Indian Economy, 5th edition (82 page)

Tax Expenditure

As per the current
Economic Survey 2012-13
, there is significant divergence in India between the official rates of taxes and the actual or
effective rate of taxation
(which is a simple ‘ratio of tax revenue collected to the tax base’). This arises on account of the
exemptions
to the tax rate. As indicated earlier in the section on
collection rates
, the magnitude of
revenue foregone
(
i.e.
tax expenditure)
is indeed high.

In case of the
direct taxes
, the situation prevails as given below:

•
Tax foregone on account of exemptions under
corporate income tax
for 2011-12 was estimated at Rs. 51,292 crore. In this case,
deduction
on account of accelerated depreciation, deduction for export profits of export-oriented units located in special economic zones (SEZs) and profits of businesses in the power and telecom sectors were some of the major incentives. Though, the absolute amount of deductions has decreased as a result of phasing out of profit-linked deductions.

•
Tax forgone on account of exemptions under
personal income tax
for individual taxpayers was estimated at Rs. 35,698 crore in 2011-12. In this case, the bulk of the revenue foregone was on account of the exemptions given for certain investments and payments under Section 80 C of the Income Tax Act.

In so far as
indirect taxes
are concerned, revenue forgone is defined as the difference between duty that would have been payable but for the issue of exemption notification and actual duty paid in terms of the relevant notification. The situation stands as given below:

•
The revenue forgone for the financial year 2011-12 in respect of
excise duties
is estimated at Rs. 2,12,167 crore including Rs. 12,880 crore on account of area-based exemptions.

•
Duty forgone for the year 2011-12 on account of all the exemption notifications on
customs
was estimated at Rs. 2,76,093 crore.

There is merit in limiting the exemptions or their
grandfathering
22
on a case-by-case basis so as to realize fuller tax potential through a wider tax base. The
Direct Tax Code 2010
has enough scope to cut such exemptions. Similarly, the on-going indirect tax reforms such as the GST has such provisions.

14
TH
FINANCE COMMISSION

The Commission was constituted on
January 2, 2013
under the Chairmanship of Dr. Y. V. Reddy, former RBI Governor with Prof. Abhijit Sen, Ms. Sushma Nath, Dr. M. Govinda Rao and Dr. Sudipto Mundle as the other
four
members. The recommendations of the Commission will apply on the period
2015-20
and its report has to be submitted by October 31, 2014.

The broad
Terms of Reference
and the
matters
to be taken into consideration by the Commission are:

1.
Tax Devolution
&
Grant
related references

(i)
the distribution between the union and states of the net
proceeds of taxes
which are to be, or may be, divided between them under
Chapter I, Part XII
of the Constitution and the allocation between the states of the respective shares of such proceeds;

(ii)
the principles which should govern the
grants-in-aid
of the revenues of the states out of the Consolidated Fund of India and the sums to be paid to the states which are in need of assistance by way of grants-in-aid of their revenues under
Article 275
of the Constitution for purposes other than those specified in the provisos to
Clause (1)
of that article; and

(iii)
measures needed to augment the Consolidated Fund of a state to supplement the resources of the
panchayats
and
municipalities
in the state on the basis of the recommendations made by the Finance Commission of the state.

2.
To review the state of finances,
deficit
, and
debt
levels of the union and states and suggest measures for maintaining a stable and sustainable fiscal environment consistent with equitable growth including suggestions to amend the FRBMAs currently in force. The Commission has been asked to consider and recommend incentives and disincentives for states for observing the obligations laid down in the FRBMAs.

