special article
The Fiscal Situation and a Reform Agenda
for the New Government
M Govinda Rao
The fiscal situation of the central government is
worrisome. The problem is largely structural and not
cyclical. Indeed, the slowdown of the economy has only
partly contributed to the deterioration in 2008-09. The
new government at the centre is faced with the
formidable challenge of containing the worrisome fiscal
deficit, while continuing to provide a stimulus necessary
to revive the economy. It also has to institute a
restructuring programme towards achieving fiscal
consolidation in the medium term. Such a
programme should draw lessons from the past and
design a plan for the centre as well as the states.
M Govinda Rao (mgrnipfp.org.in) is at the National Institute of Public
Finance and Policy, New Delhi.
Economic & Political Weekly  EPW   june 20, 2009  vol xliv no 25
1 Agenda for Fiscal Reforms
T
he finance minister, in his 2008-09 budget speech had
stated, “It is widely acknowledged that the fiscal position
of the country has improved tremendously”. Yet, within a
year, the situation has changed dramatically and fiscal deficit in
the country has reached unprecedented level and Standard and
Poor decided to revise the outlook from “stable” to “negative”
stating, “With high government debt burden and deficits, its weak
fiscal profile has been the single largest negative factor”. Indeed,
the finance minister while presenting the Interim Budget
2009-10, claimed that breaching of the fiscal deficit targets was
mainly due to the global economic slowdown when he stated,
“…extraordinary economic circumstances merit extraordinary
measures. Now is the time for such measures. Our Government
decided to relax the FRBM targets”.
The global financial crisis which began with the bursting of the
housing bubble in the United States and aggravated by the col-
lapse of several international financial institutions beginning
with Lehman Brothers swiftly had an impact on the real sectors
and has caused a recessionary environment in the US, Japan and
European countries. Although, initially, the emerging market
economies including India felt that they could decouple them-
selves from the global financial meltdown, it was soon recognised
that this was simply not possible. Thus, the adverse impact of the
recession in the countries of the Organisation for Economic Co-
operation and Development (OECD) on India was much more than
that was initially envisaged. Reviving the economy required
strong stimuli from both fiscal and monetary policy instruments,
but it was soon realised that the headroom for providing fiscal
stimulus side was very limited.
The central government put forward three fiscal stimulus
packages in 2008-09, but the fiscal contents of these packages
were not very significant mainly because there was hardly any
headroom. Of course, there were tax cuts of 6 percentage points
in union excise duties and 4 percentage points in service tax.
Another important component of the package was allowing an
additional half a percentage of the gross state domestic product
(GSDP) borrowing to the states. Not surprisingly, the economy has
continued to slow down and clear signs of revival are yet to
emerge though the GDP estimate of the last quarter at 5.8% is
marginally higher than the previous quarter’s at 5.3%. In this
situation, there will be considerable pressure on the new govern-
ment to provide additional stimulus packages to revive the eco­
nomy, but the package of measures will be constrained by the
lack of fiscal space and limited policy manoeuvrability.
77
speciAl article
In order to understand how much additional fiscal stimulus
can be given, it is important to understand the nature of the
fiscal imbalance in the country. In other words, it is necessary to
analyse how much of the deficit is structural and how much of it
is cyclical. While the cyclical component of the deficit is not a
serious cause for concern, the structural component needs to
be attended to. This will also help in identifying the policy
measures to be implemented in the short and medium term to
nurse the fiscal situation back to health. The country will have
to live with high deficits in 2009-10 for any attempt to make a
significant adjustment will have a severe impact on the growth
of the economy. This, however, does not mean that important
reform cannot or should not be undertaken in the current year.
Some of the reforms could actually help to release larger re-
sources for providing the stimulus and some reform measures
could help to create a better environment for the revival of
private sector sentiment.
This paper attempts to make an assessment of the fiscal situa-
tion in the country. It will analyse the trends in fiscal imbalances
and examine the efforts at fiscal consolidation since the enact-
ment of Fiscal Responsibility and Budget Management Act
(FRBMA) at the centre and Fiscal Responsibility Acts (FRA) in the
states. It will address the question on the efficacy of FRBMA and
its shortcomings in achieving fiscal consolidation and the lack
of counter-cyclical element in the fiscal restructuring plan
adopted by the central and state governments as recommended
by the Twelfth Finance Commission (TFC). The paper will also
examine the adequacy of fiscal stimulus packages implemented
so far and analyse the fiscal space available for further stimulus
by the new government at the centre. The paper discusses also
the immediate reform measures to provide the stimulus while
containing the fiscal deficit in the short term and achieving fis-
cal correction in the medium and long term. It also discusses
the next stage of fiscal consolidation and the design of the new
fiscal responsibility legislation to avoid the shortcomings of the
last FRBMA.
2  Fiscal Consolidation in India since 2001-02
The latter part of the 1990s saw a sharp deterioration in the fiscal
situation at both central and state levels. Most analysts attribute
the problem to significant pay and pension revision, but there are
other important factors contributed to the deterioration. These
include a sharp decline in the central revenues from customs and
excise duties, an increase in the interest burden due to both in-
creasing volume of indebtedness and higher interest rates and
continued proliferation of subsidies and transfers. The gross tax
revenue of the centre relative to GDP declined from 10.2% in
1991-92 to 8.2% in 2001-02 and this was due to 2 percentage point
decline in customs duties, 1 percentage point decline in union
excise duties, which was offset by a 1 percentage point increase
in direct taxes. Interest payments as a ratio of central revenues
increased from 40.3% in 1991-92 to 53.4% in 2001-02. Even as
revenue receipts relative to GDP showed a declining trend, the
revenue expenditures as a ratio of GDP increased from 6.8% in
1991-92 to 14.1% in 2001-02. All these factors culminated in
creating the worst fiscal imbalance scenario possible in 2001-02
78
with the revenue and fiscal deficits as ratios of GDP at 7% and
10.3%, respectively (Table 1, Figure 1).
Since 2001-02, however, there has been an appreciable turna-
round – up to 2007-08. The consolidated fiscal deficit declined
relative to GDP from 9.9% in 2001-02 to 5% in 2007-08 (Table 1).
The revenue deficit declined by 6.4 percentage points from over
Table 1: Fiscal Indicators of the Central and State Governments (% of GDP)
State Centre Consolidated
Revenue Primary Fiscal Revenue Primary Fiscal Revenue Primary Fiscal
Deficit Deficit Deficit Deficit Deficit Deficit Deficit Deficit Deficit
1996-97 1.18 0.85 2.72 2.39 -0.20 4.10 3.60 1.30 6.40
1997-98 1.07 0.93 2.90 3.05 0.50 4.80 4.10 2.10 7.30
1998-99 2.51 2.20 4.27 3.85 0.70 5.10 6.40 3.70 9.00
1999-00 2.78 2.39 4.72 3.49 0.75 5.40 6.30 3.80 9.50
2000-01 2.54 1.81 4.25 4.08 0.93 5.70 6.60 3.70 9.50
2001-02 2.65 1.43 4.14 4.40 1.47 6.19 7.05 2.90 10.32
2002-03 2.33 1.25 4.06 4.40 1.11 5.91 6.72 2.36 9.97
2003-04 2.30 1.46 4.38 3.57 -0.03 4.48 5.87 1.43 8.85
2004-05 1.24 0.68 3.42 2.49 -0.04 3.99 3.73 0.64 7.42
2005-06 0.20 0.17 2.52 2.58 0.39 4.09 2.77 0.55 6.61
2006-07 -0.60 -0.38 1.87 1.94 -0.19 3.44 1.34 -0.56 5.31
2007-08* -0.48 0.11 2.30 1.12 -0.91 2.7 0.64 -0.83 5.00
2008-09 ** -0.52 0.08 2.08 4.45 2.47 6.02 3.92 2.54 8.09
(-0.41) (3.44)
* The estimate for the central government are actuals and for the states, revised estimates.
