Manage the fisc?

What is the Budget’s approach to the fiscal question? The short answer is it has given a cold shoulder to the hawks.

The revised estimate (RE) for fiscal deficit in 2021-22 is 6.9% of the GDP against the 6.8% figure given in last year’s budget estimates (BE). This probably is an underestimate of the extent of fiscal overshooting given the fact that at 17.6%, the nominal GDP growth for 2021-22 has turned out to be considerably higher than 14.4% figure which the 2021-22 Budget assumed. By budgeting for a fiscal deficit of 6.4% in 2022-23 and announcing a gross market borrowing of ₹14.95 lakh crore, the government has indicated that it will not give up on its spending plans, which it believes are crucial to boosting long-term growth prospects of the economy, for the sake of fiscal prudence. When seen in the context of both the US Federal Reserve and the Reserve Bank of India raising interest rates over the next fiscal year, this is a bold but laudable move.

To be sure, the government could end up doing better than expected on the deficit front in the next fiscal, given the fact that the Budget has a conservative nominal GDP growth estimate of just 11.1%. The headline fiscal deficit number – it is reflective of the total borrowing requirement of government – is keenly watched by bond markets and rating agencies. But what goes into the making of this headline number is equally important for the economy. It is here that looking at the fine print of the budgetary numbers is important.

Let us take the question of the tax burden first. The government’s tax collection is an important component of its overall receipts. There are both direct and indirect taxes in the economy and the former are considered to be progressive in nature. This is because it is mostly the rich who pay direct taxes and tax rates increase with income levels. The 2022-23 BE numbers expect the share of direct taxes in gross tax revenues to increase to 51.5%. This is marginally higher than the 49.7% share in 2021-22 RE numbers and significantly higher than the 46.6% share in 2020-21, the year when the pandemic’s disruption was the worst. A fall in share of indirect taxes is good news as far as the incidence of tax burden is concerned.

To be sure, on the larger question of improving the tax-GDP ratio, the Budget has not been able to achieve much. At 10.7%, the taxGDP ratio in the 2022-23 BE figures is higher than the 9.9% BE number for 2021-22. But it is still lower than the 11% plus levels seen in 2016-17 and 2017-18. When read with the fact that higher taxes on petroleum products have resulted in a windfall gain on the revenue front, this statistic is a matter of even greater concern. It is also worth noting that even the direct tax to GDP ratio has fallen compared to past levels. This number is expected to be 5.5% according to 2022-23 BE numbers while it was 6% in 2018-19, a year before the government reduced corporate tax rates. Next is the question of fiscal federalism. India’s constitution mandates a formula based transfer of taxes between the centre and the states. This formula is decided by the finance commission every five years. According to the 15th Finance Commission’s recommendations, the Centre is supposed to share 41% of revenue with the states. Here, the situation continues to be grim. The 2022-23 BE numbers put the share of states in gross tax revenue at 29.6%, largely the same as past two years.

The huge discrepancy between the Finance Commission mandated share of the actual share of states is on account of the centre classifying a large part of its taxes as special cess and duties, keeping them outside the divisible pool of revenues. When read with the fact that the Budget has also brought in other provisions to influence the spending behaviour of the states – interest-free loans to boost capex is one such example – this is not good news on the fiscal federalism front. To be sure, the issue of Centre-state resource sharing is more vexed than what the headline numbers on states’ share suggests because, driven by political considerations, the Centre has been increasingly spending more and more money on sectors which are technically in the purview of states. This issue has been repeatedly flagged by NK Singh, the chairman of the 15th Finance Commission.

There are two major factors which could change the budgetary fiscal maths over the course of the next fiscal. The first is a big spike in interest rates on government bonds due to a combination of higher market borrowings by the government and global tightening in liquidity. This could lead to a significant increase in interest payment expenditure of the government.

The second could be a higher than expected inflation, resulting in lower growth. That could mean lower revenue and higher spending requirements especially on the capex front.