3.
In Commission is required to consider –

•
the
resources
of the central government and the
demands
on the resources of the central government;

•
the
resources
of the state governments and
demands
on such resources under different heads, including the impact of debt levels on resource availability in debt-stressed states;

•
the objective of not only balancing the receipts and expenditure on revenue account of all the states and the union but also generating surpluses for capital investment;

•
the
taxation efforts
of the central government and each state government and the potential for additional resource mobilization;

•
the level of
subsidies
required for sustainable and inclusive growth and equitable sharing of subsidies between the central and state governments;

•
the
expenditure
on the non-salary component of maintenance and upkeep of capital assets and the non-wage-related maintenance expenditure on Plan schemes to be completed by March 31, 2015 and the norms on the basis of which specific amounts are recommended for the maintenance of capital assets and the manner of monitoring such expenditure;

•
the need for
insulating the pricing
of public utility services like drinking water, irrigation, power, and public transport from policy fluctuations through statutory provisions;

•
the need for making public-sector enterprises competitive and market oriented; listing and disinvestment; relinquishing of non-priority enterprises;

•
the need to balance
management of ecology, environment, and climate change
consistent with sustainable economic development; and

•
the impact of the proposed
goods and services tax
on the finances of the centre and states and the mechanism for compensation in case of any revenue loss.

5.
To review the present
public expenditure management
systems and recommend, including –

•
budgeting and accounting standards and practices;

•
the existing system of classification of receipts and expenditure;

•
linking outlays to outputs and outcomes; and

•
best practices within the country and internationally.

6.
To review the present arrangements of financing of
Disaster Management
with reference to the funds constituted under the Disaster Management Act 2005 and make recommendations.

7.
To indicate the basis on which it has arrived at its findings and make available the
state-wise estimates of receipts and expenditure
.

The Commission is required to generally take the base of population figures as of 1971 in all cases where population is a factor for determination of devolution of taxes and duties and grants-in-aid. However, the Commission may also take into account the demographic changes that have taken place subsequent to 1971.

Introduction

Public finance is a much wider title which includes all those matters which are connected with public money, the money a government gets, spends, borrows, lends, raises or prints. Public finance, i.e., finances of the government now named as
public economics
does not only discuss the issue that how much of the country’s resources the government should acquire for its own use but also discusses the ‘efficiency’ with which the money should be used. Public finance gets reference in the ancient treatise
Arthashastra
1
of Kautilya which covers ‘treasury, sources of revenue, accounts and audit’ in a very detailed way—however, the subject has gathered much significance in the post Second World War period once the governments’ role in the economy started expanding
2
due to various reasons namely, the rise of public sector, delivery of public goods, law and order, defence, etc. By the
s
econd World War, the importance of the government’s role in the economy was emergently felt and it was believed that all needs of the people cannot be met if the economy is left to the market (i.e., private sector) in its entireity. For example, national defence, law enforcement and other major areas which must be cared for by the national government besides the supplies of
affordable or free
healthcare, education, social security measures, etc. could only be taken care of by the governments (
as they are not profit driven)
. This is why there was an agreement among the experts and the policymakers to expand the government’s role in the economy. This led to the ultimate rise of the public sector around the world.
3
Here we will be looking into the major concepts related to the area of public finance with special reference to India.

Budget

An annual financial statement of income and expenditure is generally used for a government, but it could be of a firm, company, corporation etc
4
. The ‘word’ has its origin in the British parliamentary exercise of preparing such statement way back in the mid-18th century from the
f
rench word
‘Bugeut’
meaning a leather bag out of which the financial statement was brought out and presented in the parliament. Today, this word is used to mean the annual statement in all economies around the world.

The
c
onstitution of India has a provision (Art. 112) for such a document called Annual Financial Statement to be presented in the Parliament before the coummencement of every new fiscal year—popular as the Union Budget. Same provision is there for the States too.

Data in the Budget

The Union Budget has
three sets
5
of data for every concerned sector or sub-sector of the economy:

(i)
Actual data of the preceding year (here preceding year means one year before the year in which the Budget is being presented. Suppose the Budget presented is for the year 2008–09, the Budget will give the final/actual data for the year 2006–07 because the Budget is presented in February end of financial year 2007–08. After the data either we write ‘
A
’, means actual data/final data or write nothing (India writes nothing).