** The estimate for the central government is revised estimates and for the states, budget
estimates.
The 2006-07 figures are actual for the central government and revised estimates for states.
Source: Budget Documents, Government of India, and Finance Accounts, State Governments
7% in 2001-02 to just about 0.6% in 2007-08. The aggregate fiscal
deficit in 2007-08 is estimated at about 5%. Furthermore, im-
provements were seen at both the central and state levels (Figure 1).
In fact, the reduction in fiscal deficit exceeded the targets set
under the fiscal responsibility legislation though the performance
of the centre in reducing the revenue deficit has lagged behind
the plan. Notably, according to the fiscal restructuring plan
recommended by the TFC, the central and state governments
taken together were required to phase out the revenue deficits
and bring down the consolidated fiscal deficit to 6% of GDP.
The plan envisaged the central government compressing the
deficit to 3% of GDP and the consolidated deficit of the states to
be reduced to 3%.
Figure 1: Trends in Fiscal Imbalances in India
7  –
Centre rev deficit
6  – Centre fiscal deficit
5  – State fiscal deficit
4  –
3  –
2  –
State rev deficit
1  –
0  –| | | | | | | | |
-1  –
1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2007- 2008-
08(RE) 09(BE)
In 2008-09, however, there was a sharp reversal of the trend.
Although the consolidated revenue deficit for the central and state
governments was budgeted at 0.5% and the consolidated fiscal
deficit was budgeted at 4.5%, the revised estimates place the rev-
enue deficit at 4.4% and fiscal deficit at 6%. When the impact of
the tax cuts and slow growth of tax revenues due to economic
slowdown is taken into account, the revenue and fiscal deficits as
june 20, 2009  vol xliv no 25  EPW   Economic & Political Weekly

ratios of GDP could increase to 5% and 6.5%, respectively. In the
case of states, the available information for 14 of the 28 states
shows that the aggregate revenue surplus which was estimated at
over 0.6% of GSDP in the budget estimate would be reduced to
0.4% and fiscal deficit as a ratio of GDP shows an increase from
2.8% to 3.4%. Assuming that the situation in other states is simi-
lar, we can expect the aggregate fiscal deficit to be about 3% of
GDP which implies that the consolidated fiscal deficit for 2008-09
could be as high as 9.5%. In addition, there are off-budget liabili-
ties amounting to Rs 96,000 crore by way of bonds issued to oil
companies (Rs 75,942 crore), fertiliser companies (Rs 20,000
crore) and this works out to about 2% of GDP. Thus, the consoli-
dated liabilities of the central and state governments including off-
budget liabilities add up to over 11.5% of GDP in 2008-09. This
magnitude of the fiscal deficit is unprecedented and has even sur-
passed the highest level of deficit incurred in 2001-02 (10.3%).
It must be noted that the sudden deterioration in the fiscal situ-
ation is neither sudden nor is it due mainly to the economic slow-
down in the country. It was not sudden because a substantial pro-
portion of the deficit in the year was due to the non-payment of
subsidies that accrued in the previous year, but the payment was
simply postponed to 2008-09. However, a substantial proportion
of the deficit was due to budgeting of expenditures for pay revi-
sion, loan waiver and additional expenditure provision for imple-
mentation of the National Rural Employment Guarantee Act
which was extended to 250 districts from the 100 districts in the
previous year, but was not budgeted.
There are three important questions from the viewpoint of
policy. First, is the improvement in the fiscal situation until
2007-08 attributable to fiscal responsibility legislations? Second,
is the sharp deterioration in the fiscal situation in 2008-09 due to
the fiscal stimulus packages announced by the government to
combat the economic slowdown? Finally, a related question: how
much of the fiscal imbalance in the country seen in 2008-09 is
cyclical and how much of it is structural? Before answering these
questions, it is important to analyse the fiscal trends at the cen-
tral and state levels separately.
3 Trends in Central Government Finances
Both the central and state governments contributed to the
progress in fiscal consolidation until 2007-08 broadly in equal
measure, although, the improvement in the state finances itself
was, to a considerable extent, due to higher tax devolution and
grants from the central government. Analysis shows that during
the past decade the fiscal deficit of the central government was
the highest in 2001-02 at 6.2%. Similarly, the revenue deficit of the
central government was the highest in 2001-02 at 4% of GDP. In
subsequent years, there was a steady reduction in both revenue
and fiscal deficits and the reduction was sharper after the FRBMA
was passed in August 2003. The fiscal deficit relative to GDP de-
clined from 6.2% in 2001-02 to 4.5% in 2003-04 and further to 2.7%
in 2007-08. Similarly, the revenue deficit was reduced from 4.4%
in 2001-02 to 3.6% in 2003-04 and further to 1.1% in 2007-08.
The sharp improvement in the fiscal situation after passing the
FRBMA has led to the impression that (i) the improvements in the
fiscal situation were mainly attributable to the legislation; (ii) the
Economic & Political Weekly  EPW   june 20, 2009  vol xliv no 25
special article
large fiscal deficit that exists today is cyclical and not structural
and therefore, is not a major cause of worry; and (iii) since the
deficit is cyclical, there is still considerable scope for the new gov-
ernment to introduce further stimulus packages for combating
the economic slowdown. Surely, the new government at the cen-
tre will be under considerable pressure to follow an expansionary
policy to increase spending on food subsidy, loan waiver and
other populist schemes.
The important question is: if indeed there has been a struc-
tural improvement in the fiscal health over the years until
2007-08, how could it turn so bad within a year? Although the
budget estimate for 2008-09 shows that the revenue and fiscal
deficits relative to GDP would be contained at 1% and 2.5%, re-
spectively, the revised estimates for the year show that the reve-
nue deficits would increase to 4.4% and fiscal deficit would in-
crease to 6%. The indications are that the revenue receipts would
be even lower than shown in the revised estimates by a further
half a per cent of GDP. In addition, there are off-budget liabilities
amounting to about 2% of GDP making increase in aggregate
central liabilities to 8.5% of GDP. Not just that these are much
higher than the targets set in the FRBMA, but these are the high-
est – higher than the deficit even in 2001-02.
A close analysis shows that although some part of the deficit is
attributable to cyclical factors, the deficit is largely structural.
