Progressive Fiscal Policy in India

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Progressive Fiscal Policy in India

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 ii

Progressive Fiscal Policy in India

Edited by

Praveen Jha

Copyright © Praveen Jha, 2011 All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage or retrieval system, without permission in writing from the publisher. First published in 2011 by Sage Publications India Pvt Ltd B1/I-1 Mohan Cooperative Industrial Area Mathura Road, New Delhi 110 044, India www.sagepub.in Sage Publications Inc 2455 Teller Road Thousand Oaks, California 91320, USA Sage Publications Ltd 1 Oliver’s Yard, 55 City Road London EC1Y 1SP, United Kingdom Sage Publications Asia-Pacific Pte Ltd 33 Pekin Street #02-01 Far East Square Singapore 048763 Published by Vivek Mehra for Sage Publications India Pvt Ltd, typeset in 11.5/13.5 pt Adobe Garamond by Star Compugraphics Private Limited, Delhi and printed at Chaman Enterprises, New Delhi. Library of Congress Cataloging-in-Publication Data Progressive fiscal policy in India/edited by Praveen Jha. â•…â•…â•‡ p. cm. â•… Includes bibliographical references and index. â•… 1. Fiscal policy—India.â•… I. Jha, Praveen K. (Praveen Kumar) HJ1335.P76â•…â•…â•… 339.5'20954—dc22â•…â•…â•… 2011â•…â•…â•… 2011001398 ISBN:â•‡ 978-81-321-0558-9 (HB) The Sage Team:â•‡ Gayatri Mishra, Swati Sengupta, Amrita Saha and Deepti Saxena

Contents

List of Tables List of Figures List of Abbreviations Acknowledgements Introduction by Praveen Jha

ix xvii xxi xxix xxxiii

Section I: Overall Macroeconomic Policy Regime and Its Linkages with Fiscal Policy 1. Finance Capital, Fiscal Deficits and the Current Global Crisis Prabhat Patnaik 2. Liberalization as a Constraint on Fiscal Policy: Some Lessons from the Indian Experience C. P. Chandrasekhar 3. Inclusive Growth in Neoliberal India—A Mirage? Nirmal Kumar Chandra

3

21 38

4. Growing Inequality: A Serious Challenge to the Indian Society and Polity S. L. Shetty

86

5. Assessing Tax Policy and Tax Compliance in the Reform Era Saumen Chattopadhyay

148

v

Progressive Fiscal Policy in India

Section II: Pressing Concerns Relating to Fiscal Federalism in India â•‡ 6. Challenges to Fiscal Policy in India in the Era of Reforms T. M. Thomas Isaac and R. Ramakumar

177

â•‡ 7. Fiscal Devolution in the Era of Liberalization: The Indian Experience Jayati Ghosh

206

â•‡ 8. Thirteenth Finance Commission: Core Issues and New Challenges D. K. Srivastava

222

â•‡ 9. Horizontal Imbalances in Indian Federalism Tapas K. Sen 10. Regaining the Constitutional Identity of the Finance Commission: A Daunting Task for the Thirteenth Commission K. K. George and K. K. Krishnakumar 11. Towards a Rational and Progressive Fiscal Policy: What Role for Local Governments? M. A. Oommen

246

264

283

Section III: Public Policies and Institutions towards Addressing the Development Deficits 12. Unbalanced Growth, Tertiarization of the Indian Economy and Implications for Mass Living Standards 299 Utsa Patnaik 13. From Outlays to Outcomes: Some Missing Links N. C. Saxena 14. Social Sector Expenditures: An Analysis for All India and States, 1980–81 to 2007–08 S. Mahendra Dev and N. Sreedevi vi

326

339

Contents

15. Centrally Sponsored Schemes: Are They the Solution or the Problem? Praveen Jha, Subrat Das and Nilachala Acharya

374

16. Improving India’s Health: The Significance of Public Financing Mita Choudhury and A. K. Shiva Kumar

406

17. Financing the Right to Education Santosh Mehrotra

422

About the Editor and Contributors Index

440 448

vii

viii

List of Tables

2.1

Tax-GDP Ratios by Country

3.1

Trade, Current Account and Capital Account Balances as Percentages of GDP Public Debts as Percentages to Gdp Revenues Forgone (` in crore) and Share (Per cent) in Aggregate Tax Collected, FY 2008 and 2009 Expenditure of Central and State Governments on Social Sectors as Percentages of GDP Health Facilities and Per Capita Income in Sri Lanka and India Credit to Farmers According to Different Size and Classes of Landholding and the Overall Distribution of Landholdings Distribution of Outstanding Loans of Cultivators from Different Sources (Percentages) Distribution of Credits to SSIs by Size of Credit Limits, March 2007 Incremental Deposit, Credit and Investment in Government Papers of Commercial Banks, March 2008–February 2009

3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9

4.1 4.2

Percentage of People below Poverty Line in India (1973–2004) Number of Persons Below Poverty Line in India (1973–2004) (in lakh) ix

25 44 45 51 56 62 70 71 74 76 91 91

Progressive Fiscal Policy in India

4.3

Ratio of Poverty across Major States (Rural and Urban in 2004–05) 4.4 Proportions and Numbers of Poor People as per International Poverty Lines: China and India 4.5 Regional Breakdown of the 2005 Headcount Index and Number of Poor for Various Poverty Lines 4.6 Population Living Below Poverty Line: SCs and STs 4.7 Poverty Ratio Using a Holistic Poverty Line 4.8 Trends of Social Sector Expenditure by General Government (Centre and State Governments combined) 4.9.1 Secondary Education—Enrolment and Dropout, 2004–05 4.9.2 Dropout Rates by Social Composition, 2004–05 4.10 Progress towards Achieving MDGs in India 4.11 Some Health Parameters: India and Its Neighbours 4.12 Past and Present Scenario on Employment and Unemployment (CDS basis) 4.13 Distribution of Workers by Type of Employment and Sector (million) 4.14 Growth in Organized Sector Employment (per cent Per Annum) 4.15 Unemployment rate among Youth (Age Group 15–29 years) (per cent) (CDS basis) 4.16 Incidence of Unemployment among Rural Agricultural Households (CDS basis) 4.17 Patterns of Income Distribution as per NCEAR Surveys (in per cent) 4.18 Distribution of NDP at Current Prices between Rural–Urban Areas 4.19 Distribution of GDP between Agricultural and Non-agricultural Sectors (at Current Prices) 4.20 Gini Coefficients for the Annual Series of State-wise Real Per Capita GSDP 4.21 Classification of Income Tax Payable by Individuals and Average Taxes Payable—By Range of Income x

92 94 95 96 97 99 100 100 101 102 104 105 105 105 106 107 108 110 111 113

List of Tables

4.22 Top Earners amongst Company Executives 4.23 Total Remuneration of 277 Executives 4.24 Percentage Increase in 2006–07 of Executives’ Salaries over 2002–03 4.25 Range-wise Total Remuneration of Executives (Amount in ` Crore) 4.26 Range-wise Increase in Total Remuneration of Executives (Range Sorted on the basis of remuneration in 2006–07) 4.27 Non-government Non-financial Public Limited Companies—Selected Financial Ratios (in percentages) 4.28 Certain Key Characteristics of Operational Holdings 4.29 Changes in the Size Distribution of Operational Holdings and Operated Area 1960–61 to 2002–03 4.30 Select Ratios and Growth Rates of Agriculture and Allied Activities Sector 4.31 Outstanding Credit of Scheduled Commercial Banks According to Size of Credit Limit (Amount in ` Crore) 4.32 Priority Sector Advances (` crore) 4.33 Number of Offices of Scheduled Commercial Banks according to Population Group 4.34 Population Group-wise Distribution of Employees of Scheduled Commercial Banks in India 4.35 Bank Group-wise Lending to Real Estate and other Sensitive Sectors 4.36 Secondary Market Turnover in Financial and Commodities Markets (Amount in ` crore) 4.37 Business Growth of Futures and Options Segment of NSE 5.1 5.2 5.3 5.4

