Fiscal crisis and review of the Constitution

THE LOFTY and fundamental goal in the Constitution to give unto ourselves a democratic republic seems elusive. People are rarely involved in the processes of governance. And, the elected representatives are hardly accountable to the electors. At the same time, people now become aware of events within the country and all over the globe as they happen. And, the Internet will enhance the access to knowledge and information several times easier and faster. The day is not very far when the housewife gets up in the morning, logs into the Internet, keys in her password and registers her views on any subject she likes. In such a context, the political system becomes somewhat dysfunctional. We cannot restrict democratic participation to making a choice between tweedledum and tweedledee once in five years. We need to think afresh on the democratic processes themselves.

Secondly, the nation has failed to realise its full potential and acquire the stature befitting its size. We have fallen way behind, way way behind China, the only other nation of comparable size. Meanwhile, we have perforce to come to terms with the inescapable forces of globalisation and liberalisation. In the context of globalisation, policy choices the nation states can autonomously exercise become severely restricted. What will make a difference between failure and success then is effective management more than the policies. When Mr. Chandrababu Naidu says that he is the CEO of Andhra Pradesh he is not indulging in hyperbole. As we grapple with the forces of globalisation and liberalisation, it is essential that the political and civil service systems throw up professionally competent people as ministers and officials. Amateurism, however well-intentioned, will just not do.

Thirdly, we have failed to provide the basic services expected of a civilised society. There is no safe drinking water for half the population. Sanitation and sewerage facilities are hard to come by. Garbage accumulates all around us. Roads are full of potholes. A functioning public lighting system is the exception rather than the rule. This sad state of affairs can be traced to the fiscal crisis on hand.

So, whether the Constitution has failed us or we have failed the Constitution the fact of the matter is that as a nation we have failed to meet the aspirations of the people. There is need for introspection and dispassionate analysis of what needs to be done to equip ourselves to meet the challenges of the future.

Revenue deficit

Since I am some kind of an expert on public finance, people keep asking whether it is true that the Union and State Governments have become bankrupt. My reply is it depends on how you define bankruptcy. When the Government speaks of fiscal deficit it is referring to deficit after taking credit for all its borrowings. The real test of bankruptcy, in my view, is the extent of revenue deficit, that is, the extent to which current expenditure exceeds the current revenues. In the case of the Andhra Pradesh Government, for example, the so-called fiscal deficit is only of the order of Rs. 200 crores; but the revenue deficit is more than Rs. 2000 crores. Thus, the Government is borrowing Rs. 2000 crores at an interest rate of 11 to 12 per cent to meet its current expenditure in excess of its current revenues. And, it is doing this year after year. This is the case with all the other State Governments and the Union Government.

The revenue deficits have now reached such proportions that they cannot be camouflaged anymore. Any amount of economic theorising cannot ignore the reality that if we borrow to meet current expenditure year after year, the interest burden will mount and consume a greater and greater proportion of the current revenues.

In the Constitution, Article 112 in the case of the Union and Article 202 in the case of the States make it mandatory for the Executive to present to the legislature an annual financial statement (popularly known as Budget) in respect of each financial year. The Budget should give the projected revenues and expenditure for the forthcoming financial year. This is to secure legislative approval for the levy of taxes as well as the incurring of expenditure. This legislative control of public purse is a basic feature of any democracy and hence of our Constitution.

Articles 112 and 202 further state that the estimates of expenditure should distinguish expenditure on revenue account from other expenditure. The intention clearly was that revenue expenditure should be met from current revenues. The Constitution makers, perhaps, never imagined that we would suffer from selective amnesia in working the Constitution; otherwise they would have made their intention more explicit and binding. The obvious remedy now is to amend Articles 112 and 202 to stipulate that the total of revenue expenditure in the annual budget shall not exceed total revenues.

Let me hasten to add that the responsibility for fiscal profligacy cannot be laid wholly at the door of the elected representatives. Civil servants and professional economists who have been rationalising it are equally responsible. Side-stepping the capital-revenue classification of expenditure envisaged in the Constitution, they have evolved what is called Plan-nonPlan classification. Plan expenditure has come to be invested with a certain halo even if it happens to be revenue expenditure and hence justified even when the aggregate revenue expenditure exceeds the current revenues. It is noteworthy that the Planning Commission itself is not a Constitutional body.