Notably, the reduction in taxes consequent to the stimulus pack-
ages and lower revenue collections due to the slowdown in the
economy can at best account for 1.2% of GDP. While the budget
estimate of gross tax revenue as a ratio of GDP for 2008-09 is
close to 13%, the revised estimate is placed at 11.8%. As regards
expenditures are concerned, the increase from the budget esti-
mate of 13.8% of GDP to 16.6% of GDP in the revised estimate is
not due to any stimulus package but only to adequately fund the
commitments made in the budget speech. The structural weak-
nesses in the budget can be brought out by a more detailed analy-
sis of fiscal situation.
Thus, both revenue and fiscal deficits of the central govern-
ment as ratios of GDP declined steadily from 2001-02, and the de-
cline was much sharper since 2003-04, which gives an impres-
sion that the improvement was due to the fiscal discipline im-
bibed by the FRBMA. However, a careful analysis shows that ac-
cording to the FRBMA implementation task force’s restructuring
plan, while the revenue deficit was expected to be reduced to
0.3% of GDP in 2007-08 and eliminated by 2008-09, it was 1.1%
in 2007-08 and is estimated at 4.5% in 2008-09. As regards the
fiscal deficit, until 2007-08 the adjustment was broadly accord-
ing to plan which implies that a substantial portion of the adjust-
ment was achieved by compressing capital expenditures from al-
most 4% of GDP in 2003-04 to 2.5% in 2007-08.
Notably, it was the sharp increase in the tax revenues, particu-
larly in direct taxes, that led to the appreciable reduction in the
revenue deficit. In fact, the centre’s gross tax revenues as a ratio
of GDP increased by 4.4 percentage points between 2001-02 and
2007-08 of which a 3.4 percentage points increase was since
2003-04 (Table 2, p 80). During the period 2003-08, revenue from
direct taxes increased at a compound rate of 30.7% per year with
corporation tax increasing at 31.3% a year and personal income
79
speciAl article
tax revenue increasing at 30% a year. The nominal increase in
GDP during this period was 14.3% and given the buoyancy coeffi-
cient of 1.1, we can explain a growth rate of 15.7% to the increase
in GDP, which implies another 15 percentage point increase must
Table 2: Trends in Central Finances
% of GDP Percentage Points
2001-02 2003-04 2007-08 2008-09 Imporve- Imporve- Deteriora-
(RE) ment in ment in tion in
2007-08 2007-08 2008-09
over over over
2001-02 2003-04 2007-08
Net revenue receipts 8.83 9.58 11.55 10.36 2.71 1.97 1.19
Tax revenue (net) 5.86 6.79 9.36 8.59 3.51 2.58 0.78
Non-tax revenue 2.97 2.79 2.18 1.77 -0.79 -0.61 0.41
Gross revenue receipts 11.18 12.02 14.82 13.35 3.64 2.80 1.47
Gross tax revenue 8.21 9.23 12.64 11.57 4.43 3.40 1.06
Personal income tax 1.40 1.50 2.53 2.26 1.13 1.03 0.27
Corporation tax 1.61 2.31 4.11 4.09 2.50 1.80 0.02
Customs 1.77 1.77 2.22 1.99 0.45 0.45 0.23
Excise 3.18 3.30 2.63 2.00 -0.55 -0.66 0.64
Service tax 0.14 0.29 1.09 1.20 0.95 0.81 -0.10
Others 0.10 0.08 0.05 0.04 -0.05 -0.03 0.01
Revenue expenditure 13.23 13.14 12.67 14.81 0.56 0.48 2.14
of which tional stimulus to the economy. However, under-provision in the
Interest payments 4.72 4.50 3.64 3.55 1.07 0.86 -0.09
Major subsidies 1.34 1.58 1.49 2.38 -0.15 0.09 0.90
Defence expenditure 1.67 1.57 1.22 1.42 0.45 0.35 0.20
Capital outlay 2.67 3.96 2.52 1.80 0.15 1.44 -0.72
Total expenditure 15.90 17.11 15.19 16.60 0.71 1.92 1.42
Fiscal deficit 6.19 4.48 2.70 6.02 3.48 1.77 3.31
Revenue deficit 4.40 3.57 1.12 4.45 3.28 2.45 3.33
Source: Budget documents of the central government for various years.
be attributed to other factors. The main factor that has contri­
buted to the growth of direct taxes was the institution of the Tax
Information Network (TIN) in 2003-04 and entrusting this task to
the National Security Depository Ltd (NSDL).1 The important les-
son from this is that the government can mobilise substantial ad-
ditional revenues if only it strengthens the information system of
union excise and customs duties, entrusting the task to a compe-
tent information technology company rather than continuing
with the depleted National Informatics Centre (NIC) which does
not have the capacity to institute the information system required
for the effective enforcement of these taxes.
It must be noted that the task force on the implementation of
FRBMA had worked out the plan for achieving the targets envis-
aging both increase in revenues and compression of expendi-
tures. However, while the increase in revenues conformed, the
government failed to compress expenditures according to the
plan (Rao, Sen and Jena 2008). According to the plan, the reve-
nue expenditures as a ratio of GDP were to be compressed from
13.1% in 2003-04 to 11.3% in 2007-08 and further to 11% in
2008-09. As against the planned decline of almost 1 percentage
point, the revenue expenditure actually declined by just about
0.5 percentage points, to 12.7% in 2007-08, but increased sharply
to 14.8% in 2008-09 (RE). In fact, during this period, spending on
debt servicing declined by almost 1 percentage point as the inter-
est rates declined and the government swapped debt with high
interest rates with lower interest rates. This implies that the non-
interest expenditure as a ratio of GDP actually increased from
80
8.6% in 2003-04 to 9.1% in 2007-08. Thus, the structural problems
on the expenditure side of proliferation of subsidies and untar-
geted transfers were not simply addressed in the implementation
of FRBMA.
Is the deterioration in the fiscal health in 2008-09 due to the
fiscal stimulus given to combat the economic slowdown? A closer
examination shows that the revision was mainly because there
was significant under-provision of expenditures in the 2008-09
budget estimates and during the course of the year expenditures
had to be provided to fund the commitments made in the budget.
The detailed analysis of the Supplementary Demands (Table 3)
shows provision for additional cash expenditures amounting to
almost 2.8% of GDP. This includes provision for pay revision, ad-
ditional funds for food and fertiliser subsidies, funding of the
loan waiver scheme and additional allocation to various flagship
programmes including the National Rural Employment Guaran-
tee. Thus, in order to show that the government was adhering to
the FRBMA, the expenditures were simply under-budgeted. Thus,
the deterioration in the fiscal situation was not due to any stimu-
lus package, though, these expenditure certainly provide addi-
budget estimates results in poor planning and implementation of
expenditures and contributes to low productivity of public spending.