Share of Central Taxes in GDP in the Reform Era Increase in Non-corporate and Corporate Assessees Personal Income Tax: Income per Return and ETR Profit-wise Distribution of Companies and Effective Tax Rate xi

117 118 119 119 120 121 124 125 131 133 135 137 138 139 141 143 157 159 160 161

Progressive Fiscal Policy in India

5.5

Buoyancy Estimates of Central Taxes in the Reform Era 5.6 Tax Expenditures: Revenue Foregone 5A.1 Percentage Composition of Major Central Taxes

164 166 171

6.1â•… Distribution of the Number of States that Availed Normal WMA, by the Number of Days the State government Treasuries Availed WMA, 2001–02 to 2007–08 180 6.2 Investment outstanding in 14-day intermediate treasury bills, All States, 2001–02 to 2005–06, as on end-March, (in ` Crores) 183 6.3 Selected Features of the Pattern of Revenue Receipts of State Governments, 1980 to 2009 (as Percentage to GDP at Current Market Prices) 186 6.4 Selected Features of the Pattern of Capital Receipts of State Governments, 1990–91 to 2007–08 (as Percentage to GDP at Current Market Prices) 187 6.5 Selected Features of the Pattern of Expenditure of State Governments, 1990–91 to 2006–07 (as Percentage to GDP at Current Market Prices) 189 6.6 Key Interest Rates on State government Borrowings from the Centre and the Market, 1990–91 to 2005–06 (in Per cent Per Annum) 191 6.7 Year of Passing of State FRBM Acts and the Proposed Year of Elimination of Revenue Deficits, India 197 8.1 8.2 8.3 8.4 8.5

Annual Buoyancy of Central Taxes Central Budget 2009–10: Selected Variables (` crore) Transfers Relative to Centre’s Gross Revenue Receipts Share of Centre and States in Revenue Receipts: Before and After Transfers (Average for Finance Commission Periods) (Per cent) Relative Shares of Centre and States in Revenue and Total Expenditures (Per cent) xii

226 227 235 236 236

List of Tables

8.6 8.7 8.8

Share in Total Transfers for Different Groups of States (Per cent) Share of Different Categories of States in Tax Devolution (Per cent) Share in Finance Commission Grants (Per cent)

10.1 Share of States in Central Government Revenue (Figures in percentages) 10.2 Assessment and Actuals: Central Finances as per Eleventh and Twelfth Finance Commissions’ Awards (` in Crores) 10.3 Per Capita Grants-in-aid to Major States recommended by the Twelfth Finance Commission (Figures in `) 10.4 Non-plan Revenue Surplus/Deficit of All States (1978–2010) Finance Commission’s Forecasts and Actuals (` in Crores) 10.5 Non-plan Revenue Surpluses after all Transfers under the Award of the Twelfth Finance Commission 10A.1 Grants-in-aid Recommended by the Twelfth Finance Commission for State Specific Needs 11A.1 State-wise Distribution of Per Capita Own Revenue of PRIs 2002–03 12.1 Per cent contribution (three-year averages centred on specified years) of the Economic Sectors to GDP in India, from Output Values in 1999–2000 prices 12.2 Data for Figure 12.2: Three-year Averages Centred on Specified Years (Values in 1999–2000 Prices at Factor Cost) 12.3 Share of Agriculture in GDP and Employment and Per Worker Relative Output During 1983 to 2004–05 (in Percentage) 12.4 Number of Workers (All-India Rural, in Million), and Real Output per Worker (in `100 and in 1999–2000 Prices at Factor Cost) xiii

240 241 243 269 273 275 278 279 279 294

300 302 303 304

Progressive Fiscal Policy in India

12.5 Data for Figure 12.8 12.6 Data for Figure 12.9 (First two and Last Two Columns Used) 12.7 Data for Figure 12.10 13.1 India’s Social Indicators Compared with Other Developing Countries 13.2 Share of expenditure on education and health as a percentage of total expenditure by the states 14.1 Combined Social Sector Expenditure: Share of States 1990–91, 2000–01 and 2006–07 (%) 14.2.1 Social Sector Expenditure by Centre and States: 1980–81 to 2006–07 14.2.2 Combined Government Expenditure on Social Sector 14.3 Public Expenditure on Education and Health: International Comparisons 14.4 Social Sector Ratios 14.5 Central Government Expenditure on Social Sector 14.6 Social Sector Expenditure (Social services + Rural Development) by Centre 14.7 Central Government Intra-sectoral Allocation: In Education, Health and Rural Development: 1992–93 to 2008–09 (%) 14.8 Trend Growth Rates of Social Sector Expenditure of All States (per cent Per Annum) 14.9 State-wise Per capita Real Expenditure on Social Services and Rural Development (1993–94 Prices) 14.10 Index of Per capita Real Expenditure on Social Services and Rural Development (1993–94 Prices) 14A.1 All States’ Social Sector Expenditures as per cent of GDP 14A.2 The Proportion of All States Social Sector Expenditure in the Total Expenditure (Revenue + Capital) xiv

315 318 321 327 328 342 344 346 348 349 350 352 354 357 359 360 369 371

List of Tables

14A.3 All States Per Capita Real (1993–94 Prices) Social Sector Expenditure (`)

372

15.1 Gross Devolution and Transfers from Centre to States 15.2 Resources Transferred from Centre to States as per Finance Commission Recommendations 15.3 Magnitude and Composition of GBS for Plan by the Centre (which comprises—Central Assistance for State and UT Plans and Plan expenditure by Central Government Ministries) 15.4 Composition of Total Grants from the Centre to States 15.5 Growing Share of the Union Budget for Plan Schemes of Central Government Ministries 15.6 Funds for Central Government’s Plan Schemes Directly Transferred to State/District Level Implementing Agencies

397

16.1 Comparative average Total Expenditure per hospitalized case during last 365 days by type of hospital adjusted by Consumer Price Index—Rural and Urban 16.2 Projected Public Expenditures on Health 16.3 Taxation and Public Health Expenditures in India

413 418 419

17.1 Utilization of SSA funds by Educationally Backward States

436

xv

380 382

387 389 394

xvi

List of Figures

2.1 2.2 2.3

Tax–GDP Ratios Contribution to Decline in Tax–GDP Ratio 1989–90 to 2001–02 Contribution to Increase in Tax–GDP Ratio 2001–02 to 2008–09

3.1 GFD as a Percentage of the GDP, 1981–2008 3.2 Tax Revenue as Percentage of Gdp and Na-gdp, 1971–2008 3.3 Personal Income Tax, Corporate Tax and Indirect Taxes as Percentages of Non-agricultural GDP, 1971–2008 3.4 Corporate Income Tax as a Percentage of OS of the Corporate Sector, 1981–2006 3.5 Centre’s Total Expenditure as a Percentage of Gdp, 1971–2008 3.6 Revenue Expenditure, Interest Payments and Capital Expenditure as Percentages of Centre’s Total Expenditure, 1971–2008 3.7 Percentage share in GDP of Central and State Government Outlays on Social Services, including Education and health, 1986–2006 3.8 Share of Agriculture and SSI in Bank Credit, 1980–2008 (per cent) 3.9 Percentage Shares of Direct and Indirect Credit in Total Bank Credit to Agriculture, 1972–2006 xvii

24 27 28 44 47 48 50 54 55 56 67 68

Progressive Fiscal Policy in India

4.1 4.2

Tax Burden (Tax Payable as Percentage of Income of Returns) 114 Share of Agriculture and Other Small-scale Industries Credit in Total Scheduled Commercial Bank’s Credit 129