Plan-nonPlan classification masks not merely the character of revenue expenditure but also the fact that almost the whole of the Plan expenditure is met from borrowings. When the Central Government gives Plan assistance to the States, bulk of it is by way of repayable loans. Thus, as things stand the Planning Commission approves how much to spend and on what programmes; the Central Government then borrows the money from the market and provides Plan assistance to the States. Consider an alternative scenario where the State Government determines its own expenditure programmes and proceeds to directly borrow from the market. This would make for greater fiscal accountability.

Role of Planning Commission

There is more to the way we have worked the Constitution and the planning process. Article 280 of the Constitution enjoins the appointment of Finance Commission to make recommendations on the distribution of tax revenues between the Union and the States. This was a wholesome provision. If all the tax revenues and all the revenue expenditure to be met therefrom came under the purview of this quasi-judicial body, as was originally intended, maybe, just maybe, there was some chance that the fiscal crisis would have been nipped in the bud. This was not to be. The Finance Commission has been confined to nonPlan revenue expenditure and Plan expenditure on revenue account came under the purview of the Planning Commission. We started burning the candle at both ends.

Further, the Planning Commission has come to play a much greater role in Centre-State financial relations. Statutory transfers envisaged in the Constitution have become secondary to the far more discretionary transfer of resources. This has had its own adverse impact on the Centre-State relations and, indeed, on the working of the political system.

I am not against planning. I have been part of the system and have personally tried my best to make it succeed. I am also fully conscious that, in developing countries, unleashing the market forces without let or hindrance could lead to wastage, inefficiency, and exploitation of the weak. But, for planning to succeed we require a higher order of all round discipline including, and especially, financial and fiscal discipline. We ended up in having less discipline. My point is that a carefully worked out scheme in the Constitution was given the go-by without providing for an alternative scheme of financial discipline.

Clearly, the role of the Planning Commission needs to be re- appraised not only from the point of view of the fiscal crisis but also in the context of the Centre-State relations on the one hand and the emerging trends of globalisation and liberalisation on the other. The Planning Commission and the corresponding Planning Boards at the State level should not concern themselves with the minutiae of allocating the budgetary resources of governments or with any other executive decision for that matter. Their roles, which should remain advisory, should encompass the way the economy as a whole is functioning. These bodies should recommend the directions in which the economy needs to be progressed at the macro and sector level. They should fearlessly comment on the efficiency with which capital as well as the real resources in the economy are being deployed. They should review and comment on the Union and State Budgets but after their presentation. They should also independently publish all statistics relating to the performance of the economy.

Ignoring the fiscal discipline implied in Articles 112 and 202 relating to government budgets and bypassing the Finance Commission created under Article 280 in respect of Plan expenditure on revenue account were thus two contributing factors to the current fiscal crisis. A third factor is the way the Constitutional provisions relating to distribution of functions between the Union and States have been worked in practice. A fourth factor is the way sources of tax revenue are assigned to the Union and the States in the Constitution itself.

Division of powers

The legislative powers of the Union and the States are described in Articles 245 to 255 and the related Seventh Schedule of the Constitution. List I of the Seventh Schedule, called the Union List, describes the subjects on which Parliament has the exclusive right to legislate. List II, called the State List, similarly describes the subjects on which State legislatures have the exclusive right. On the subjects incorporated in List III, called the Concurrent List, both the Union and State legislatures can legislate.

A major concern of the Constitution makers was to prevent the emergence of centrifugal forces. They had thus made a provision in Article 249 enabling Parliament to legislate even on a State subject provided the Upper House, the Rajya Sabha, passed a resolution to that effect with two-thirds majority. Further, if there be any inconsistency between the laws passed by the Union and State legislatures, the Union legislation would prevail.

The Constitutional scheme is thus simple and sound insofar as it relates to legislation per se. But, these provisions have been deemed sufficient to permit the Union Government to initiate expenditure programmes on subjects incorporated in the State List. Legislation incorporating policies with a wider national perspective is one thing; but public expenditure programmes must conform to sound principles of efficiency and accountability.

As a rule, the farther away the executing agency from the authority allocating resources to the programme the greater the scope for inefficiency, wastage, and, let us face it, leakage of funds. In addition, there are, what I have termed as, `transmission costs' in the implementation of programmes through multiple layers of administration. Take drinking water supply. If a programme is taken up by the Union Government for implementation in all villages imagine the number of officials that would be involved in the Union Government, the State Government, the district administration and so on. Imagine whether each village would ever come to know how much money is allocated to it. Imagine the amount of time it takes for the funds to reach the village. Imagine how difficult it is for the official sitting in New Delhi to satisfy himself that the funds released are truly and properly spent in each village on providing drinking water.

