Budget 2015: Check out the Finance Commission's tips to fix fiscal deficit
The Commission has patted states on the back for largely meeting the fiscal consolidation targets set for them, while rapping the Centre on the knuckles for not being disciplined enough and amending the FRBM Act and Rules at its will.
With the Fourteenth Finance Commission report being tabled three days before the budget, it was inevitable that Finance Minister Arun Jaitley would be asked, at his press conference on the subject, how the report (which recommended 42 percent tax devolution) would affect the Centre's finances, particularly the fiscal deficit. Wait till Saturday, was his response but the report must have had him and his team dismayed.
But if he is serious about fiscal consolidation in the long term, there are a lot of tips the report gives. The chapter on fiscal consolidation in the Commission’s report has suggested sweeping changes in the mechanisms that are supposed to maintain fiscal discipline among governments and could test the sincerity of politicians who declare their commitment to fiscal prudence. Of course, not all of them will please Central governments very much.
It has been a general lament of public finance experts — and state governments — that there is no system to enforce fiscal discipline on a fiscally profligate Central government, even as it wields the stick on states, forcing them to be fiscally prudent.
The Finance Commission has found a way out of this unfair situation. It has suggested that the existing Fiscal Responsibility and Budget Management Act be replaced with a Debt Ceiling and Fiscal Responsibility law, invoking Article 292 of the Constitution. The Article says that Parliament can, by law, fix borrowing limits on the Union government. (Borrowing limits broadly means capping the fiscal deficit.) Noting that the existing FRBM Act is "implicitly consistent" with Article 292, the Commission suggests that invoking the Article explicitly could "accord greater sanctity and legitimacy to fiscal management legislation". It asks states to do the same under Article 293(1), which has similar provisions relating to them.
Apart from the new law, the other recommendations include amending the current FRBM Act to remove the concept of effective revenue deficit, mandating the setting up of an independent fiscal council to vet the fiscal implications of budget proposals before they are finalised and putting a statutory ceiling on the sanction of new capital works to a certain multiple of the annual budget provision.
But the charge of fiscal fundamentalism – a moniker thrown at anyone who suggests that the government should not spend as if there were no tomorrow – is unlikely to stick. Recognising that the insistence on fiscal deficit targets often squeeze necessary developmental expenditure in states, the Commission has also recommended that states be given additional borrowing headroom if they meet certain conditions.
The Commission says it recognises "that the fiscal environment should be conducive to equitable growth" and points out that "the medium term framework for fiscal environment that we envisage is not mere consolidation, but prudent fiscal empowerment. . ." Its roadmap, it says, "treats a conducive fiscal environment as the joint responsibility" of the Union and state governments.
The Commission has patted states on the back for largely meeting the fiscal consolidation targets set for them, while rapping the Centre on the knuckles for not being disciplined enough and amending the FRBM Act and Rules at its will. "While the Union government has been generally able to enforce fiscal rules on the States, its own record of adherence to fiscal rules has not been impressive." The proposed new law is meant to address this.
The independent fiscal council is also expected to do something similar. When the FRBM Act was amended in 2012, a new Section 7A got the Comptroller and Auditor General (C&AG) to undertake a periodic review of compliance by the central government. Though this has not been implemented, it will only mean be a post-facto review. What the Commission favours is an ex-ante (or prior) evaluation of fiscal implications of budget proposals and their compliance with fiscal consolidation rules. The assessment, it recommends, should be tabled in Parliament.
How this will be implemented, given the secrecy surrounding the budget remains to be seen. Former finance minister Yashwant Sinha has often spoken about the need to do away with the secrecy around the budget making process. The Commission, however, has pointed out that such an independent institution exists in several countries, including the United States, Brazil and Canada.
The Commission may have meant that the budget proposals should be vetted by the council after the budget it presented and before it is passed by Parliament. But will there be time to do this within the budget session needs to be seen.
The Commission has rejected the concept of an effective revenue deficit, introduced by President Pranab Mukherjee when he was finance minister. The concept was brought in when the central government was under fire for a high fiscal deficit, driven mainly by a galloping revenue deficit. The finance ministry under Mukherjee put out the argument that the Central government’s revenue deficit was actually not as high as it looked considering a chunk of it went as grants to states for capital expenditure. The concept was widely panned but found its way into the FRBM Act when it was amended in 2012. Former finance minister P Chidambaram, who succeeded Mukherjee, has also been critical of the idea. The Commission has called the effective revenue deficit an "artificial carving out of the revenue account deficit" and said that it "leads to an accounting problem and raises the moral hazard issue of creative budgeting".
While recommending that states’ fiscal deficit be capped at 3 percent of GSDP, the Commission has allowed them some conditional borrowing flexibility – they can borrow up to 0.25 percent of GSDP beyond the 3 percent fiscal deficit in a particular year if they maintain a debt-GSDP ratio of up to 25 percent and another 0.25 percent of GSDP if the interest payments are below 10 percent of the revenue receipts in the preceding year. Thus states can have a maximum fiscal deficit of 3.5 percent in a particular year if they have behaved well on these two counts the previous year and if there is no revenue deficit in the year for which the borrowing limit is fixed as well as the previous year. What’s more, if a state is not able to fully utilise its borrowing limit of 3 percent of GSDP in a particular year (converted into an actual figure), the shortfall (in rupees) can be carried over into the next year. However, this can be done only within the five years of the Commission’s award period; this facility cannot be rolled over beyond 2019-20. This will be a boon for states who have complained – quite rightly – that rigid fiscal deficit rules affect their development expenditure plans.
There is no similar flexibility for the Central government. The Commission has recommended that the fiscal deficit cap for the Centre be retained at 3 percent of GDP from 2016-17 to 2019-20 and that the revenue deficit be eliminated well before 2019-20.
But the Commission has also tried to ensure that giving flexibility does not lead to governments spending recklessly. Noting that capital expenditure plans are drawn up without much thought and that poor implementation leads to time and cost overruns, the Commission has said that "there is a need to curb the scope for perverse allocation of available funds among competing projects and to ensure that the economy benefits from investments in capital works. . ." It therefore suggests a statutory ceiling on the sanction of new capital works to an appropriate multiple of the annual budget provision.
Will these recommendations get implemented? Unfortunately, there is no compulsion on the government to do so, since these are not part of the core mandates of the Commission, as set out in the Constitution (which relate only to tax devolution and sharing of resources). Several recommendations of previous Finance Commissions have remained unimplemented. Will these go the same way? That is for the government to answer.
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