5A.1 Share of major Central Taxes in GDP in the Reform Era 6.1 6.2 6.3 6.4 6.5

Investment Outstanding of State Governments in Intermediate Treasury Bills, Quarterly Estimates, 1998 to 2008 (in ` Crores) Share of Different Components of Devolution of Resources from Centre to States to GDP, in Per cent to GDP Average Rates of Interest on the Liabilities of the Centre and All States, 1980 to 2004, (Per cent Per Annum) Total Outstanding Liabilities of All Indian States as Per cent of GDP, 1991 to 2008, as on end-March (in Per cent) Revenue Deficit and Fiscal Deficit of States, 1970–71 to 2007–08 (as Per cent of GDP)

172

181 185 192 194 195

7.1

Deficit Indicators of All State Governments (as Per cent of GDP) 7.2 Composition of Total Receipts of State Governments (Per cent) 7.3 States’ Share of Total Tax Revenues of Centre (Per cent) 7.4 Gross Devolution from Centre to States 7.5 Sources of Financing Fiscal Deficit of States (Per cent of States’ GDP) 7.6 Central Schemes as Per cent of Total Grants to States

216

8.1 GDP Growth at 1999–2000 Prices: Actual and Potential

225

xviii

211 212 213 214 215

List of Figures

8.2 8.3 8.4 9.1 9.2 9.3

Share of States in Combined Revenue and Total Expenditures Share of Groups of States in Total Transfers Share of Different Groups of States in Tax Devolution Horizontal Imbalance in Non-special Category States Vicious Circle of Public Intervention for Development Per Capita Grants Received under CPS and CSS

11A.1 State-wise Distribution of Per Capita Own Revenue of PRIs 2002–03 12.1 Per cent Contribution of the Economic Sectors to GDP in India, from Output Values in 1999–2000 Prices 12.2 Sectoral Output Per Head and Gdp Per Head, 1981–82 to 2005–06, (` in Constant 1999–2000 Prices) 12.3 Share of Agriculture in GDP and Employment, 1983 to 2004–05 12.4 All-India Rural, Number of Workers, Million and Real Output per Worker (in `100 and in 1999–2000 Prices at Factor Cost) 12.5.1 Decade-wise Annual Growth Rates of Central Development and Total Spending, 1970–71 to 1999–2000 12.5.2 Decade-wise Annual Growth Rates of Spending on Economic and Social Services by State governments, 1970–71 to 1999–2000 12.5.3 Central Government Rural Development Expenditure and Infrastructure Expenditure as per cent of NNP 12.6.1 Unemployment Rates for Female Workers (All-India Rural 1993–94 and 2004–05) xix

237 240 242 247 255 256 295

301 302 303 304 309 310 311 312

Progressive Fiscal Policy in India

12.6.2 Unemployment Rates for Male Workers (All-India Rural 1993–94 and 2004–05) 12.6.3 Unemployment Rates for Female Workers (All-India Urban 1993–94 and 2004–05) 12.6.4: Unemployment Rates for Male Workers (All-India Urban 1993–94 and 2004–05) 12.7 Direct and Indirect Demand for Grain with Rising Income 12.8 Foodgrains Output and Availability, 1991–92 to 2006–07 12.9 Real Monthly Per Capita Expenditure and Per cent Spent on Food plus Clothing, 1993–94 and 2004–05 (All-India Rural) 12.10 Real Monthly Per Capita Expenditure and Per cent Spent on Food plus Clothing, 1993–94 and 2004–05 (All-India Urban) 15.1 Flow of Funds from Union Budget to a State

312 313 313 314 315 319 322 379

16.1 Health Expenditure as a Percentage of GDP, Selected Countries, 2004 409 16.2 Per Capita Health Expenditure, Selected Countries, 2004 (PPP US$) 409 16.3 Trends in Public Expenditure on health as a percentage of GDP, India, 1970–71 to 2003–04 411 16.4 Fund flow to Health Sector by Sources, 2004–05 (per cent) 411 16.5 Share of Public and Private Health Spending, Selected Countries, 2004 (per cent) 412 16.6 Relationship between per Capita Public Expenditure on Health (PPP US$) and Life Expectancy at Birth (years) across Different Countries, 2004 414 16.7 Per Capita Public Spending (`) and Life Expectancy at Birth (Years) across Selected Indian States, 2005–06 415 xx

List of Abbreviations

ACA ADRs AIBP AIITS AMC ANMs APDRP APL AWWs

Additional Central Assistance American Depositary Receipts Accelerated Irrigation Benefit Programme All India Income Tax Statistics Asset Management Companies Auxiliary Nurse Midwives Accelerated Power Development & Reform Programme Above the Poverty Line Anganwadi Workers

BE BIMARU BIS BJP BOP BPL BPO BRGF BSE

Budget Estimate Bihar, Madhya Pradesh, Rajasthan, Uttar Pradesh Bank for International Settlement Bharatiya Janata Party Balance of Payments Below Poverty Line Business Process Outsourcing Backward Regions Grant Fund Bombay Stock Exchange

CAB CAG CBGA CDPOs CDS CenVAT CEO

Current Account Balance Comptroller and Auditor General Centre for Budget and Governance Accountability Child Development Project Officers Current Daily Status Central Value Added Tax Chief Executive Officer xxi

Progressive Fiscal Policy in India

CGRR CGST CIA CII CIT CMD CMIE CMNMP CMP CPI (M) CPIAL CPIIW CPC CPS CRA CSO CSS CST CVD

Centre’s Gross Revenue Receipt Central Goods and Services Tax Central Intelligence Agency Confederation of Indian Industry Corporate Income Tax Chairman and Managing Director Centre for Monitoring the Indian Economy Chief Minister’s Nutrition Meal Programme Common Minimum Programme Communist Party of India (Marxist) Consumer Price Index for Agricultural Labourers Consumer Price Index for Industrial Workers Central Pay Commission Central Plan Schemes Credit Rating Agencies Central Statistical Organisation Centrally Sponsored Schemes Central Sales Tax Countervailing Duty

DEA DPC DPEP DPSP

Department of Economic Affairs District Planning Committee District Primary Education Programme Directive Principles of State Policy

EAPs ECCE EPWRF ERP ESOFs ETR

Externally Aided Projects Early Childhood Care and Education Economic and Political Weekly Research Foundation Effective Rates of Protection European Science Open Forums Effective Tax Rate

FA FAO FBT FC FC13

Financial Advisor Food and Agriculture Organization Fringe Benefits Tax Finance Commission Thirteenth Finance Commission xxii

List of Abbreviations

FD FDI FER FIIS FRBM FRL FY FYP

Finance Department Foreign Direct Investment Foreign Exchange Reserves Foreign Institutional Investors Fiscal Responsibility and Budget Management Fiscal Responsibility Legislations Fiscal Year Five Year Plan

GBS Gross Budgetary Support GCF Gross Capital Formation GDP Gross Domestic Product GDRs Global Depositary Receipts GDT Gross devolution and transfers GER Gross Enrolment Ratio GFD Gross Fiscal Deficit GNI Gross National Income GNP Gross National Product GoI Government of India GPs Gram Panchayats GSDP Gross State Domestic Product GST goods and Services Tax HCR HNWI HSN HUDCO IAS ICDS ICT IDEAs IEC IFPRI IGIDR IIEST

Head Count Ratio High Net Worth Individuals with Assets of at least $1â•¯million Harmonized System of Nomenclature Housing and Urban Development Corporation Indian Administrative Service Integrated Child Development Services Information and Communication Technology International Development Economics Associates Information, Education and Communication International Food Policy Research Institute Indira Gandhi Institute of Development Research Indian Institutes of Engineering Science and Technology xxiii

Progressive Fiscal Policy in India

IIT IMF IMR IRDP IT ITC ITeS

Indian Institute of Technology International Monetary Fund Infant Mortality Rate intensive Rural Development Programme Information Technology Input Tax Credit IT-enabled Services

JNNURM

Jawaharlal Nehru National Urban Renewal Mission

M&A MANVAT MAT MDGs MDM MMR MOUs MPCE MPLAD

mergers and acquisition Manufacturing Stage Value Added Tax Minimum Alternate Tax Millennium Development Goals Mid day Meal Maternal Mortality Ratio Memorandum of Understandings Monthly Per Capita Expenditure Member of Parliament Local Area Development