We now have enough experience of how these things have worked over the last 50 years. Let us benefit from it and make such changes as may be necessary. The suggestion I have is that the Union Government should normally incur public expenditure only on subjects incorporated in the Union List. For initiating an expenditure programme on any subject incorporated in the other two lists, it should follow a procedure similar to the one incorporated in Article 249 and obtain the prior approval of the Rajya Sabha with two-thirds majority. Such an approval should carry a `sunset' provision with it, that is, the programme would stand terminated after specified period of time, say, five years, unless fresh approval is granted meanwhile. If this simple procedure is followed in respect of all the Centrally-sponsored programmes currently being implemented it will be a significant step in addressing the fiscal crisis.

Tax sources

In a democratic setup, taxes are levied with the sanction of elected representatives; expenditure is also incurred with their approval. If the same legislative body authorises both taxing and spending there would be greater fiscal responsibility and accountability. However, in some cases it may be more administratively convenient for the Union Government to levy and collect a tax but the revenues thus collected may appropriately be spent on programmes undertaken by the State Governments. In such a situation, what needs to be ensured to enforce fiscal responsibility is that the assignment of tax revenues so collected should be non-discretionary and, even more important, should be done in a manner that it does not entail expectations of larger and larger share in future years.

The Constitution makers erred on the side of caution in assigning to the Union sources of taxation with greater elasticity than those assigned to the States, as they believed that a financially strong Union was necessary to ignite the development process after Independence. They, however, provided for elaborate mechanisms for distribution of revenues between the Union and the States in Articles 264 to 290.

This is a very complex subject and I shall restrict myself to making one or two general points on tax policy. The revenue yield from a tax depends primarily on the tax base and, then, on the tax rate. If the tax base is very wide, significant revenues can be garnered through low tax rates. And, low tax rates encourage voluntary compliance. If the tax base is narrow, we have to impose high rates of tax to collect the same amount of revenue. And, high tax rates encourage tax evasion. As we all know significant tax evasion is partly responsible for the present fiscal crisis, apart from eroding the ethical foundations of society. The fiscal crisis can thus be addressed if greater reliance is placed on taxes with wide tax base. The widest tax base we can conceive of is to include all incomes accruing to all the citizens in the country. A universal income tax without exception and without exemption is thus an ideal form of taxation.

One does not have to be a student of economics to appreciate that the total spending of all the citizens will be equal to the total of their incomes less the amounts saved by them. At the same time, the total spending by all the citizens will also be equal to the total value of goods and services sold to them. Thus, in the aggregate, a tax on the value of all goods and services sold has the same wide tax base as a tax on all incomes. In terms of who bears the tax burden, however, the two are different.The burden of income tax would be related to income. The rich and the poor could pay the same proportion of income as tax. Tax on goods and services would get added to the price of each; the resultant cost of goods and services would be the same for all. The poor and the rich would pay the same price for any item or service they both buy which means that the poor pay a greater proportion of their income as tax when taxes are levied on goods and services.

Unrotunately, we are not utilising the more desirable income tax as a source of revenue as much as we should. Item 82 of the Union List assigns taxes on income other than agricultural income to the Union. This tax is distinct and separate from the corporation tax mentioned in Item 85 of the Union List. The proceeds of the income tax are shared between the Union and the States under Article 270. Item 46 of the State List assigns taxes on agricultural income to the States but no State has thus far levied such a tax except on plantation income. If agricultural income is not taxed, it is not as if those with agricultural incomes are escaping tax. Perhaps, they are paying a greater proportion of their income through indirect taxes. This is an unsatisfactory arrangement.

Single tax on all incomes

My suggestion to remedy the situation and address the fiscal crisis is to levy a single tax on all incomes, both agricultural and non-agricultural, but assign the whole of the resultant tax revenue to the States. This procedure is currently adopted in respect of certain other duties and taxes under Article 269 of the Constitution. A universal income tax without exception and without exemption would ensure that the leakage of tax revenue is kept to the minimum and provide the maximum buoyancy to the resources of the State Governments. Surely, we cannot have two mutually exclusive sectors in the economy, one agricultural and the other non-agricultural, even in the new millennium.

K. S. SASTRY

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