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Budget deficits: cure or curse?

It has become necessary to restate the basic steps of a sound fiscal strategy

LACK OF public awareness or apathy regarding fiscal issues witnessed in India is a matter of concern. Public finance does not get adequate recognition even in economics and commerce syllabus in universities. This is regrettable as informed public opinion can play a useful role in the difficult task of evolving a sound fiscal system and insulating government budgets against populist pressures. In this context budget deficits merit public discussion.

When a government spends more than its revenue it runs a deficit. The gap is financed by borrowing which increases public debt. The role and functions of government have undergone radical change _ from law and order to welfare. Government spending, even if financed by borrowing, is considered necessary in some circumstances. In developed economies, during periods of depression or economic downturn, deficit financing is resorted to to stimulate recovery. In developing countries it is justified on the grounds that the range of problems facing them requires active government spending in fields such as social services and infrastructure and for promoting equitable growth.

Lag in fiscal reforms

In India, while economic reforms initiated in the early 1990s are proceeding well, fiscal reforms have lagged behind. Mounting budget deficits raised doubts on governments' ability to manage them in the future. Legislative support was considered necessary to tackle the problem. A historic law was enacted by the Central government. The Fiscal Responsibility and Budget Management Act 2003 (FRBM) lays down that revenue deficit should be eliminated and fiscal deficit brought down to 3 per cent of Gross Domestic Product by 2008-09. Revenue deficit arises when non-capital expenditure exceeds normal government revenue. Fiscal deficit is the gap between total expenditure including capital expenditure and total receipts including capital receipts.

Budget deficits are now a fact of fiscal life. The risk here is that borrowed funds may be used for non-priority and unproductive expenditure. This will fuel inflation and reduce funds for critical public and private investment.

Two questions that arise in this context are: Are the deficits being used to spur economic growth? Is the FRBM Act being implemented properly? The initial experience in this regard has not been encouraging. Important issues of fiscal policy and management are not being addressed. Deficit targets set in the Act are sought to be met through buoyancy of revenues from economic growth and not through improved efficiency in revenue collection or expenditure management. Legitimate charges on the budget are kept out of it. Achieving statutory deficit targets by whatever means including window dressing has become an end in itself. It is therefore necessary to restate the basic steps of a sound fiscal strategy to make deficit financing a tool for economic growth.

The first step in deficit management is to show the true deficit in the budget. For example, the budget is insulated from the effects of oil price increases by issuing special oil bonds to the oil companies to cover partly under recoveries of cooking gas and kerosene subsidies payable by the Government (Rs 73,500 crore in 2006-07 and Rs 40,000 crore in 2005-06) and these are not shown as expenditure in the budget. The cost of debt swap is another example. It has been shifted to the National Small Savings Fund which is now in the red. All special bonds, special purpose vehicles and off budget expenditures need to be reviewed and reflected fully in the budget so that the real deficit is addressed.

The Government should collect all tax and non-tax revenue arrears. Huge amounts were pending collection as revealed for the first time under the FRBM Act. Tax arrears stood at Rs. 1,11,107 crore at the end of 2004-05 and non- tax arrears at Rs. 45,890 crore (more than half the budget estimate of total revenue for 2006-07). The latest figures may be higher. Under non-tax arrears, Rs. 24,694 crore were overdue interest from public sector undertakings on loans taken from the Government (figures of principal default may also be substantial).

The next step is to review and eliminate unjustified and outdated tax exemptions. The amount forgone was estimated at Rs. 1, 58, 661crore at the end of 2004-05. This has to be updated and reviewed. Also, this should be treated as tax expenditure for better focus and control by Parliament.

Expenditure review

On the expenditure side, the Government should take the difficult but necessary decisions and follow up action. It should review all schemes, projects and activities to cut down non-priority, unproductive and non-development expenditure. Elimination of revenue deficit should not be done by indiscriminate cutting of revenue and non-plan expenditure. For example, maintenance of assets and running costs of health and education facilities should not be cut. The assumption that all capital expenditure is priority is not valid and needs review, especially non-plan capital expenditure (Rs. 46,833 crore in 2006-07).

Major schemes initiated such as employment guarantee, compulsory education, rural and urban infrastructure, and agriculture should be funded fully.

The cost of providing services should be reduced. One example is subsidies whose burden is sought to be cut by price increase and other means and not by more efficient and less costly services and goods.

Staff strength should be reduced and activities outsourced. This gains relevance especially as the Sixth Pay Commission is being set up. The last Commission was a fiscal disaster.

Steps should be taken to reduce the reliance of public sector undertakings on the government budget and increase their contributions to the general revenue. The dependence of the Railways on general budget should be minimized and the cross subsidy of passenger fares by freight eliminated.

Finally, a medium term plan of deficit elimination / reduction should be published with supporting figures specifically reflecting the revenue and expenditure concerns mentioned above for public debate.

An odd U.S. budget procedure

WHILE ON a visit to New Jersey (U.S.) recently, this writer was intrigued by a report dated July 6 in New York Times under the caption "New Jersey Shuts Down''. The state government had shut down non-essential services and furloughed 45,000 employees. State beaches and parks were closed as also Motor Vehicle Commission offices, the state lottery, courts, racetracks and casinos. The impasse cost the state millions of dollars.

As an ex-budget officer to the Government of India, this writer was all the more surprised to find that the reason behind this situation was the confrontation between the legislature (the Speaker) and the executive (the Governor) over a budget proposal.

There was no agreement by July 1, the start of the new financial year, on the Governor's proposal to raise state sales tax to help close the budget deficit.

This made this writer realise how fortunate Indians have been to avoid such a situation thanks to some sound budget practices. Our financial year is from April 1 to March 31. The executive submits the budget proposals to the legislature at least a month before the fiscal year begins. A full discussion and legislative approval will take time.

Meanwhile routine functions of government have to continue. This is done through a "Vote on Account'' as provided for in our Constitution. The legislature approves expenditure on running the government pending passing of the entire budget proposals. Normally this is given for two months and longer in unusual circumstances as during election times. However, the expenditure covered is only on ongoing activities and schemes and no new item is included.

Another anomaly highlighted by the New Jersey impasse is the difference in fiscal year of the state (July-June) and the federal government (October-September). In India, the Centre and State governments have the same fiscal year. This has obvious advantages. Overall fiscal policy and budget deficit planning for the whole economy is facilitated. Transfer of resources to States from the Central government can be planned more rationally.

Comparison of fiscal data and performance can be done more effectively. It is true our fiscal problems are fundamental and we are struggling with the intractable budget deficit management. But it is at least a minor satisfaction that our governments do not grind to a halt due to lack of elementary commonsense in budget procedures.

A. RANGACHARI

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