NA-GDP NCA NCAER NCD NCEUS

Non-agricultural GDP Normal Central Assistance National Council of Applied Economic Research National Co-operative Development Corporation National Commission for Enterprises in the Unorganized Sector National Child Labour Project National Common Minimum Programme National Democratic Alliance National Development Council Net Domestic Product National Family Health Survey Non-governmental Organizations Nirmal Gram Puraskar Net National Product Non-performing Assets National Police Commission National Rural Employment Guarantee Act

NCLP NCMP NDA NDC NDP NFHS NGOs NGP NNP NPA NPC NREGA

xxiv

List of Abbreviations

NREGS NRHM NRI NSDP NSE NSS NSSF NSSO

National Rural Employment Guarantee Scheme National Rural Health Mission Non-resident Indian Net State Domestic Product National Stock Exchange National Sample Survey National Small Savings Fund National Sample Survey Organisation

OBC OD OECD OMB OS OSR

Other Backward Classes Overdraft Organisation for Economic Co-operation and Development Open Market Borrowing Operating Surplus Own Source Revenue

PAN PBT PCPHS PDS PFC PHC PIT PM PMGSY PPP PR PRIs PSB PSEs PSK PSU PT QE

Permanent Account Number Profit before Tax Per Capita Public Spending on Health Public Distribution System Power Finance Corporation Primary Health Centre Personal Income Tax Prime Minister Prime Minister’s Gram Samrudhi Yojana Purchasing Power Parity Poverty Ratio Panchayati Raj Institutions Public Sector Banks Public Sector Enterprises Prarambhik Shiksha Kosh Public Sector Undertaking Pupil-teacher Quick Estimates

RBI RCH

Reserve Bank of India Reproductive and Child Health xxv

Progressive Fiscal Policy in India

RD RE RF RGI RKVY RRBs RSBY RTE RTI

Revenue Deficits Revised Estimates Revenue Foregone Registrar General of India Rashtriya Krishi Vikas Yojana Regional Rural Banks Rashtriya Swasthya Bima Yojana Right to Education Right to Information

SCA SCs SDP SEBI SEZ SFC SGST SHG SLPEs SMC SMEs SSA SSIs STPI STs

Special Central Assistance Scheduled Castes State Domestic Product Securities and Exchange Board of India Special Economic Zone State Finance Commission State Goods and Services Tax Self-help Groups State-level Public Enterprises School Management Committee Small and Medium Enterprises Sarva Shiksha Abhiyan small-scale industries Software Technology Parks of India Scheduled Tribes

TB TDS TFC TFR ThFC TNIP ToR TSC

Tuberculosis Tax Deduction at Source Twelfth Finance Commission Total Fertility Rate TOR of the Thirteenth Commission Tamil Nadu Integration Nutrition Project Terms of Reference Total Sanitation Campaign

UEGS UFC UNDP

Urban Employment Guarantee Scheme Union Finance Commission United Nations Development Programme xxvi

List of Abbreviations

Unicef UPA UPSS UTs

United Nations Children’s Fund United Progressive Alliance Usual Principal and Subsidiary Status Union Territories

VAT

Value Added Tax

WHO WMA

World Health Organization Ways and Means Advances

xxvii

xxviii

Acknowledgements

As is well known, the era of economic liberalization since the early 1990s has witnessed a paradigm shift from a largely state-guided to a market-driven framework for the Indian economy, and every arena of the country’s economic system has undergone significant changes. Over this period, different product and factor markets have been made more open—domestically as well as internationally— and the overall growth rate has accelerated in recent years, driven largely by the consumption of the elite. However, over the same period, the growth rate of the commodity-producing sectors has come under substantial pressure and the well-being of the masses has not shown any significant improvement; rather, in several key respects there have been setbacks to the important indicators of well-being. This regime change has not only discouraged public investment but also required the state to withdraw from important sectors. Furthermore, the state has become a vehicle for numerous exemptions and concessions to the capitalist class as a whole on the pretext of protecting their confidence in the economy. In other words, India’s fiscal policy for close to two decades now, has been influenced considerably by the neoliberal economic policy discourse. The essence of neoliberalism gets reflected in the implementation of the Fiscal Responsibility and Budget Management (FRBM) Acts aimed at curbing fiscal activism of the government through a self-imposed target of eliminating revenue and minimizing fiscal deficits. Downsizing the scale and intensity of government activism xxix

Progressive Fiscal Policy in India

lies at the core of neoliberal policy reforms, and this has reflected in most of the development indicators, in particular the huge deficits with respect to even the most basic needs such as food, elementary literacy, avoidable morbidity, etc. It was this backdrop which provided the Centre for Budget and Governance Accountability (CBGA) with the motivation to organize a conference, ‘Towards Progressive Fiscal Policy’, in December 2008 in New Delhi. The objective of this conference was to engage in meaningful dialogue on policy issues towards promoting progressive fiscal policies for inclusive development, which could address the needs and aspirations of the marginalized. The single-most important message emerging from the conference was that all progressive forces should engage to influence the state in order to ensure that opportunities for decent livelihood options and basic minimum services such as primary education and health care, etc., are provided to all. Attempts should be made towards a constructive interface of progressive forces with policymakers which would provide an impetus to the efforts towards making fiscal policies accountable to the common people. The deliberations at the conference were extremely worthwhile, covering a large gamut of the relevant issues; it was felt that disseminating these high-quality contributions to a large audience through a book would be valuable. I express my gratitude to all the contributors to this volume for providing their papers and responding to my requests in timely fashion. Without their keen interest and cooperation this venture would not have seen the light of day. My heartfelt thanks for their high-quality contributions and support to all the authors for this volume: A. K. Shiva Kumar, C. P. Chandrasekhar, D. K. Srivastava, Jayati Ghosh, K. K. George, K. K. Krishnakumar, M. A. Oommen, Mita Choudhury, N. C. Saxena, Nilachala Acharya, Nirmal Kumar Chandra, N. Sreedevi, Prabhat Patnaik, R. Ramakumar, S. L. Shetty, S. Mahendra Dev, Santosh Mehrotra, Saumen Chattopadhyay, Subrat Das, T. M. Thomas Isaac, Tapas K. Sen and Utsa Patnaik. xxx

Acknowledgements

For reasons of space, we were not able to include all the conference papers in the present book. We are bringing out a separate volume comprising papers which focus on specific experiences of select states with respect to critical issues in their public finance. I am grateful to all of them whose work is not directly represented in this book, but their ideas greatly enriched the discussions: Abhijit Sen, Aditya Kumar Patra, Atul Kumar Singh, Arun Kumar, Bhagabata Patro, Madhusudan Ghosh, N. J. Kurian, Pranab Chattopadhyay, Rajesh Mani, Smita Gupta, Subhashis Gangopadhyay, Surajit Das and T. R. Manjunath. Special thanks are due to all the chairs and discussants at the conference for sharing their views on the subject: Alakh N. Sharma, Amiya Bagchi, Atulan Guha, G. K. Chadha, Himanshu, Jyotirmoy Bhattacharya, Prasenjit Bose, Pronab Sen and Pulin Nayak. I must also note the active participation by a large number of scholars, activists and students in the conference. Their questions and deliberations greatly enriched the quality of not only the conference but also the present volume. As may be expected, they are too numerous to be acknowledged individually. This book would not have been possible without the invaluable support provided by Bhumika Jhamb, Divya Singh, Navanita Sinha and Nilachala Acharya who formed the core team at CBGA, working on the conference and the volume. Thanks are also due to the entire team of CBGA—Gyana Ranjan Panda, Harsh Singh Rawat, Jawed A. Khan, Kaushik Ganguly, Khwaja Mobeen UrRehman, Pooja Parvati, Ranjeet Singh, Rupashree Mohapatra, Sakti Golder, Subrat Das, Sumita Gupta, Trisha Agarwala and Yamini Mishra. A special mention to Deepak L. Xavier, Indranil, Ram Gati Singh and Siba Sankar Mohanty, members of the CBGA team in the past, for their contributions to the conference. Over the years, I have benefited immensely from close interactions with several excellent scholars and friends in particular at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi, and their inputs have had a deep influence on my thinking and intellectual engagements. This book has also xxxi