The above analysis indicates that the government failed to
achieve the adjustment as envisaged in the FRBMA, particularly
in containing the expenditures and protecting capital expendi-
tures. Whatever adjustment was achieved was attributable
mainly to the increase in tax revenues arising mainly from im-
provement in computerised information system and to some ex-
tent, reduction in the interest rates. The analysis also shows that
overwhelming proportion of the deficit continues to be structural
and not cyclical. Furthermore, the increase in the expenditures
was not due to fiscal stimulus packages but to adequately fund
Table 3: Supplementary Demand for Grants of the Central Government
Supple-1 Supple-2 Total Total
Rs Crore Rs Crore Rs Crore (% of GDP)
(I) Cash expenditures
1 Pay revision 22,700 - 22,700 0.43
2 Fertiliser subsidy 38,863 6,000 44,863 0.85
3 Food subsidy 5,064 6,500 11,564 0.22
4 Creation of farmers' debt relief fund 15,000 - 15,000 0.28
5 NREGS (contribution to fund) 10,500 - 10,500 0.2
6 Transfers to states and implementing
agencies for other schemes - 22,000 22,000 0.41
6 Others 13,486 7,980 21,466 0.4
7 Total 1,05,613 42,480 1,48,093 2.79
II Expenditure matched by receipts/recoveries/savings
1 Fertiliser subsidy bond 14,000 7,656.06 21,656 0.41
2 Subscription to IMF quota 8,622.6 - 8,623 0.16
3 Securities for oil marketing cos 65,942 - 65,942 1.24
6 Others 7,107.4 1,968.63 9,076 0.17
Total 1,31,672 13,124.69 1,44,797 1.98
Ministry of Finance, Government of India.
the commitments made in the budget itself. Inadequate funding
of the programmes in the budget only creates inefficiency in
expenditure implementation.
Thus, even as it passed the FRBMA, the government missed
the opportunity to adhere to the set targets by weeding out
june 20, 2009  vol xliv no 25  EPW   Economic & Political Weekly

unproductive expenditures. In particular, the proliferation of
explicit and implicit subsidies has long been a concern not only
because to the large and growing magnitude but also its poor
targeting and fiscal responsibility legislation provided a good
opportunity to rationalise them. Successive governments were
concerned about the increasing burden and in 2004 the govern-
ment had placed a White Paper on the subject in Parliament. Yet,
there was very little progress on this front in reducing or ration-
alising the subsidies. The new government will have to address
this issue not only to create additional fiscal space for combating
the economic slowdown, improving productivity in public spend-
ing and revert to the fiscal correction path.
4 Trends in State Government Finances
The deterioration in the fiscal health of the states in the latter
part of the 1990s following significant increases in pay and pen-
sions of government officials, declining tax devolution from the
centre and increasing burden of debt servicing caused a steady
deterioration in the fiscal health of the states in the latter part of
the 1990s. The Eleventh Finance Commission was asked to rec-
ommend an incentive linked fiscal restructuring plan to achieve
correction. However, the incentive linked grants by the commis-
sion had serious design shortcomings (Rao 2003) and the situa-
tion did not show much improvement until 2003-04. Therefore,
the TFC was mandated to draw up a fiscal restructuring plan to
restore the balance. According to its recommendation, each of
the states was required to phase out its revenue deficit and con-
tain the fiscal deficit at 3% of GSDP. The commission recom-
mended debt restructuring and a write off scheme to the states
linked to passing of fiscal responsibility legislation and compres-
sion of revenue and fiscal deficits. All the states except Sikkim
and West Bengal have passed the fiscal responsibility legislations
after 2005-06.
However, since 2003-04, the fiscal health of the states has
shown a steady improvement until 2007-08 (RE). The aggregate
revenue deficits of the states as a ratio of GSDP declined from
2.3% in 2003-04 to a surplus of about 0.5% in 2007-08. This 2.8
percentage point improvement in the revenue deficit helped to
reduce the fiscal deficit by 2.1 percentage points and increase the
capital outlay by about 0.9 percentage point (Table 4). Thus, the
states in the aggregate were able to generate revenue surplus of
about half a per cent and reduced their fiscal deficit to a little over
2% of GDP which is 1 percentage point more than that was recom-
mended in the fiscal restructuring plan of the TFC. In addition,
they could increase the capital outlay by about 1 percentage point
of GDP. Surely, fiscal consolidation in the states until 2007-08 has
helped them to cope better with the economic slowdown.
Table 4 presents the analysis of the sources of improvement in
state finances. As already mentioned above, between 2003-04
and 2007-08, there was a 2.8 percentage point improvement (rel-
ative to GDP) in the revenue deficit position and this has helped to
reduce the fiscal deficit by 2.1 percentage points. It is also seen
that the improvement in the revenue deficit due to larger revenue
collections was 2.1 percentage points or about 78% and the ex-
penditure reduction was only due to lower interest payments. Of
the 2.1 percentage point improvement in revenues, the contribution
Economic & Political Weekly  EPW   june 20, 2009  vol xliv no 25
special article
of own tax revenues was 0.7 percentage point and tax devolu-
tion and grants from the centre contributed to 1.4 percentage
point improvement. Again, the higher transfers were mainly at-
tributable to the increased buoyancy of central tax revenues
during this period. With the reduction in the union excise duties
as a part of the fiscal stimulus packages and slowing down of the
economy, there would be a significant deceleration in central
tax revenues and this could adversely affect state finances in the
next two years.
Own tax revenues of the state governments increased by 0.7
percentage point during the period and a close examination
shows that much of the increase is attributable to the introduc-
tion of value added tax (VAT) to replace the cascading type sales
tax in April 2005. Of course, buoyant economy, rationalisation of
stamp duties and a boom in the real estate market also resulted in
a significant increase in stamp duties and state excise duties as
well. The economic slowdown and the reduction in excise duties
is likely to shrink the VAT base of the states and with the housing
market under severe strain, there could be a significant decelera-
tion in the states’ own revenues after 2008-09.
On the expenditure side, the adjustment was only 0.6 percent-
age point and this is almost entirely due to lower interest pay-
ments. Besides lowering of interest rates due to the debt swap
scheme adopted in 2004-05, lower volume of borrowings from
the National Small Savings Fund and to some extent, the write-
off of debt repayment as per the recommendation of the TFC have
contributed to the improvement.
Surely, the economic slowdown in 2008-09 has adversely af-
fected state finances significantly. Available information on the
revised estimates for 14 states for 2008-09 shows that the posi-
tion has deteriorated since due to the slowdown in the economy
and declining tax devolution and the revenue surplus is likely to
Table 4: Trends in State Finances
% of GDP Percentage Point
Improvement
2001-02 2003-04 2006-07 2007-08 2008-09 2007-08 2007-08
(RE) (BE) (RE) over (RE) over
2001-02 2003-04
Fiscal deficit 4.14 4.38 1.87 2.30 2.08 1.84 2.08
Revenue deficit 2.65 2.30 -0.60 -0.48 -0.52 3.13 2.78
Revenue receipts 10.94 11.22 12.80 13.40 13.27 2.45 2.17
Own tax revenue 5.41 5.59 6.09 6.25 6.21 0.84 0.66
Own non-tax 1.38 1.35 1.53 1.33 1.23 -0.04 -0.02
Tax devolution 2.29 2.44 2.90 3.16 3.19 0.86 0.72
Grants 1.87 1.85 2.28 2.66 2.64 0.79 0.81
Revenue expenditure 13.59 13.53 12.20 12.92 12.74 0.68 0.61
Interest payment 2.70 2.92 2.25 2.19 2.00 0.51 0.73
Capital outlay 1.39 1.87 2.37 2.73 2.68 -1.35 -0.86
Net lending 0.10 0.21 0.15 0.22 0.20 -0.13 -0.02
Source: NIPFP Data Base.
