ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Faulty Logic of Fiscal Orthodoxy

The Kelkar Committee takes fiscal orthodoxy to the extreme and suggests steps that will jeopardise growth.

The report of the Committee on the Roadmap for Fiscal Consolidation (the Vijay Kelkar Committee) paints an alarming fiscal situation and calls for the immediate implementation of fiscal correction measures to revive growth and employment. The Kelkar Committee has suggested a series of mid-term fiscal corrections including a huge contraction in Plan expenditure. According to the report, the measures proposed, if implemented, can put central government finances back on the path of fiscal consolidation (as proposed by the Thirteenth Finance Commission) and this should, in turn, stimulate growth. There is no unanimity on whether deficit r­eduction is a must for higher growth. Indeed, worldwide, an important school of thought recognises the need for a countercyclical fiscal policy to arrest the economic downturn that set in during 2008. But even if one accepts the new fiscal conservatism as has been aggressively propagated since the onset of economic reforms in India, there are serious questions about the road map proposed by the Kelkar Committee. Although the report suggests some very obvious generic measures to raise the tax to GDP ratio, the main focus of the report is to reduce government expenditure on subsidies, “rightsize” Plan expenditure, as it calls it, and take steps to increase disinvestment proceeds.

One needs to understand that much of the increase in the centre’s fiscal deficit since the beginning of the global financial crisis has been due to the series of fiscal stimulus packages provided by the government. A large part of these stimuli were in the form of a general reduction in the rates of indirect taxes. The cuts in tax rates and the slowdown in growth resulted in a significant decline in revenue collection after 2008-09. In fact, between 2008-09 and 2009-10, the actual revenue from customs duty, central excise and service tax fell by Rs 16,555 crore, Rs 5,622 crore and Rs 2,519 crore, respectively. Although the tax rates have since been revised upwards, revenue growth remains sluggish. According to the Kelkar Committee, the likely shortfall in tax revenue in 2012-13 will be around Rs 60,000 crore, which as a percentage of GDP works out to 0.6%. And if we take into account the expected shortfall (Rs 20,000 crore) in proceeds from disinvestment, the total shortfall on the receipts side works out to almost 0.9% of GDP. In other words, the fiscal deficit slippage from 5.1% (Budget Estimates 2012-13) to 6.1% of GDP, as projected in the report, is primarily due to the decline in revenues. But the stance of the Kelkar Committee is that the primary reason for the fiscal imbalance is the unbridled growth of subsidies and Plan expenditure. If one looks at the subsidy figures without any prejudice it will be observed that while subsidies as a percentage of GDP jumped sharply from 1.37% in 2007-08 to 2.21% in 2008-09, they declined to 2.09% in 2010-11. The increase to 2.35% in 2011-12 (Revised Estimates) will have to be understood as the fallout of the rise in inter­national crude prices and the corresponding growth in the petroleum subsidy from 0.23% of GDP in 2008-09 to 0.77% of GDP in 2011-12 (RE); this trend is continuing in 2012-13. Of course, a growing petroleum subsidy bill is a matter of concern and one has to take proactive steps towards rationalisation of the prices of petroleum products. But it needs to be acknowledged that much of the price issue in the petroleum sector can be addressed without creating hardship by rationalising taxation of the sector. The report, sadly, is silent on the taxation of the petroleum sector – an important source of revenue for both the centre and states – without reforming which there can be no reform of petroleum prices.

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