Progressive Fiscal Policy in India

benefited, directly or indirectly, from their contributions. The list of all those I am indebted to is a long one and it would be difficult to thank each one of them individually here. However, special mention must be made of Abhijit Sen, C. P. Chandrasekhar, Jayati Ghosh, Prabhat Patnaik, Utsa Patnaik and Vikas Rawal. Needless to add that they cannot be implicated for the shortcomings of the present endeavour. Finally, I am extremely grateful to Dr Sugata Ghosh and his team at SAGE Publications for their exceedingly competent handling of the manuscript, and for putting up with unreasonable demands at times. It has been a pleasure to work with them. Praveen Jha

xxxii

Introduction Praveen Jha

Practical men, who believe themselves to be quite free from any intellectual influences, are usually the slaves of some defunct economist…soon or late, it is ideas, not vested interests, which are dangerous for good or evil. —Keynes (1936: 384–85)

As is common knowledge, fiscal policy refers to a range of instruments and strategies adopted by governments with respect to their resource mobilization and expenditure and these are put into motion, primarily, through the budgetary processes of a government. By deciding how to raise resources, and where and how to spend money, budgetary policies help to define the priorities of government and such decisions have major implications for growth prospects as well as for income distribution in an economy. Sure enough, what all constitute the elements of a progressive fiscal policy is a contested and complex question, and the answer to it will obviously depend, inter alia, on contending theoretical/ philosophical perspectives, the specificities of an economy and its state of development. However, in our judgment it would be appropriate to take the view that, for such a policy, apart from a healthy pace of economic transformation, issues of poverty and equity ought to be its central concerns; hence such a progressive fiscal policy should be embedded in an overall macroeconomic policy framework that nurtures a process of pro-poor growth which xxxiii

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ensures equitable distribution of income and/or productive assets, including human capital, so that the fruits of development are shared by all in an egalitarian manner. In other words, a progressive fiscal policy should aim to contribute towards a pro-poor growth which ensures, preferably, that the poor and the marginalized benefit disproportionately in each period’s growth increment, or at least guarantees fulfilment of the basic needs. Achieving the first outcome requires measures that assure the pro-poor distribution of that increment, that is, facilitating a larger share of the proceeds of economic growth in favour of the poor, although the second yardstick may not be as ‘demanding’. Some obvious examples of measures in support of such a macro-policy regime would be: investments in nutrition, health and education programmes for the poor; land reforms and other asset redistributive policies and infrastructural facilities (e.g., irrigation for land owned by the poor; investments in credit programmes or input subsidies aimed at subsistence farmers) (Chenery et al., 1974). Thus, a progressive fiscal policy, with other supportive elements of an overall macropolicy such as monetary and exchange rate policies, can be put in place by governments towards the promotion of full employment, generation of participatory economic growth and wealth creation and the equitable distribution of income and assets across all sections of the society to ensure ‘greatest addition to welfare of the greatest numbers’, to use the oft-repeated phrase by economists. As is well known, during the so-called ‘Golden Age of Capitalism’, especially in Europe, the United States and other developed countries, fiscal policy was a powerful instrument to address the issue of basic needs of the masses and to revert the income inequalities trend inherited from liberal capitalism. Progressive and selective taxes, direct taxation of wealth and inheritance, wholly publicly funded (or highly subsidized) provisioning of services and goods considered ‘meritorious’ (health, education and housing) and a social security system based on universality were among the major government instruments employed to secure equitable distribution of growth gains and continuously raise the level of standards of living of the people (Antunes, 2001). In these countries, the xxxiv

Introduction

post-war dominant economic policy paradigm born out of the exigencies of World War II and the legacies of the Great Depression of the 1920s and ’30s, backed by the theoretical armoury of the Keynesian Revolution and a host of other important contributions to the emergent and powerful discipline of so-called Development Economics, established models of ‘mixed economy’, and ‘welfare state’, with governments committed to full employment. There was a sense of confidence among the majority of economists and academicians of all ideological persuasions regarding the ability of the government to intervene in economic management effectively to address the issues of maintenance of full employment, to create the major pillars of the welfare state (health, water and sanitation, education, social services, social security and pensions), and the provisioning of the essential infrastructure for an efficient capitalism (public utilities, energy, transport and communications, banking and financial institutions). However, as is well known, after having ruled the economic policy roost for more than a quarter of a century following World War II, the Keynesian paradigm came under increasing attack and was ‘officially’ discredited in several advanced capitalist countries, beginning with the United Kingdom and the United States, after being blamed for stagflation and all other presumed and perceived macroeconomic ills afflicting the system. There was a push to replace it by the rediscovered nineteenth-century blend of minimalist state, deregulation, privatization and free trade under the rubric of neoliberalism. Macroeconomic policy-making under the aegis of neoliberal ascendancy has been overwhelmingly guided by the objective of attaining and maintaining macroeconomic stability, defined largely by strict adherence to rather conservative levels of inflation, budget and current account deficits, with no regard whatsoever to the basic needs of the people in any meaningful sense. Further, adoption of stabilization programmes have coincided with major policy thrusts towards trade liberalization, market decontrols and privatization, and a rollback of the developmental role of the state. xxxv

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As in the developed world, economic policy discourses in developing countries in the post-World War II era were significantly imbued by the spirit of dirigisme, drawing on Keynesianism as well as a range of heterodox and radical perspectives. Sure enough, India was no exception in this respect, and its overall development trajectory, after it gained Independence from the British Colonial rule, was formulated, at least in principle, within a progressive framework. For close to four decades after Independence, Indian policy-makers stuck to a path of mixed economy planning strategy, which included extensive regulatory controls over the economy and was broadly based on an ‘inward-looking import substitution industrialisation’ model of development. Several government-owned enterprises were established, and a host of administrative controls were adopted to steer the economy towards its planned trajectory. Public sector enterprises were assigned a significant role in terms of creating vibrant infrastructural facilities to facilitate the growth process. It may be recalled that the role of the public sector, in its broader sense, was not only to control the commanding heights of the economy, but also to take initiatives in the provision of essential services and in meeting the basic needs of the people. The role of public services in rearranging the flow of income was emphasized by the Committee Report on ‘Distribution of Income and Levels of Living’, headed by Dr P. C. Mahalanobis, when it observed that: [R]eal incomes, particularly of the low income groups are increasingly affected by the provision of various types of services provided by the states which do not get reflected in the income data. Some of the services like low cost housing, free primary education, health and social welfare services, improve the relative income position of the low income groups and their trend to reduce concentration in the distribution of real income. (Planning Commission, 1964: 19)

However, as is generally well acknowledged, the socialist rhetoric of the post-independence era up to the 1980s notwithstanding, India’s development strategy suffered from serious structural limitations as it did not address adequately, inter alia, the fundamental constraints of asset and income inequality, which obviously limited xxxvi