be reduced by about 0.2% of GDP and the fiscal deficit may in-
crease by about 0.7 percentage point. Most of the states for which
information is available are yet to undertake the pay revisions
and when the fiscal position in other states is also considered, the
states taken together may not generate any revenue surplus and
may end up with the fiscal deficit of about 3.5% of GSDP, which is
equivalent to 3% of GDP. While these targets conform to those set
by the TFC in the fiscal restructuring plan, the situation is far
81
speciAl article

from being comfortable. This is because, in the next year Among the low income states, Bihar, Orissa, Madhya Pradesh
(2009-10), when the impact of pay revision in all the states are and Uttar Pradesh improved their revenue deficit as a ratio of
effected and the impact of the economic slowdown on the states’ GSDP by over 5 percentage points. Bihar has the largest revenue
own tax revenues and tax devolution are taken account of, a sub- surplus of 4.1% of GSDP in 2008-09. While Orissa used the im-
stantial revenue deficit is likely to re-emerge and the fiscal deficit provement in the revenue deficit to reduce the fiscal deficit and
may increase substantially. the volume of debt in the state, Bihar, Madhya Pradesh and Uttar
Pradesh used the improvement partly to reduce fiscal deficit but
Finances of Individual States more substantially increase capital expenditures. It must also be
Almost all states have shown significant improvements in their noted that despite improvement in the fiscal situation in all the
fiscal health in 2008-09 as compared to 2001-02 (Table 5). Inter- states, some states continue to have worrisome fiscal problems.
estingly, on an average, the improvement in the fiscal health of Among the non-special category states, Kerala, Punjab and West
the states in low income states was much more than that of high Bengal continue to have substantial revenue deficits even in
income states in both revenue deficits, fiscal deficits as well as 2008-09. Similarly, the states of Goa, Kerala, Punjab, Tamil Nadu
in capital expenditures. Similarly, improvement in the fiscal and West Bengal have budgeted their fiscal deficits much higher
health of special category states was better than that of general than the target of 3% of GSDP. In terms of the improvement in the
category states. fiscal situation in 2008-09 over 2001-02, in the case of revenue
Table 5: Fiscal Consolidation since 2001-02 deficits, the largest improvement was
Fiscal Deficit Revenue Deficit Capital Outlay*
in Orissa (6.5 percentage points) and
2001-02 2008-09 (BE) Improve- 2001-02 2008-09 (BE) Improve- 2001-02 2008-09 (BE) Improve-
ment (2-3) ment (5-6) ment (9-8) the smallest was in Kerala (1.3 percent-
1 2 3 4 5 6 7 8 9 10 age points). As regards the fiscal deficit,
I General category states Orissa’s performance has been the best
High income states as it brought down the deficit relative to
Andhra Pradesh 4.28 2.92 1.36 1.83 -0.21 2.05 2.44 6.76 4.31
GDP by 6.2 percentage points. West
Goa 5.82 4.50 1.31 3.22 -1.26 4.48 2.60 5.76 3.16
Gujarat 5.27 2.40 2.87 5.45 -0.02 5.46 -0.18 2.42 2.59
Bengal too brought down the deficit by
Haryana 4.32 1.23 3.09 1.66 -0.86 2.53 2.65 2.09 -0.56 almost 4 percentage points, though a
Karnataka 5.39 2.99 2.40 3.01 -1.28 4.30 2.37 4.36 1.98 substantial part of the reduction is by
Kerala 4.22 3.46 0.77 3.37 2.07 1.30 0.86 1.39 0.53 compressing capital expenditures. In
Maharashtra 4.02 2.19 1.82 3.02 -0.16 3.18 1.00 2.35 1.35 terms of improving capital outlay, Bihar’s
Punjab 6.22 3.22 3.00 4.74 0.69 4.06 1.48 2.53 1.06 performance was the best.
Tamil Nadu 3.18 3.34 -0.16 1.84 -0.03 1.87 1.34 3.37 2.03 Table 6 (p 83) presents the sources of
West Bengal 7.51 3.56 3.95 5.64 2.32 3.32 1.88 1.25 -0.63 improvement in revenue deficit in each
Average 4.85 2.77 2.07 3.38 0.21 3.17 1.47 3.04 1.57
of the States. It is seen that an over-
Low income states
Bihar 4.47 2.98 1.49 2.28 -4.13 6.42 2.19 7.11 4.93
whelming proportion of improvement
Chhattisgarh 3.60 2.45 1.15 1.88 -2.28 4.16 1.73 4.73 3.00 was due to the increase in revenues and
Jharkhand 3.89 2.52 1.38 0.87 -2.42 3.29 3.02 4.94 1.91 more particularly due to higher central
Madhya Pradesh 4.20 3.14 1.05 3.64 -1.88 5.52 0.56 5.02 4.47 transfers. There was hardly any com-
Orissa 8.45 2.17 6.28 6.04 -0.48 6.52 2.42 2.65 0.24 pression of revenue expenditures even
Rajasthan 6.28 2.98 3.30 4.14 -0.69 4.83 2.13 3.67 1.53 as the ratio of interest payments to GSDP
Uttar Pradesh 5.21 3.12 2.09 3.25 -2.93 6.18 1.95 6.04 4.09 in 2007-08 was lower than in 2001-02
Average 5.25 2.89 2.37 3.37 -2.21 5.58 1.88 5.09 3.21 by 0.4 percentage point. Since 2005-06,
Average of general
some of the states could avail of the
category states 4.97 2.81 2.17 3.38 -0.51 3.89 1.60 3.65 2.05
II Special category states
benefits of debt rescheduling and write-
Arunachal Pradesh 11.70 -15.44 27.14 -2.62 -23.14 20.52 14.32 7.70 -6.62 off recommended by the TFC.
Assam 3.79 2.13 1.66 2.30 -2.74 5.04 1.48 4.87 3.39 The pattern of fiscal adjustment since
Himachal Pradesh 8.81 5.63 3.19 5.02 -0.20 5.22 3.80 5.83 2.03 2001-02, however, shows significant
Jammu and Kashmir 8.17 6.61 1.57 1.85 -9.15 11.00 6.32 16.28 9.96 variation among the states. In general,
Manipur 10.22 1.67 8.55 4.84 -13.92 18.76 5.38 15.59 10.21 a higher central transfer to states by
Meghalaya 4.79 1.48 3.31 0.73 -6.15 6.88 4.06 7.63 3.57
way of tax devolution and grants helped
Mizoram 21.70 3.68 18.02 13.38 -5.18 18.56 8.32 8.85 0.54
to significantly reduce revenue deficits
Nagaland 8.09 3.08 5.01 2.46 -7.28 9.74 5.63 10.36 4.73
in every state. However, high income
Sikkim 5.88 14.56 -8.68 -12.58 -17.57 4.99 18.47 32.13 13.66
Tripura 8.45 6.56 1.89 -0.86 -6.37 5.51 9.30 12.93 3.63
states improved their revenue efforts as
Uttarakhand 3.83 3.05 0.78 2.06 -4.74 6.80 1.77 7.79 6.02 well. In these states, of the 3 percentage
Average 6.38 3.55 2.83 2.40 -5.08 7.47 3.99 8.71 4.72 points improvement in the revenue
Average of all states 5.06 2.85 2.21 3.32 -0.78 4.10 1.74 3.95 2.21 deficit, higher tax effort contributed
Negative sign for both fiscal deficit (Col 3) and revenue deficit (cols 5 and 6) indicates surplus. 1.5 points or almost 50% mainly due
GSDP figures are projected using trend growth rate on last two available years; * Capital outlay includes net lending.
