A three-pronged strategy

Lay out a credible fiscal consolidation plan, reverse tax buoyancy decline, and boost non-tax revenues

In two months from now, Union Finance Minister Nirmala Sitharaman will present the Budget for 2021-22. This will be her third Budget and much more challenging than her previous two exercises in July 2019 and February 2020.

There is, however, a perception that with the Indian economy bouncing back next fiscal year in terms of growth, Budget-making will be a lot easier than the tough challenges the finance minister is encountering in the current year. Revenues would increase as a consequence, making the task of managing government expenditure less onerous. So, why should next year’s Budget be more challenging?

This is a flawed assessment. It is true that the Union government’s receipts next year would improve significantly because, compared to the current year’s contraction, the economy next year is expected to notch up a record growth rate. But in spite of that, the challenges for the 2021-22 Budget will not go away. On the contrary, they would become more formidable.

The first challenge will arise from expectations. In 2020-21, the Budget numbers would be deeply disappointing. Most people are already prepared to see a sharp deterioration in government finances. While revenues will be substantially short of the targets, savings on expenditure would be small. With hugely enhanced borrowings, the fiscal deficit would be at least more than double of what was budgeted at the start of the year.

When Ms Sitharaman presents the revised numbers on revenue and expenditure on February 1, 2021, nobody would be surprised by those slippages. Instead, most people would be expecting healthier numbers for 2021-22 as they all will reckon that a smart recovery in gross domestic product (GDP) would result in an improved revenue situation. It is this burden of expectation of healthier government finances in 2021-22 that the finance minister will have to carry on her shoulders. Managing that expectation in itself would be a tough challenge for at least two reasons.

One, the finance minister will have to present revenue estimates that are seen to be based on a realistic and credible assessment of the state of the economy. The revenue projections in her last two Budgets have gone awry. The actual net revenue collection in 2019-20 was over 14 per cent less than what was initially projected in the Budget Estimate. In 2020-21, that shortfall will be higher.

The shortfall during the current year can be explained away by a contraction of the economy in the wake of Covid-19 and the economic lockdown. But the shortfall in 2019-20 was due to over-ambitious target setting and failure to assess that the economy had begun to slow. Therefore, the revenue target that Ms Sitharaman sets for 2021-22 will be keenly watched. It has to reflect the expected recovery in the economy next year and at the same time has to be realistic to inspire confidence in the achievability of the targets. It is going to be a tightrope walk for the finance minister.

Two, an improved economic situation will also raise expectations of a clear articulation of a road map for fiscal consolidation in the coming one fiscal year or two, after the huge slippage that 2020-21 would experience. Just presenting higher revenue numbers for next year would not be enough. Equally important would be to present a credible trajectory of a reduction in the fiscal deficit next year and the year after.

The best course would be to synchronise the deficit reduction road map with the pace at which revenues are projected to increase. But this is easier said than done. Expectations of fiscal consolidation would be high and managing them would require exquisite skills in presenting numbers transparently and setting targets without stretching credulity.

Apart from managing expectations, the next year’s Budget will also have to deal with a central issue in tax revenues that is often ignored. For the last few years, the buoyancy factor for Central taxes has been on a steady decline. It rose in 2014-15 and 2015-16, but it has been falling steadily since then. From 1.63 in 2015-16, the buoyancy factor for the Centre’s gross tax collection fell to 1.54 in 2016-17, 1.05 in 2017-18, 0.77 in 2018-19, and -0.5 in 2019-20.

This is an alarming situation. The buoyancy factor measures the incremental rise in tax collection in relation to growth in the economy. A number below 1 would suggest that tax revenues are rising at a slower pace than the economy’s growth rate. A declining buoyancy factor points to the need for a serious revamp of the taxation structure, the coverage of the tax base, and the efficiency of the tax collection system. Merely relying on growth next year may not, therefore, boost tax revenues. There is need for a closer study of the factors that have led to a decline in tax buoyancy and making amends in those areas. These will not be easy tasks. Hence, the challenge would be even tougher next year.

Finally, there is the question of non-tax revenues that the Centre collects every year. The Centre’s non-tax revenues used to be about 3 per cent of GDP about two decades ago, when Yashwant Sinha was finance minister. The last time non-tax revenues reached a level close to 3 per cent of GDP was in 2010-11. Since then, they have stayed well below 2 per cent of GDP.

The debate over raising the share of tax revenues in the government kitty has always been intense. That is how it should be. But it is puzzling that no such debate takes place over the need for raising the share of non-tax revenues in the total government revenues. Non-tax revenues are by rule not part of the divisible pool. So, the Centre gets to keep the entire collection without having to share it with the states. Yet, this neglect of non-tax revenues defies logic and sensible fiscal planning.

Illustration: Binay Sinha

At present, non-tax revenues are largely dependent on telecom spectrum fees (about 34 per cent) and dividends as well as profits from public-sector enterprises, banks, and the Reserve Bank of India (almost 40 per cent). This overdependence on a few items is denying the government the opportunity of exploiting the true potential of raising non-tax revenues from other areas.

The fact is most government services, administered by different Central ministries, are offered at ridiculously low fees. For instance, there are no reasons why civil service aspirants (one million of them submit applications for these tests every year) should be charged only Rs 100 for the preliminary examination or Rs 200 for the main examination. Similarly, the government can surely raise more fees from operators of direct-to-home television service providers, whose customers now are over 70 million.

The list of such government services that could augment non-tax revenues could be longer. But the point is that the government must direct its energies to ensure that the services it offers in various sectors of the economy generate adequate fees at least to reimburse the cost it incurs. That alone would help the Centre raise its non-tax revenues closer to 3 per cent of GDP. This could mean additional non-tax revenues of about Rs 2 trillion, all of which could be retained by the Centre.

In short, the Budget exercise for next year would need some forward-thinking on how it could prepare a credible plan for restoring the government’s fiscal health within a predetermined time frame, address the weaknesses in the taxation system to improve tax buoyancy, and widen the reach and increase the rates of non-tax levies to augment the government’s revenues from areas that so far have been ignored.