Introduction

the economic prospects for the masses. To be sure, compared to the colonial period, very significant economic advances were made, but both with respect to growth as well as its progressive distribution, outcomes remained well below potential, and even the issues of the basic needs of the masses received inadequate attention. Thus, with respect to the thumb rule stated at the outset, an evaluation of India’s overall growth strategy and accompanying macroeconomic policy (including its fiscal component), certainly the way it unfolded for almost four decades after independence would suggest significant gaps and failures. [For reason of space, we need not get into a detailed discussion of the causes underlying India’s poor performance in these respects. Interested readers may refer to Patnaik and Chandrasekhar (1995) and Chandrasekhar and Ghosh (2002) for excellent accounts]. As is well known, since the early 1990s there has been a tectonic shift in India’s overall macroeconomic policy framework. The explicit adoption of a neoliberal economic reform programme in mid-1991 was the key moment in transition from a largely dirigiste strategy to that of a market-led growth strategy. Through the wellknown package of stabilization and structural adjustment, the respective roles of the market and the state were dramatically redefined in every conceivable economic policy arena and some of the major changes included: (a) reduction of the presence of state as producer, regulator as well as facilitator, and thus, a whittled down role for the public sector, while allowing market forces an increasingly greater space to decide on production, prices and other important variables within the domestic economy; (b) greater international competition, which obviously implied that all economic decisions of the relevant domestic and foreign actors were influenced by ever-changing global scenario including international relative prices; (c) increasing liberalization of the financial sector beginning with reduced control of the banking system, permitting rapid proliferation of non-banking financial institutions, instruments, etc., and a greater role in the domestic economy for the foreign financial players; and (d) adoption of the conventional neoliberal xxxvii

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‘fiscal fundamentalism’, that the state must do its utmost to reduce fiscal deficit if not eliminate it altogether. A great deal has been written during the last couple of decades about India’s experience of neoliberal globalization and it is not possible to even identify all the major debates and deliberations here. In the following chapters, we only flag a couple of issues central to the fiscal policy regime in the neoliberal era. A perusal of the relevant international experience would suggest that high rates of resource mobilization by governments and its utilization in enhancing productive capacity, particularly through investments in different kinds of infrastructure, are of critical significance for putting an economy on a trajectory of success in economic development—further, public investments continue to play an extremely important role in ensuring fulfilment of a whole range of social goals even at advanced stages of economic development. The obvious lesson from these observations is that the importance of increasing and sustaining appropriate levels of public revenues can hardly be stressed too much; more so in most developing countries. As it happens, it is precisely this ability of the governments (i.e., to maintain adequate levels of public resources), which has come under tremendous pressure due to the neoliberal policy regime. Apart from the spurious arguments advanced in support of fiscal fundamentalism, which contribute towards lower taxes as well as cuts in public expenditure,1 typical macroeconomic and trade policies associated with liberalization lead to reductions in public tax revenues [as a proportion of Gross Domestic Product (GDP)]. For instance, many countries in the developing world offer explicit

1 However, certain kinds of expenditures, mainly the interest payments, which indeed are the result of a high interest rate regime, kept on mounting at an ever-increasing rate throughout the decade of the 1990s, which consumed away the major chunk of government revenue. It is worthwhile to note here that tax revenue of the central government as percentage of GDP declined from the achieved 12 per cent, in the late 1980s to less than 10 per cent during the decade of 1990s.

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and implicit incentives to attract foreign capital (e.g., tax breaks, subsidies, etc.), which is then followed by giving similar incentives to domestic capital (on grounds of non-discrimination), thus, leading to pressure on tax cuts in tariffs on imports and exports, which almost automatically results in demands for reductions in domestic excise duties (on ground of a level playing field). Thus, in aggregate, the revenue-raising capacity of a government can be seriously compromised. Furthermore, in addition to incentives for foreign producers, all kinds of incentives to attract globalized finance in general (in the hope that it would increase growth prospects) often become the order of the day in most developing countries. In India, for instance, in order to attract globalized finance, Indian policy regime deliberately kept the spectrum of interest rates at a notoriously high level by international standards during the period of late 1980s and 1990s. This regime change not only discouraged investment, but it forced the states and the Centre to allocate scarce financial resources on the item of interest payments. It is worth emphasizing here that the ‘neoliberal’ belief that opening up to globalization and inflow of finance capital is good for growth is seriously flawed.2

This belief, in case of the Third World, is sustained by the argument that the international mobility of capital at the current juncture results in a migration of capital from the North to the South, setting up productive enterprises in the latter and, thus, overcoming the phenomenon of uneven development in the world economy. The mistake here lies in confusing mobility of finance for being the mobility of productive capital. There are, no doubt, individual micro instances of such mobility, but in macro terms the magnitude of productive capital movement from the North to the South is still limited. When we, for example, consider the fact that not all fresh Foreign Direct Investment (FDI) inflows are necessarily growth-promoting (indeed such FDI that merely substitutes for the domestic investment and would have occurred in its absence, is likely to be growth-reducing, since it constitutes an implicit form of de-industrialization), it is clear that the gains in terms of higher growth in the Third World from opening up to the globalization process, would, from this source at any rate, be rather meager (Patnaik, 2006). 2

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Quite to the contrary, opening up to globalized finance may have a distinctly growth-retarding effect.3 Thus, the decade of 1990s was marked by varying degrees of retreat of the State from the previously held philosophy of public sector predominance in the production of goods and provision of services.4 Wide-ranging policy changes were made to guide the economy to move along market-led growth strategies, which included, inter alia, the policy of liberalization of interest rate control (1993–94), policies related to demonetization of deficits (1997–98), capital account convertibility (following the recommendations of Tarapore Committees I and II), policy of accumulation of foreign exchange reserves (without taking into account the substantial cost it imposes on the economy in terms of volatility of exchange rates and inflation, net interest cost of possessing a huge inventory of foreign exchange cushion), dismantling the existing structure of public enterprises through public disinvestment and the legislation and implementation of fiscal austerity measures as inscribed in the so-called Fiscal Responsibility and Budget Management Act, 2003, by the Union Government and uniform set of Fiscal Responsibility Legislations (FRLs) enacted and

As Patnaik has argued persuasively, it invariably brings in its train a process of deflation of the economy via reduced State expenditures. Finance capital is always opposed to an ‘activist State’ in matters of employment and welfare promotion. To avoid the consequences of possible capital flight, the states make every attempt to ensure that the ‘confidence of the investors’ in the economy is not undermined. They do so by eschewing any activist role in employment promotion, and by subjecting the economy to a deflationary process (by maintaining high rate of interest), which reduces the growth rate of the economy (by dampening the investment climate). The opposition of finance capital to employment stimulation by the State becomes manifest even when the economy operates at a level of activity which is so low as to rule out any genuine fears about inflation and exchange rate depreciation (Patnaik, 2006). 4 The introduction of the Eighth Five Year Plan drew pointed attention to changes in the country’s fiscal philosophy, governing the withdrawal of the states and allowing increasing role for the market mechanism. 3

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implemented by the state governments. In sum, macroeconomic and fiscal policies pursued during the post-reform phase reflect that our government was overwhelmed by the prescriptions of supply-side economics: tax less, borrow less and spend even lesser, and balance the budgets.5 The other important issue to highlight here is that the already severe challenges confronting the states in financing developmental programmes have been further aggravated. The fiscal inadequacy of the Indian State has been an area of concern since independence. We may allude to a host of recent factors, which include, inter alia, a rising interest burden, growing pension liabilities, mismanaged administrative expenditures, massive losses incurred by state Public Sector Undertakings (PSUs) primarily on account of inability of the states to collect their dues against big firms and industries, and inelastic and less buoyant tax systems. The decelerating trends in central transfers (relative to GDP as well as net receipts of the central government) under the aegis of neoliberal dispensation have exacerbated the fiscal crisis of the states further. Such fiscal stress, in turn, has seriously jeopardized the states’ ability to discharge their constitutional mandates involving improving the standard of living of the masses as enshrined in the Directive Principles of State Policy (DPSP). An important inhibiting factor in this regard has been the FRLs enacted by almost all the states barring West Bengal and Sikkim, as they limit the autonomy of the states pertaining to pursuance of their budgetary policies. The financing pattern of the gross fiscal deficit has continued to reflect the predominance and buoyancy of small savings. A major chunk of the states’ fiscal deficits are 5 The proponents of ‘fiscal rectitude’ maintain that high rates of taxation distort relative prices, and thereby emit a wrong signal to the market agents. This, in turn, leads to an inefficient allocation of scarce resources and to achieving a sub-optimal level of total output and employment. In their view, income/wealth taxation generates disincentive to working and saving. This, again, leads to sub-optimal level of loanable resources, which lowers the growth potential of the economy. Thus, they advocate for the downsizing of government activism.

