggests improving the quality of expenditure. By improving quality of expenditure it means to (1) higher level of capital expenditure on the plan side. (2) Lower level of subsidies (2) enhanced resources to centre {to improve their fiscal performance}. In summary, raising the tax-GDP ratio, enhancing fiscal federalism and furtherance of subsidy reforms are essential for fiscal consolidation.

Trends in Subsidies

Subsidy is one of the major non-plan expenditures that results in Centre’s increased fiscal deficit. In 2013-14, India’s bill for major subsidies was Rs. 2,.47 Lakh crore, which stood at 2.26 per cent of GDP. In 2015-16, this bill stands at Rs. 2.44 Lakh Crore standing at 1.7% of GDP. Since many years, the government’s efforts have been to rationalize the subsidies. Deregulation of petrol and diesel prices and direct benefit transfer of subsidy for domestic LPG, along with a decline in global crude oil prices, helped in containing the petroleum subsidy bill at Rs. 30,000 crore in 2015-16 as against Rs. 57,769 crore in 2014-15. This implies that the efforts of the government are in right direction. The below chart shows the trend in India’s subsidy bill in recent years.

The government’s challenge is two pronged. On one hand, the current government’s intention is to decrease the percentage of the GDP spend on subsidies to 1.6% of GDP by 2017-18. On the other hand, the subsidy leakage has to be curbed by cutting out the loopholes and middlemen using technology.

In 2014-15, the Finance Department had introduced the JAM {Jan-Dhan, Aadhaar, Mobile} trinity as an expanded version of direct transfer of benefits (DBT) program started in 2013. The objective of JAM trinity is to increase poor’s access to benefits while curbing the leakage in subsidies. It combines bank accounts opened through Jan Dhan Yojana, Aadhaar cards and mobile numbers to make sure that the subsidy benefits reach to India’s poor and needy.

Towards more rationalizing the subsidy regime, the Economic Survey 2015-16 has proposed direct transfer of cash subsidies for fertilisers, food as well as the minimum support price paid to farmers to ensure transparency and plug leakage. Apart from proposing a free market for agriculture produce, the survey has also recommended an end to the subsidy on Kerosene. The proposal of direct transfer of fertilizer subsidy on the basis of land cultivation or purchase of fertilizer bags will need some innovative mechanism and also will need to comply with WTO and other international trade obligations.

Trends in Government Debt

The debt of the central government is of two types viz. internal and external. Internal debt is owed to domestic lenders while external debt is owed to external / foreign lenders. Internal debt includes market borrowings in the foam of T-Bills, Government bonds, small savings, provident funds, etc etc.

• Internal debt is that part of the total debt that is owed to lenders within the country. External debts are Rupees/ Foreign currency debts from foreign countries, Financial institutions such as WB, ADB etc. External debt also includes the NRI deposits.

India’s public debt management policy is focussed on long term sustainability. The following table shows the total outstanding liabilities of the Central Government at end of March in five successive years:

Following are important observations from the above table and respective data:

• At the end of March 2015, the central government has total outstanding of Rs. 62.78 Lakh Crore which comes to near half of GDP (49.6%). This means that each Indian has an average liability of Rs. 5698/-.
• Most of India’s public debt (97%) is internal debt. This figure is particularly important because having more fraction of external debt is dangerous to the sovereignty of the nation. Further, we see that the external debt is on declining trend which is good.

Implications of Fiscal Deficit

Prolonged fiscal deficits lead to accumulation of debt beyond levels that are sustainable and can result in higher real and nominal interest rates, slower growth in capital formation and potentially lower rates of output growth. High and rising public debt levels may also impact public finances through debt servicing dynamics that worsen the government’s fiscal position.