With the focus on central finances, the steep deterioration in states' finances has frequently been overlooked
When a blight affects the head, it is natural for people to neglect the rest of the body. And so, with the focus on central finances, the steep deterioration in states' finances has frequently been overlooked. The deterioration started in the 1980s, and accelerated in the late 1990s, moving from 3 per cent of GDP to 4.5 per cent. This is why one must take heart from the outcome of the recently concluded meeting of the state finance ministers, who have shown a new urgency in their efforts to restore their fiscs to good health.
As a first step, they have agreed to stop the counter-productive sales tax war from January 1. Four floor rates (0, 4, 8 and 12 per cent) will come into force, while a comprehensive value added tax will be introduced from April 1, 2001. For good measure, the finance minister has promised a single excise rate. These will be seminal changes, and it must be hoped that the deadlines will not be allowed to slip.
The main reasons for the declining financial health of the states are well known -- a high wage bill, few sources of revenue, and uneconomic pricing of services provided by the state (power and water supply, for instance). As long as central transfers were increasing, till 1971-91, the pressure was not felt by the states. But when the transfers started slowing down, states finances collapsed. This situation has been exacerbated by the rise in interest rates, for the states are all net borrowers.
The proposed tax changes are welcome. A full-fledged VAT should do a power of good, since it is widely suspected that excise revenues have been flat in relation to GDP in part because of widespread and growing tax evasion--which will become more difficult under VAT. The new system should also help remove some of the distortions that now devil the indirect tax structure.
It is a pity, though, that little attention has been paid to cutting expenditure. The straw to break the camel's back came with the recommendations of the Fifth Pay Commission, which placed an additional burden of about Rs 2,000 crore on the states. But expenditure restructuring is not yet on anyone's agenda, and is obviously deemed a hot potato. Nor has there been a proper attempt to charge economic prices. A decision to do so in respect of power was taken two years ago but has come to nought. The revenue deficit, which is the main culprit, has therefore risen from 0.7 per cent of GDP in the first half of the 1990s to 1.6 per cent in 1998-99, the highest level ever. The proportion of states with a revenue deficit has also increased from 13 per cent in 1980-81 to 85 per cent now. ="description" content="">