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financed by small savings collections through the securities issued to the National Small Savings Fund (NSSF). This is an exogenous source of financing for the states, since neither the quantum nor cost of these borrowings are within their discretion. The rates on these small savings instruments were decided by the central government and were administered at usually higher than on-market borrowings by the states (thereby, leading to soaring debt and debt servicing burden with the high cost borrowing). However, during the last couple of years, there have been efforts to align the interest rates on securities issues by the state government to NSSF with Open Market Borrowing (OMB) rates. It may be worthwhile to note here that market borrowings by states have been a contentious experiment. This has forced the market to differentiate states according to their performance while bidding for state government debt and have allegedly motivated states to improve their performance in order to reduce their cost of borrowings. However, it is not unreasonable to assume that financially weaker states will have to pay a premium for availing market loans, over and above the market rate for no fault of theirs. Another constraining factor has been the cascading effects of revision of pay by Central Pay Commission (CPC) as state governments are forced yield to the demands of their own employees, resulting in disproportionate increases in salary bills, and hence a concomitant reduction in the non-salary component of government programmes, given the declining revenue expenditure on account of expenditure ceilings imposed through finance commission incentives. Such undesirable shifts in its composition of expenditure as a direct consequence of pay revision and expenditure cap imposed through Fiscal Responsibility Facilities through Finance Commission recommendations have some serious implications for the public provisioning of vital services and hence for the welfare of the people. Thus, the overall architecture of fiscal federalism in the country is of major concern. As is well documented with the Tenth Finance Commission (1995–96/1999–2000), both the Terms of Reference (ToR) for successive Finance Commissions as well xlii

Introduction

as their recommendations have implied a strong push towards the growing dominance of Centre over the states in the federal fiscal architecture in India. We may note here that a Debt Relief Package (Fiscal Reform Facility) for the states recommended by the Twelfth Finance Commission (in 2004 for the five years from 2005–06 to 2009–10) made it mandatory for states to enact Fiscal Responsibility and Budgetary Management (FRBM) legislations from the fiscal year 2005–06 (in order to make states eligible for the said package) and reduce deficits in their state budgets progressively. As noted earlier, except West Bengal and Sikkim, almost all other states have enacted FRBM legislations by now, and thus made it legally binding for the state governments to eliminate revenue deficits and keep fiscal deficits at less than 3 per cent of the Gross State Domestic Product (GSDP) by 2009. Even those economists who advocate strongly for government’s efforts to reduce the size of the public debt have questioned the arbitrariness in the targets set under the central and state FRBM Acts that limit severely the range and degree of state intervention through the use of progressive fiscal policy. More importantly, serious concerns have been raised about the nature of ‘fiscal correction’ achieved by most of the states in the FRBM era, since such reductions in deficits have been achieved at the cost of compression of capital outlay and social sector spending from the state budgets.6 It is in this backdrop of the shift to a neoliberal policy regime, highlighted very briefly in the foregoing, that the present volume engages with concerns relating to a progressive fiscal policy at the current conjuncture, and is expected to add value to the existing literature. The issues of equity aspects of fiscal and macroeconomic policies rarely figure, in any meaningful sense, in the mainstream

As it happens, it is the capital expenditure head, the soft target, that has bore the brunt of the forced spending cuts. And not surprisingly, the states’ capital expenditure, as the percentage of GDP, has declined quite significantly during the post-FRBM phase. It was 5.36 per cent in 2003–04, which declined to a disappointing level of 3.98 per cent in 2006–07. 6

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fiscal policy deliberations. The contributions contained in this volume will, hopefully, fulfil this gap; the volume as a whole puts forth persuasive and cogent arguments for pursuance of active fiscal policy to promote growth as well as greater equity in distribution, which, in turn, may lead to accelerated rate of poverty reduction and desired pace of human development. Most of the articles included in this volume have been selected from the papers that were presented in a conference organized by the Centre for Budget and Governance Accountability (CBGA) in December 2008. The core concerns covered in the present volume may be broadly grouped under three heads. Section I. Overall Macroeconomic Policy Regime and Its Linkages with Fiscal Policy This section includes following chapters: Finance Capital, Fiscal Deficits and the Current Global Crisis, by Prabhat Patnaik; Liberalization as a Constraint on Fiscal Policy: Some Lessons from the Indian Experience, by C. P. Chandrasekhar; Inclusive Growth in Neoliberal India—A Mirage?, by Nirmal Kumar Chandra; Growing Inequality: A Serious Challenge to the Indian Society and Polity, by S. L. Shetty; Assessing Tax Policy and Tax Compliance in the Reform Era, by Saumen Chattopadhyay. Section II. Pressing Concerns Relating to Fiscal Federalism in India Chapters included in this section are: Challenges to Fiscal Policy in India in the Era of Reforms, by T.M. Thomas Isaac and R. Ramakumar; Fiscal Devolution in the Era of Liberalization: The Indian Experience, by Jayati Ghosh; Thirteenth Finance Commission: Core Issues and New Challenges, by D. K. Srivastava; Horizontal Imbalances in Indian Federalism, by Tapas K. Sen; Regaining the Constitutional Identity of the Finance Commission: A Daunting Task for the Thirteenth Commission, by K. K. George and K. K. Krishnakumar; Towards a Rational and Progressive Fiscal Policy: What Role for Local Governments? by M. A. Oommen. xliv

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Section III. Public Policies and Institutions towards Addressing the Development Deficits The third section comprises of the following chapters: Unbalanced Growth, Tertiarization of the Indian Economy and Implications for Mass Living Standards, by Utsa Patnaik; From Outlays to Outcomes: Some Missing Links, by N. C. Saxena; Social Sector Expenditures: An Analysis for All India and States, 1980–81 to 2007–08, by S. Mahendra Dev and N. Sreedevi; Centrally Sponsored Schemes: Are They the Solution or the Problem? by Praveen Jha, Subrat Das and Nilachala Acharya; Improving India’s Health: The Significance of Public Financing, by Mita Choudhury and A. K. Shiva Kumar; Financing the Right to Education, by Santosh Mehrotra. The current conjuncture, particularly the global economic meltdown and its ramification for India has added further urgency in addressing the whole range of issues. In the following, core concerns contained in different papers are stated very briefly. The chapter by Prabhat Patnaik sets the tone of the present volume and maps the hostility of finance capital against government intervention. In his view, the ‘social legitimacy’ of capitalism gets seriously compromised by the fact that state expenditure can take the economy to near-full employment irrespective of the ‘state of confidence’ of the capitalists. As regards the means of financing of development programmes, the paper unequivocally states that mix of borrowing and tax-financed public spending generates national income, and hence the whole theory of crowding out hypothesis is logically flawed. On the much debated issue of fiscal prudence and their implications for the well-being of society, the chapter strongly advocates for an expansionary role of the state. Reemphasizing the effectiveness of coordinated global action in the context of current recession, the paper makes it clear that protectionism will make the situation even worse. Reflecting upon the very sizeable fiscal package (primarily to bail out financial system of the United States), the chapter warns that the strategy seems to be to sustain xlv