Source: Finance accounts and budget documents of state governments. to the introduction of VAT. However,
82 june 20, 2009  vol xliv no 25  EPW   Economic & Political Weekly

own non-tax revenues declined by 0.23 percentage point.
The tax devolution and grants together increased by 1.07 per-
centage points during the period. These states could compress
their revenue expenditures by 0.6 percentage point of which,
almost 0.3 percentage point was due to lower interest payments.
The increase in own tax effort was more than 3 percentage
points in Andhra Pradesh, more than 2.5 percentage points in
Punjab and Tamil Nadu and more than 2 percentage points in
Karnataka. Except Goa and Gujarat every state improved its tax
effort. In the case of Kerala too, the tax-GSDP ratio increased by
1.7 percentage points and central transfers increased by over
1 percentage point, but as revenue expenditures increased by
over three points, the revenue deficit actually increased by 0.2
percentage point.
Table 6: Fiscal Consolidation from 2001-02 to 2008-09 (BE) (% of GSDP)
States Reduction Increase in Change (+/-) in creased by over 5 percentage points since 2001-02 and the in-
in Revenue Interest Payments
Deficit Own Own Share in Grants Revenue Interest
Taxes Non-taxes Central
Taxes
Expenditure Payments
I General category states
High income states
Andhra Pradesh 2.05 4.09 0.82 1.22 1.39 5.48 -0.20
Goa 4.48 0.71 -1.42 1.07 1.06 -3.07 -0.55
Gujarat 5.46 -0.17 -1.67 0.66 0.07 -6.58 -0.88
Haryana 2.53 0.88 0.47 0.37 0.16 -0.64 -1.01
Karnataka 4.30 4.52 -0.14 0.76 0.75 1.60 -0.19
Kerala 1.30 2.04 0.04 0.81 0.68 2.28 -0.06
Maharashtra 3.18 0.80 -0.69 0.58 1.44 -1.04 -0.31
Punjab 4.06 1.66 -0.19 0.83 2.27 1.19 -0.69
Tamil Nadu 1.87 2.59 0.13 1.32 0.98 3.14 -0.32
West Bengal 3.32 0.94 0.07 1.24 -0.16 -1.24 -0.17
Average 3.17 1.82 -0.18 0.84 0.86 0.20 -0.40
Low income states
Bihar 6.42 0.70 -0.12 6.43 6.04 6.63 -1.15
Chhattisgarh 4.16 1.80 -0.05 1.73 2.15 1.45 -0.94
Jharkhand 3.29 1.57 0.77 1.23 0.97 1.25 0.73
Madhya Pradesh 5.52 4.02 0.15 3.01 2.68 4.35 0.38
Orissa 6.52 0.97 0.35 1.41 2.16 -1.63 -2.35
Rajasthan 4.83 2.30 0.45 2.61 0.61 1.14 -0.48
Uttar Pradesh 6.18 3.19 0.69 3.90 1.65 3.24 -1.27
Average 5.58 2.43 0.44 3.19 2.11 2.60 -0.84
Average of
general
category states 3.89 2.03 0.01 1.49 1.22 0.89 -0.54
II Special category states
Arunachal Pradesh 20.52 0.89 9.50 8.41 26.21 24.49 0.47
Assam 5.04 1.04 1.46 2.90 7.21 7.57 -0.35
Himachal Pradesh 5.22 1.34 2.47 0.70 1.14 0.43 -0.77
Jammu and
Kashmir 11.00 2.83 0.67 2.71 1.24 -3.55 -1.27
Manipur 18.76 0.41 1.72 2.94 3.77 -9.92 -2.12
Meghalaya 6.88 1.58 0.30 4.25 13.14 12.39 -0.07
Mizoram 18.56 1.10 0.98 9.71 5.63 -1.13 -1.83
Nagaland 9.74 0.40 0.47 5.09 2.72 -1.07 -0.73
Sikkim 4.99 0.73 2.78 2.28 -2.86 -2.06 -2.18
Tripura 5.51 1.16 -0.54 2.41 2.14 -0.34 -0.82
Uttarakhand 6.80 2.17 1.36 3.49 4.30 4.52 0.13
Average 7.47 1.56 1.43 2.91 4.57 2.98 -0.62
Average of
all states 4.10 2.00 0.09 1.58 1.40 1.00 -0.55
GSDP figures are projected using average growth rate of last two available years.
Source: Finance accounts and budget documents of state governments.
Economic & Political Weekly  EPW   june 20, 2009  vol xliv no 25
special article
The low income states, on the other hand, reduced their revenue
deficit – GSDP ratio by 4.8 percentage points. This was achieved
even as non-interest revenue expenditures on social and economic
services increased by 2.3 percentage points but due to lower in-
terest payments, total revenue expenditure increased by 1.7 per-
centage points. Thus, larger transfers from the centre increased
the revenues of these states by 4 percentage points and better
revenue effort from own sources increased the revenues by another
2.4 percentage points. However, easing of resource constraints
enabled these states to make additional allocation to social and
economic services in both revenue and capital accounts.
In the case of special category states, the revenue deficit rela-
tive to GSDP was compressed by 5.9 percentage points mainly on
the strength of higher central transfers. The ratio of tax devolu-
tion and grants to the GSDP from the central government in-
crease in own revenues was about 2.5 percentage points. At the
same time, revenue expenditures too increased by 1.8 percentage
points. Although revenue deficits were reduced by 5.9 percentage
points, compression of fiscal deficit since 2001-02 was only 2.3
percentage points as a significant portion of revenue deficit re-
duction (3.6 points) was used to augment capital expenditures.
The analysis of the indicators of fiscal health in different states
summarised in Table 7 (p 84) shows that going purely by deficit
indicators, the performances of low income states were as good if
not better than those of high income states. In fact, in 2006-07
(RE), the average revenue and fiscal deficit in the latter were
higher than in the former. While the low income states, on aver-
age, had a revenue surplus of 0.65% of GSDP, the high income
states had a deficit of 0.77%. Similarly, the average fiscal deficit in
low income states (3.9%) was only marginally higher than that of
the high income states (3.3%). The revenue and fiscal deficits in
individual states do not show a clear pattern with their per capita
income levels. The correlation coefficient of the revenue deficit
with per capita income in the general category states is 0.15 indi-
cating that the deficits are higher in high income states, though
the coefficient was not significant. Similarly, the correlation of
coefficient of fiscal deficits with per capita income was not signifi-
cant (-0.09). It is also seen that among the low income states
every state except Bihar and Jharkhand had revenue surpluses
whereas among the high income states all the states except Kar-
nataka and Gujarat had deficits.
