States and the fiscal gridlock

By S. Swaminathan

The overriding concern of Finance Ministers at the Centre, beginning with Dr. Manmohan Singh in 1991 and continuing to this day, with Mr. Yashwant Sinha, has been that of containing the gross fiscal deficit (GFD) as a percentage of the gross domestic product (GDP).

Two demonstrated fallacies in this obsession in fiscal policy have been (1) the decline in public investment in infrastructure and agriculture in real terms and (2) the failure of administrative action in ensuring that the benefits of government spending (and subsidies) actually reached the intended beneficiaries rather than being siphoned off into illicit conduits.

What is even more puzzling about the fiscal policy of the Centre dedicated at least verbally to the mission of bringing down the GFD percentage in terms of GDP is that it virtually overruled the need for fiscal correction at the States level.

Over the years, not only have the GFD of the States remained at high levels (around 4-4.5 per cent of GDP) but the Centre's fiscal predicament itself has been aggravated to a large extent by the inadequacies of additional resources mobilisation initiatives of the State governments not to speak of the rampant inefficiencies and malpractices in tax enforcement, at the State level.

While the aggregate disbursements of State governments had risen from Rs. 266,361 crores in 1998-99 (Accounts) to Rs. 350,767 crores in 2000-01 (Budget Estimates), or by 31.7 per cent, the gross transfer of resources from the Centre (devolution of funds covering share in Central taxes, loans and grants) had increased from Rs. 103,627 crores to Rs. 139,661 crores as per Central budget proposals, or by nearly 35 per cent.

Over the years, the Finance Commissions appear to have acquiesced in the habitual tendency of spendthrift State governments to blame their fiscal deficits on the narrowness of their tax-base (as decreed by the Constitution of India) thereby deflecting attention away from their unwillingness to adopt fiscal prudence.

Fiscal correction no cake-walk

Right from the time when the Narasimha Rao Government embarked upon economic reforms in 1991, the mantra chanted by the policymakers for fiscal correction emphasised containment of non- Plan expenditure and reduction of market borrowing on an almost dogmatic presumption that when once government borrowing from the market came down, investments by the private sector would boom both because of the availability of capital and the easing of interest rates.

A complementary prescription was that of lowering of tax rates for the purpose of stimulating revenue buoyancy on the model of the famous ``Laffer curve.'' Now from hindsight, it is obvious that what is fiscal correction according to the so-called Washington Consensus could actually result in investment inertia and economic stagnation. Dr. Manmohan Singh, the former Finance Minister, has a greater claim to know how the route to fiscal correction does not lie in mere reduction in public expenditure.

Speaking at Bangalore on Wednesday at a conference on ``Public Finance in Indian States'', he is reported to have cautioned that any hidebound reduction in public expenditure in the country, from the current level of about 32 per cent of the GDP (with the States accounting for about 16.5 per cent), would be counter- productive and perhaps would have disruptive consequences for the social sector. It is another matter that public expenditure in many States on education, health and social services, is conspicuously misdirected and is at unacceptable levels of cost- effectiveness.

If compression of public expenditure does not hold the key to fiscal correction, what should the States do? Dr. Singh has, of course, argued for the ``primordial'' strategy of stricter prioritisation of expenditure, at the State level involving ``removal of implicit and explicit subsidies which have not served any social purpose''.

This is the rub. Every form of subsidy ranging from food to public transport has its own social justification and political advocacy no matter what its cost-benefit analysis would show. Dr. Singh is not unaware of the political trappings of the subsidy syndrome. To expect the State governments to extricate themselves from the utter folly of subsidised power for well-to-do farmers or of low-cost higher education for people regardless of their income status is to believe that politicians, at the State level, are more conscientious about tax-payers' money than their counterparts at the Centre!

Two obvious areas for reform

While, at the level of the Centre, subsidies are largely accounted for in explicit expenditure, at the level of the States, the picture is quite hazy with the major part of subsidies concealed in the budget through grants and subventions to State electricity boards, public transport undertakings and various institutions providing a range of socio-economic services. The point is that any reform with reference to subsidies would first call for greater transparency of the budgeting process. The concept of recovery of ``user charges'' based on true costs is often bandied about but is rarely incorporated in financial statements of governments.

The second major area of reforms - often talked about but rarely ``taking off'' - is the re-engineering of State governments in terms of the new realities of an economic policy which dictates that government expenditure must be driven by the ``felt needs'' of the poorer sections of the community rather than be allowed to be appropriated by the relatively better-off sections.

This is the challenge for State fiscal policy, which would operate, both for generation of revenue and for prioritisation of expenditure. Reforms in the power sector must thus be seen not in the mere context of who owns the generating plants and the transmission and distribution systems, but rather in terms of how to generate sufficient resources from within, to augment capacity and to enhance efficiency. And so with the chronically inefficient systems of public transport. If parallel private fleets have already proved their economic viability and social utility, why should State governments continue to swear by the ``nationalisation'' gospel?

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