(ii)
Provisional data of the current year (since the Budget for 2008–09 is presented at the end of the fiscal 2007–08, it provides Provisional Estimates for this year (shown as ‘
PE
’ in brackets with the data).

(iii)
Budgetary estimates for the following year (here following year means one year after the year in which the Budget is being presented or the year for which the Budget is being presented, i.e., 2008–09. This is shown with the symbol ‘
BE
’ in brackets with the concerned data.).

One comes across certain other kinds of data, too in day-to-day government economic literature. There are such three other kinds of data—

(i) Revised Estimate (RE)

Revised Estimate is basically a current estimation of either the budgetary estimates (BE) or the provisional estimates (PE). It shows the contemporary situation. It is an interim data.

(ii) Quick Estimate (QE)

Quick Estimate is a kind of revised estimate which shows the most latest situation and is useful in the process of going for future projections for some sector or sub-sector. It is an interim data.

(iii) Advance Estimate (AE)

Advance Estimate is a kind of quick estimate but done ahead (is advance) of the final stage when data should have been collected. It is an interim data.

Developmental and Non-developmental Expenditure

Total expenditure incurred by the government is classified into two segments—developmental and non-developmental. All expenditures of productive nature are developmental such as on the heads of new factories, dams, bridges, roads, railways, etc.—all
investments.

The expenditures which are of consumptive kind and do not involve any production are non-developmental, i.e., paying salaries, pensions, interest payments, subsidies, defence expenses, etc.

This classification is not used in the Indian Public finance management now (see
Plan
and
Non-Plan Expenditure,
in the next entry).
6

Plan and Non-Plan Expenditure

Every expenditure incurred on the public exchequer is classified into two categories—the plan and the non-plan. All those expenditures which are done in India in the name of
planning
is the
plan expenditure
and rest of all are
non-plan expenditures
. Basically, all asset creating, and productive expenditures are plan and all consumptive, non-productive, non-asset building are non-plan expenditures and are developmental and non-developmental expenditures, respectively.

Since the financial year 1987–88, there was a terminology change in Indian public finance literature when developmental and non-developmental expenditures were replaced by the new terms plan and non-plan expenditures, respectively. (It was suggested by the Sukhomoy Chakravarti committee.)
7

Meanwhile
, a high-power Panel headed by Dr. C. Rangarajan (Chairman, Prime Minister’s Economic Advisory Council), in
September 2011
suggested for redefining
Plan
and
Non Plan
expenditures as the
Capital
and
Revenue
expenditures as the former set of terms ‘blur the classification’ – this will facilitate linking expenditure to ‘outcomes’ and better public expenditure, the panels suggested.
Major
suggestions of the Panel are:

•
Plan
and
Non-Plan
distinction in the Budget is neither able to provide a satisfactory classification of ‘developmental’ and ‘non-developmental’ dimensions of government expenditure nor an appropriate budgetary framework. It has therefore become ‘dysfunctional’,

•
Suggests for
redefining roles
of the Planning Commission (PC) and the Finance Ministry (FM) as per which the PC should be responsible for formulation of the five-year plan and the task of firming up annual budgets should be entrusted to the FM.

•
The PC should dispense with the exercise of approving annual plans of states and it could hold a strategy or review meeting with representatives of the states.

•
Public expenditures should be split into
capital
and
revenue
expenditures.

•
Public expenditure should have ‘management approach’ based on measurable ‘outcomes’, indicating that the reponsibility should be assigned to the Finance Ministry.

Analysis of the Situation:
While the need for looking beyond the budget is well accepted, there are many factors raising doubts on the ‘efficacy’ and ‘relevance’ of the five-year plans as the instrument. The division of expenditure between
Plan
and
non-Plan
is artificial and creates problems, such as –

•
Plan expenditure tends to get priority especially when austerity and expenditure reduction has to be done periodically for fiscal consolidation. Non-Plan expenditure gets the
cut
even if it is vitally needed for economic development, an example is budget provision for maintenance of assets such as hospitals, schools and irrigation dams already created under Plan but whose maintenance is treated as non-Plan.