5 Improving the Fiscal Environment:
Fiscal Correction versus Additional Stimulus
Given the difficult fiscal situation in the country, the new finance
minister faces the formidable challenge of providing additional
fiscal stimulus to the slowing economy, making additional funds
available for initiating and expanding the flagship programmes
and schemes expounded in the Congress Party’s manifesto while
containing the fiscal deficit which has reached alarming propor-
tions. Although the interim budget estimates the fiscal deficit of
the centre at 5.5% of GDP, the tax cuts announced after the in-
terim budget and the additional expenditure needed to expand
the flagship programmes and to fulfil the promises made in the
election manifesto could increase the deficit to about 6.5% of GDP
83
speciAl article
and deficit at the state level would be close to 3% of GDP. Thus,
the consolidated fiscal deficit in 2009-10 could remain at the
same level as in 2008-09 at about 9.5% of GDP.
With the recessionary climate in the OECD countries and the
slowdown in the Indian economy, it would be unrealistic to ex-
pect any significant adjustment in the deficit and the 2008-09
level of deficit would continue. Nevertheless, there will be a lot of
expectations that the budget will provide yet another stimulus
package. Furthermore, from the viewpoint of reviving the eco­
nomy speedily, the government will have to increase allocations
to infrastructure and some of the asset creating flagship schemes
such as rural roads. Equally important is the need to provide
clear signals to the private sector and this would require initiat-
ing a number of reforms.
Table 7: Important Fiscal Performance Indicators in States (2006-07)
Average Revenue Fiscal % of Per Capita Tax-GSDP
Per Capita Deficit Deficit Revenue Dev Ratio
GSDP (Rs) (% of GSDP) (% of GSDP) to Fiscal Spending (%)
Deficit (Rs)
2006-07 2006-07 (RE) 2006-07 (RE) 2006-07 (RE) 2006-07 (RE) 2006-07 (RE)
I General Category States
High income states budget for 2009-10 takes fertiliser subsidy 13% lower than the
  Andhra Pradesh 33,142 -0.85 1.71 -49.74 4,281 7.23
  Goa 93,485 -0.79 2.72 -29.03 13,043 7.20
  Gujarat 44,627 -0.55 1.74 -31.34 4,336 5.70
  Haryana 53,591 -0.97 -0.72 134.92 5,564 6.66
  Karnataka 33,400 -1.79 2.02 -88.55 5,158 10.05
  Kerala 39,742 1.62 2.35 69.02 2,957 7.34
    Maharashtra 45,632 -0.13 1.93 -7.01 4,142 6.68
  Punjab 46,919 -1.39 0.42 -330.61 3,854 6.18
  Tamil Nadu 37,635 -0.90 1.35 -66.94 4,005 9.48
  West Bengal 30,395 2.62 3.59 72.90 2,034 3.67
  Average 39,097 -0.19 1.80 -10.65 3,940 6.89
Low Income states
  Bihar 10,286 -2.24 2.71 -82.70 1,797 3.61
  Chhattisgarh 26,196 -3.40 -0.05 7255.28 3,323 6.47
  Jharkhand 23,591 -1.04 1.00 -103.34 2,182 3.51
  Madhya Pradesh 19,106 -2.21 1.82 -120.97 2,525 6.94
  Orissa 23,312 -1.93 -0.70 274.62 2,352 5.19
  Rajasthan 22,545 -0.37 2.32 -16.08 2,947 6.77
  Uttar Pradesh 16,882 -1.31 2.56 -50.97 2,183 6.13
  Average 18,012 -1.57 1.77 -88.72 2,320 5.79
  General
  category states 28,928 -0.60 1.79 -33.59 3,155 6.57
II Special category states
Arunachal Pradesh 27,583 -17.10 -2.63 650.07 15,843 1.92
Assam 22,503 -2.81 -0.90 310.73 2,887 4.43
Himachal Pradesh 43,535 -0.55 2.67 -20.75 8,043 4.81
Jammu and Kashmir 26,597 -2.09 4.99 -41.86 7,330 4.99
Manipur 27,991 -5.44 5.77 -94.37 9,091 1.48
Meghalaya 28,344 -2.76 0.88 -314.93 6,005 3.59
Mizoram 29,850 -7.04 5.34 -131.74 15,424 1.89
Nagaland 29,858 -6.82 1.93 -352.74 8,387 1.47
Sikkim 34,812 -8.89 3.76 -236.40 15,379 6.72
Tripura 29,708 -6.87 -1.06 648.51 2,614 2.76
Uttarakhand 32,130 -2.37 2.34 -101.20 5,518 6.64
Average 27,726 -3.12 1.55 -201.97 5,290 4.54
Average of
all states 28,853 -0.75 1.78 -42.32 3,295 6.45
(1) The GSDP figures are projected applying average annual growth rate since 2001-02 to the
latest available figure
(2) The states like Haryana, Chhattisgrah, Orissa, Arunachal Pradesh, Assam, and Sikkim have
shown fiscal surplus in 2006-07.
Source: Finance accounts of state governments .
84
On the revenue front, the most important measures are:
(i) generating resources through spectrum 3G auction; and
(ii) seriously initiating a divestment/disinvestment programme.
Even if the government decides not to give up strategic control
and retain majority holdings of the companies, there are a
number of profit-making companies with more than 85% hold-
ings. If properly implemented, it is possible to generate an addi-
tional 1.5% of GDP from the two measures. Other important reve-
nue measures would include strengthening and deepening the
TIN in the case of direct taxes. On indirect taxes, the NIC has not
been able to create the information system needed for imple-
menting a complex tax like VAT and moving from this to the regime
of goods and service tax (GST) could create a chaotic situation. It
would be useful to entrust the task of creating a proper informa-
tion system to a competent IT company.
There are a number of reforms the government could initiate
in this year’s budget on the expenditure front. Given that the in-
ternational prices of crude oil and gas are low, the volume of fer-
tiliser subsidy would be substantially lower and the interim
revised estimate of the previous year. What is, however, impor-
tant is that the time is opportune for reforming the subsidy re-
gime when the feedstock prices of fertilisers are low. Even if 200
kg of balanced mix of fertiliser is given to all the farmers at a sub-
sidised price in order to protect the interest of the small farmers
and the balance is decontrolled and sold at the market rates, it
can substantially reduce the subsidy bill in the coming years. It is
also possible to fix the prices based on the nutrient content. This
will not only help in promoting balanced use of fertilisers, but
also encourage investment and upgradation of technology in the
fertiliser sector. Similarly, the low price of crude oil and petro-
leum products provides an opportunity for the government to
dismantle the administered price regime. This will obviate the
need to issuing oil bonds, which amounted to about Rs 76,000
crore in 2008-09.
