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Feasibility aspect in Indian context
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Governments in India, whether at the Centre or in the states, have no strong ideological commitment to fiscal orthodoxy unlike the New Zealand governments of the 1990s, says T. V. Somanathan
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WHILE THERE are debates among economists about how high a fiscal deficit is desirable or sustainable and under what circumstances, there is a broad consensus that the current levels of India's fiscal deficit at both Central and State levels are too high. This is the backdrop to the reported approval of the Union Cabinet of an altered version of the much-debated and long-awaited Fiscal Responsibility and Budget Management Bill. Press reports have suggested that the new Bill will be a `milder' version. This article examines, in the light of international experience, a more fundamental question: is legislation likely to be effective as a cure to India's chronic fiscal malady?
The fundamental question to be answered is whether a fiscally irresponsible government can be restrained and made fiscally responsible by the passing of fiscal responsibility legislation. If the answer is yes, then there is obviously a strong case for it not only at the Central but also at the State level. In answering this question, international experience can provide valuable insights. Two aspects have to be considered. First, in countries which have enacted such legislation and are considered success stories, what was the role played by legislation? Second, if legislation was the key to success in those countries, can the same technique be applied in India?
New Zealand example
Two countries that enacted fiscal responsibility laws and are generally considered exemplars in this respect are New Zealand and the United States. New Zealand was the first to introduce a Fiscal Responsibility Act with that very title. This Act has been hailed by many experts as a model. Indeed from an economist's point of view, it is conceptually and theoretically elegant. However, it is noteworthy that this enactment was passed by a government that gave up control over its central bank, and was already strongly committed to a tight fiscal policy and indeed to all the elements of conservative economic orthodoxy and the "Washington Consensus.''
It is a moot point whether it was the Act that induced the Government to be fiscally responsible or whether the Government already politically committed to fiscal conservatism simply used the Act to declare and achieve its aims. Significantly, the New Zealand law leaves a lot of room for the Government of the day to choose the actual level of fiscal deficits. In the words of the official New Zealand Government publication on the Act which is worth quoting in extenso:
"The definitions of `prudent' level of debt, or risk management, a level of Crown net worth that provides a `buffer against future events' or a `reasonable' degree of predictability are not specified in the legislation. It is left to the Government of the day to interpret the relevant fiscal terms... and to justify those interpretations to Parliament and the public. This is because there is no one level of debt, for example, that could be considered prudent at all times. What may be considered prudent in 1994 is influenced by the prevailing structure of the economy...These and other relevant factors are likely to change over time. The presumption here is that governments should follow these principles. Governments are allowed to depart temporarily from these principles if they wish, and for whatever reasons they like. The legislation requires however that a government specify its reasons for the departure from the principles, how it expects to return to the principles and when. This recognises the difficulty of attempting to anticipate all future events and therefore the need for some short-term policy flexibility, but also requires that departures are transparent and should only be temporary.''
Thus, the Act provides the Government with tremendous flexibility, albeit with a requirement of transparency. But even the transparency is within the Government's discretion: The same document goes on to say that "[t]he Act allows for decisions, circumstances or statements to be withheld from disclosure if that disclosure is likely to prejudice the substantial economic interests of New Zealand, prejudice the security or defence of New Zealand or the international relationships of the New Zealand Government, compromise the Crown in any material way in negotiation, litigation or commercial activity or result in material loss of value to the Crown.'' An Indian civil servant confronted with such legislation would need just five minutes to come up with a plausible justification for deviating from fiscal rectitude or withholding a document.
Attempts in U.S.
In the U.S., the first and very radical legislative attempt to put a ceiling on the deficit and then force the Government to reduce it (the so-called Gramm-Rudman-Hollings Act of the Reagan era) was an abject failure. This was largely because the cuts required to enforce the Act became impractical in the face of unavoidable increases in expenditure on mandatory items like social security. The Act was simply violated and the deficit continued to rise. This gave rise to the Budget Enforcement Act 1990, which does not impose any mandatory deficit target and distinguishes between mandatory expenditure (not subject to ceilings) and discretionary expenditure (subject to detailed and tight ceilings). This law also allows for the effect of the business cycle since there is no ceiling on the deficit itself. In a time of boom, tax revenues increase and the deficit will shrink; in times of recession tax revenues will decline; since there is no change in expenditure ceilings, the deficit will rise.