•
Review and implementation of schemes is another area of direct responsibility for the Ministry of Finance and the Ministry of Statistics and Programme Implementation. The Finance Minister himself had, in the budget speech for 2005-06, promised to ensure that programmes and schemes were not allowed to continue indefinitely from one Plan period to another without an independent and in-depth evaluation. The Planning Commission, serving as the
focal point for Plan allocations
, dilutes the role of the Finance Ministry in this case.

•
‘Output’ and ‘Outcome Budgeting’ was introduced by the Central Government from the Budget for 2005-06. Non-Plan expenditure remains out of its purview. This means, for example, the outcome of expenditure on running schools and hospitals will not be evaluated. This again is another fallout of the artificial division into Plan and non-Plan.

The
dichotomy
results in
dual
and
confusing
responsibility of the Ministry of Finance and the Planning Commission and adversely affects the whole budget process, formulation and implementation. The Ministry of Finance is responsible for fiscal consolidation, containing the fiscal deficit and abiding to the FRBM Act. But in formulating the Budget its role in Plan expenditure budgeting is
diluted
by the discussions which the ministries have with the Planning Commission. The finalisation of Plan allocations for the State budgets also suffers from this weakness. Ultimately, the Central Government has to fix the market borrowing by State governments taking the overall sustainable borrowing limits, including the requirements of the Central Government. The Planning Commission tends to have a more optimistic estimate of resources likely to be available for financing the Plan expenditure as ‘fiscal deficit’ management and control is not its direct responsibility.

Revenue

Every form of money generation in the nature of income, earnings are revenue for a firm or a government which do not increase financial liabilities of the government—i.e., the tax incomes, non-tax incomes along with foreign grants.

Non-revenue

Every form of money generation which is not income or earnings for a firm or a government (i.e., money raised via borrowings) is considered a non-revenue source if they increase financial liablities.

Receipts

Every receiving or accrual of money to a government by revenue and non-revenue sources is a receipt. Their sum is called
total receipts.
It includes all incomes as well as non-income accruals of a government.

Revenue Receipts

Revenue receipts of a government are of two kinds—Tax Revenue Receipts and Non-tax Revenue Receipts—consisting of the following income receipts in India:

Tax Revenue Receipts

This includes all money earned by the government via the different taxes the government collects, i.e., all direct and indirect tax collections.

Non-tax Revenue Receipts

This includes all money earned by the government from sources other taxes. In India they are—

(i)
Profits
and
dividends
which the government gets from its public sector undertakings (PSUs).

(ii)
Interests
recieved by the government out of all loans forwarded by it, be it inside the country (i.e., internal lending) or outside the country (i.e., external lending). It means this income might be in both domestic and foreign currencies.

(iii)
Fiscal services
also generate incomes for the government, i.e., currency printing, stamp printing, coinage and medals minting, etc.

(iv)
General Services
also earn money for the government as the power distribution, irrigation, banking, insurance, community services, etc.

(v)
Fees
,
Penalties
and
f
ines
received by the government.

(vi)
Grants
which the governments receives—it is always external in the case of the central government and internal in the case of state governments.

Revenue Expenditure

All the expenditures incurred by the government are either of
revenue kind
or
current kind
or
compulsive kind.
The basic identity of such expenditures is that they are of consumptive kind and do not involve creation of productive assets. They are either used in running of a productive process or running a government. A broad category of things that fall under such expenditures in India—

(i)
Interest
payment by the government on the internal and external loans;

(ii)
Salaries,
Pension
and
Provident Fund
paid by the government to the government employees;

(iii)
Subsidies
forwarded to all sectors by the government;

(iv)
Defence
expenditures by the government;

(v)
Postal Deficits
of the government;

(vi)
Law and order
expenditures (i.e., police & paramilitary);

(vii)
Expenditures
on social services
(includes all social sector expenditures as education, health care, social security, poverty alleviation, etc.) and
general services
(tax collection, etc.);