On the tax reform front, although it may not be possible to gen-
erate revenues and the government may actually lose some, the
government can do a number of important things and simplification
and rationalisation of the tax system itself can serve as a fiscal
stimulus. Perhaps the time is opportune for abolishing the fringe
benefits tax and securities transaction tax. The government may
also clean up the tax structure by abolishing various cesses so
that the tax system is made simple and transparent.
There is considerable discussion as to whether the GST can be
introduced as per the plan in April 2010. Unfortunately, the pre-
paratory work that is required for the proposed dual GST is yet to
be done. This includes passing the constitutional amendments to
empower the central government to levy consumption tax beyond
the manufacturing stage and enabling the states to levy service
taxes. In addition, the dual GST, as the states are supposed to get
powers to levy taxes on services of an all-India nature, the rules of
revenue appropriation will have to be negotiated. Above all, the
information system to administer the state GST, particularly on
interstate transactions has not been put in place. The central gov-
ernment as well as the Empowered Committee of State Finance
Ministers would do well to initiate measures in these areas and
june 20, 2009  vol xliv no 25  EPW   Economic & Political Weekly

speed up the process so that even if it misses the target of April
2010, it can set a clear time table for the switchover.
In the mean time, it is possible for the central government to
make substantial progress in rationalising its domestic indirect
taxes with a view to evolving a GST at the manufacturing stage.
The time is opportune because both the CENVAT rates and the
rates of service tax have been reduced by 6 and 4 percentage
points, respectively to provide a fiscal stimulus and the rates have
been reduced to 8% and 10%, respectively. This would require
the implementation of the important recommendation of the Ex-
pert Group on Service Tax in 2001-02. The group recommended
that the service tax should be generalised by extending it to all
services excluding a small exempted and negative list of services.
Converting the selective taxation of services into a general taxa-
tion of services is an important precondition to move towards the
GST. This will not only extend the tax base significantly, but also
will obviate the need to define each service and avoid tremen-
dous scope for litigation that exists at present. In addition, it will
also help to generalise input tax credit for all goods and services.
On the excise duty front, it is necessary to bring about conver-
gence of tax rates. In fact, it is easy to move towards a single tax
rate for all commodities excluding sumptuary items.
In the next stage, it is possible to switch over to the GST at the
manufacturing stage by unifying the two taxes simply by having a
common threshold and a uniform tax rate and enabling input tax
credit for both goods and services. The government may keep the
threshold at Rs 1 crore which is much higher than the prevailing
threshold for service tax, but much lower than that of union excise
duties. This helps to expand the tax base and to begin with, levy-
ing the tax at 9% which would be revenue neutral. In respect of
sumptuary items of consumption such as cigarettes and petroleum
products, a separate excise may be levied in addition to the gen-
eral GST. This reform can be initiated in the forthcoming budget
itself by converting the prevailing selective service tax into general
and effecting convergence in central excise duties and in the next
budget, the centre can move over to the manufacturing stage GST.
Another important fiscal issue that the budget will have to
deal with is to address the next stage of fiscal consolidation.
Although the final blueprint for this will have to wait for the
recommendation of the Thirteenth Finance Commission, it is
important to think about the next stage of fiscal consolidation
based on the experience gained from the implementation of the
FRBMA. The important issue that needs to be noted is that static
fiscal targets are clearly inappropriate to deal with cyclical changes
in the economy. It may be appropriate to fix the deficit target with
a band. Similarly, it may be more appropriate to fix the fiscal defi-
cit target as a ratio of expenditure rather than GDP as it takes a
longer time to get the firm estimate of the latter. The fiscal respon-
sibility legislation should be followed by a Medium-Term Fiscal
Plan (MTFP) which should specify the targets on both revenue and
expenditure sides. It is important to note that fiscal discipline is
not a function of the finance ministry alone; it has to be owned by
the government and all spending departments should be a part of
implementation. This would entail that along with the passing of
the FRA, the Ministry of Finance should put forth the indicative
targets of expenditure to each of the spending departments for
Economic & Political Weekly  EPW   june 20, 2009  vol xliv no 25
special article
the next three years and the latter, in turn, should work out a clear
prioritisation and action plan based on the indicated targets. In case
there are additional priority expenses, the spending departments
should negotiate with the Ministry of Finance. The important issue
is that the medium-term fiscal framework as well as expenditure
plan will have to be initiated as a part of the fiscal responsibility
and budget management exer­cise and this should be updated
every year. Mere passing of a legislation without a proper imple-
mentation mechanism will put the burden of adjustment only on
the Ministry of Finance and that will result in phasing out capital
expenditure, delaying payments, creating off-budget liabilities
and showing a lower deficit estimates in the budget but coming
out with large supple­mentary demands later in the year which
puts a heavy premium on expenditure management.
6 Conclusions
The preceding analysis shows that the fiscal situation in India is
worrisome. It is also clear that the problem is largely structural.
Much of the problem has arisen from the failure to correct the
structural problems of proliferating subsidies and transfers. It is
also important to realise that the fiscal problem in 2008-09 was
not sudden and that the slowdown in the economy has had only a
small role in the deterioration. A part of the problem was due to
non-payment of fertiliser subsidies accruing in 2007-08 and
partly it was due to spending on the loan waiver, and increased
allocations to various flagship programmes. Of course, the tax-
GDP declined in 2008-09 by 1.5 percentage points due to the eco-
nomic slowdown as well as the tax cuts announced as a part of
the fiscal stimulus package.
In this environment, the government is faced with the formi-
dable challenge of containing the worrisome fiscal deficit while
continuing to provide a necessary fiscal stimulus to revive the
economy. It has also to institute a fiscal restructuring programme
towards achieving fiscal consolidation in the medium term. The
programme should draw lessons from the past and redesign the
fiscal restructuring plan for the centre as well as the states. The
experience shows that a mere passing of legislation does not
necessarily bring about fiscal discipline. The legislation should be
followed by a clear statement of targets on both revenue and ex-
penditure sides through a MTFP and a clear plan to restructuring
expenditures through a Medium-Term Expenditure Plan updated
every year. This will involve the entire government, not just the
finance ministry in enforcing fiscal discipline.
Note
1 In 2002-03, almost 80% of the companies which were required to make Tax
Deduction at Source (TDS) simply did not file the returns and the income tax
department did not have any information on the non-filers. It is in this back-
ground that TIN was established to focus on the compliance by TDS companies.
The results on revenues were dramatic. See Rao and Rao (2006), p 104.
References
Rao, M Govinda (2003): “Incentivising Fiscal Transfers in Indian Federation”, Pub-
lius: The Journal of Federalism, Volume 33, Number 4, pp 43-62.
Rao, M Govinda and R Kavita Rao (2006): “Trends and Issues in Tax Policy and Re-
forms in India”, India Policy Forum 2005/06, pp 55-123, Brookings Institution
and NCAER.
Rao, M Govinda, Tapas K Sen and P R Jena (2008): “Issues before the Thirteenth
Finance Commission”, Economic & Political Weekly, Vol XLIII, No 36, 6 Septem-
ber, pp 41-34.
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