A study of the literature shows that the Act has been a qualified success and has helped in restraining discretionary government expenditure. Between 1990 and 1999, the U.S. federal government reduced and then completely eliminated its fiscal deficit (although since 2001, it has reappeared). However, the elimination of the deficit cannot wholly or even mainly be attributed to the Act. Indeed the most important factors were President Clinton's deliberate political choice to go in for a tough budget in 1993 and then the sustained increase in tax revenue over the 1990s due to the economic boom. The Act was a `supporting factor' that prevented discretionary spending from rising to match the revenue.
Indian scenario
Turning to India, it is necessary to note some of the contrasts. Governments in India, whether at the Centre or in the states, have no strong ideological commitment to fiscal orthodoxy unlike the New Zealand governments of the 1990s. Without amending the law, governments could simply redefine what is "prudent'' in a liberal way or point to "changes in the business cycle.'' The check exercised by public opinion on a matter as abstract as the fiscal deficit and thus the effect of "transparency,'' is likely to be negligible. Any U.S.-style distinction between `mandatory' and `discretionary' expenditure is also difficult to implement in India: would food subsidy under the Public Distribution System be considered mandatory or discretionary? What about the various employment assurance/food for work programmes? Equivalent schemes (albeit contractual ones) are considered mandatory in the U.S. and not subject to ceilings.
In India's genuinely difficult security situation, a case can be made for excluding defence expenditure from the discretionary category. Then there are accounting changes that an intelligent bureaucracy can make. Staff and their costs can be redeployed from discretionary to mandatory schemes for `unavoidable' increases due to drought, flood, earthquake, insurgency etc. Since some or all of these would be genuine, it will be almost impossible for the CAG or anyone else to decide how far such redeployments are justified.
The U.S. Budget Enforcement Act was a partial success, but this was primarily because of its rigidity: in the American constitutional system, the Executive cannot pass fiscal legislation as it pleases. A mere Act of Congress can effectively restrain the Government because it cannot easily amend a law once passed. India, like New Zealand, has a parliamentary form of government and the government of the day can, except when it lacks a majority, pass money bills without difficulty. Indeed the legislature cannot reject a money bill without toppling the government. Article 292 of the Constitution provides that Parliament may legislate debt ceilings but no special majority is prescribed. As such fiscal responsibility or debt ceiling legislation can be amended routinely by simply adding a clause to the annual Finance Act, the way the Income-tax Act or Sales Tax Act is amended!
Confronted with a choice between sticking to the ceiling by, say, not paying salaries or raising food prices on one hand, and tabling an amendment to the Act on the other, the chances of the executive adhering to the ceiling can be imagined.
Confronted with a choice between saying "aye'' to a routine clause in the Finance Bill on the one hand, and unseating the government on the other, how many ruling party or ruling coalition members of Parliament or legislature would vote against an amendment?
In short, a fiscal responsibility Act is unlikely, by itself, to provide a cure to India's fiscal problems. In terms of enforceability it is unlikely to be more effective than, say, the Indian Electricity Act that prescribes a 3 per cent rate of return for electricity undertakings including the Electricity Boards. However, the Directive Principles of State Policy in the Constitution have some value even though they are not justiciable.
Hard-to-enforce social legislation on Dowry Prohibition and Age of Consent has had some effect in bringing about gradual change and a fiscal responsibility law might have similar benefit. Legislation can sometimes bring about change even if it is without teeth: barking dogs have deterrent value even without biting, as many house owners know. But if the fiscal deficit is to be substantially reduced, there is no substitute for political will.
(The author, a member of the Indian Administrative Service, was formerly Group Manager, Budget Polic
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