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the financial system and wait for the next ‘bubble’ to appear rather than to revive the real economy directly through appropriate fiscal stimuli. The chapter by C. P. Chandrasekhar argues that the striking feature of the period since 1989–90 (which also marked the beginning of ‘economic reform’) till the early years of the current decade was that, despite evidence of higher growth rates and signs of growing inequality, there was no improvement in the Centre’s ability to garner a larger share of resources to finance expenditures it considered crucial, largely on account of the tax concessions provided during the years of liberalization. He emphasizes the fact that whenever there is an increase in the fiscal deficit in a neoliberal regime, the focus of attention is not on revenue generation but on expenditure curtailment. The chapter concludes with the observation that, besides adopting measures to substantially increase the tax–GDP ratio, the government could find the much needed resources to finance social expenditure by stopping all further tax concessions, reversing a range of existing concessions that are completely unwarranted and plugging loopholes that encourage tax evasion and avoidance. The subject of inclusive growth in some recent years has been in the limelight for obvious reasons. Every policy documents of the incumbent government at the Centre and the Planning Commission reiterate their abiding commitment to economic reforms with a human face. In his chapter, Nirmal Kumar Chandra observes that in the era of globalization the mandates of attaining inclusive growth have largely been overlooked in the stance of neoliberal policy paradigm. The chapter presents an assessment of the performance of United Progressive Alliance (UPA) government with respect to its stated promises and concludes that inequality may have increased in recent years on account of tax exemptions, reduced public spending and inequality in credit disbursements. The next chapter in this section by S. L. Shetty expresses grave concern over the rapidly deteriorating socioeconomic indicators towards the threshold level of economic inequality and social xlvi

Introduction

deprivation, which is likely to threaten the very social fabric, political stability and economic progress of India. It maps a whole gamut of issues relating to several dimensions of socioeconomic inequality. It also takes into consideration various available qualitative and quantitative indicators to probe persistent and growing inequalities and social deprivations in recent years. The chapter concludes that the policies and programmes themselves are inherently inegalitarian, and the selective and direct development interventions in favour of the poor have been grossly inadequate and half-hearted. The chapter by Saumen Chattopadhyay raises serious questions on the willingness of the government to tap potential resources. The author makes an attempt to present a broad overview of the tax policy and tax collection during the reform era and examines the nature and direction of tax reform measures since 1991, and its relationship with economic growth. In the view of the author, the nature of the recent growth with widening of tax base with concomitant worsening of income distribution is possibly one reason behind higher direct tax collection. In this regime of corporate sector-driven growth, profits have been given special treatment and profit level has witnessed unprecedented high growth. What is needed, therefore, is to focus more on direct tax collection through combating tax evasion and elimination of tax expenditures through removal of tax concessions. The chapter by T.M. Thomas Isaac and R. Ramakumar argues that as about 85 per cent of the social sector expenditure in India is spent through state government budgets, the fiscal capacity of the states plays a dominant role in determining the strength of any counter-cyclical fiscal policy of the central government. They conclude that the so-called ‘cash surplus’ phenomenon is a perverse outcome of the constraints on expenditures and debt imposed by the provisions of FRBM Acts passed by the Centre and the subsequent FRLs by majority of the states to benefit from the fiscal incentives proposed through Twelfth Finance Commission, and hence recommend that the FRBM Act has to either go off the rule book or be drastically amended. xlvii

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During recent years, particularly the 10th Finance Commission onwards, equity considerations have been diluted and fiscal reform criterion has gained additional weightage in central transfers. The chapter by Jayati Ghosh argues that despite a clear division of powers and responsibilities among different tiers of government, state governments face a hard budget constraint emanating from some fiscal policy decisions, unlike the central government, that puts direct limits on the capacity of state governments to spend. She notes that the recent trends and patterns of fiscal devolution to states is the outcome of neoliberal policies adopted by the central government and enforced upon the states by making them implement fiscal constraints through binding legislations. The chapter concludes by saying that in a federal structure like India, state governments should be given more financial flexibility and autonomy to create their own economic strategies of development and mode of financing, without being bound to a set of failed policies simply because they continue to be espoused by the central government. The chapter by D. K. Srivastava reflects upon the situation of the ongoing economic and financial crisis and argues that the ongoing restructuring of tax administration may exacerbate the fiscal imbalances, recommending that for combating horizontal imbalances the Thirteenth Finance Commission (FC13) may have to explore relevant prospects not through the formula of devolution of funds, but rather through grants. It also suggests that in the case of education and health, equalization should be attempted with reference to the three highest per capita expenditure states, and at least major need and cost disabilities should be taken into account. Tapas K. Sen’s chapter looks into the issues of the persistence of horizontal and vertical imbalances in fiscal capacities and expenditure obligations. He argues that the map of horizontal fiscal imbalance across Indian states more or less overlaps with the pattern of regional socioeconomic inequality. He observes that the fund devolution through Planning Commission along with other central transfers, with its avowed objective of balanced regional xlviii

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development professed in several Plan documents, has failed to promote equalization in practice. Only Finance Commission transfers appear to have some equalizing effect. The chapter by K. K. George and K. K. Krishnakumar highlights that the allocation of financial powers between the Centre and the states is heavily skewed in favour of the Centre and, thus, contributes to the inability of the states in augmenting resources concomitant with their enormous expenditure responsibilities. The chapter points out that, historically, finance commissions had been wielding a big stick for disciplining the states by limiting the volume of grants barely enough to meet their deficits in non-plan revenue account, determined normatively by them. But no such stick is used in the case of the Central government. All Finance Commissions had failed to discipline the Centre by linking the states’ minimum share to the Central revenue determined normatively by the Commission for the next five years and not to what is actually collected by the Centre. If it has to gain the acceptance of the states, it has to find an equidistant attitude towards the Centre and the states. The chapter by M. A. Oommen puts forth the argument that local governments can contribute significantly in shaping a progressive fiscal policy framework and outcome for the country. The author argues that it is widely accepted that India has lost its progressive fiscal character under the present dispensation, and contends that the progressiveness of fiscal policies (in terms of equity, justice, fairness and efficiency) should be broadly reckoned in terms of tapping tax potential and enlarging public expenditure to bridge the gap of developmental deficits. While alluding to constitutional parameters, the chapter tries to spell out the framework for involving local governments in formulating a progressive fiscal framework for the country. The chapter by Utsa Patnaik analyzes the regressive implications of the ascendancy of neoliberal policies, which resulted, inter alia, in the relative stagnation of the material productive sectors, especially agriculture, during the economic reforms period. In her view, this is not accidental but has been engineered by following policies which xlix

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are strongly public expenditure deflating. The author argues that macroeconomic contraction forms the core of the policy regime of neoliberalism, though there is no objective economic rationale from the point of view of the welfare of the masses for following such policies. They do, however, subserve the long-term interests of advanced capitalist countries, which want both unhindered access to the productive capacity of tropical lands and to developing world markets, as well as mass demand deflation to contain the domestic demand of the developing country populations for the products of non-renewable and increasingly scarce resources like land and fossil fuels. The chapter by N. C. Saxena raises concerns over noncommensurate pace of improvements in social indicators vis-à-vis unprecedented economic growth figures registered during the reform era. While emphasizing the fact that development is an outcome of efficient institutions, he argues that focus must be shifted from maximizing the quantity of development funding to maximizing of development outcomes and effectiveness of public service delivery through concerted policy action to improve the social indicators of the 300 million poor, increasingly concentrated in the poorer states. This requires additional resources for the social sector. The chapter by S. Mahendra Dev and N. Sreedevi presents a comparative analysis of trends and patterns of social sector expenditures in the pre-reform and reform years covering the period 1980–81 to 2007–08 by the central and state governments and discusses, in brief, some programme implementation related issues. The chapter argues that there is an urgent need for significantly stepping up social sector expenditure and better implementation of social sector policies and poverty alleviation programmes through decentralized planning, social mobilization and community participation. The authors suggest that lack of accountability and monitoring of allocated resources, however, should not be made an excuse for not undertaking requisite investments in health and education and other services. l

Introduction

The chapter by Praveen Jha, Subrat Das and Nilachala Acharya discusses some of the pertinent issues relating to the developments in Centre–State fiscal relations and presents a brief sketch of the evolution of the federal fiscal architecture in India. It highlights some of the major changes observed in the magnitude and composition of resource transfers from the Centre to the states over the last decade, presenting a critical analysis of Centrally Sponsored Schemes (CSSs) vis-à-vis the objectives they attempt to fulfil. The authors conclude that there is a strong case for some drastic changes in the policy paradigm relating to public spending in the country; especially with regard to the CSSs. In their view, government interventions for socioeconomic development in the country should promote entitlements for people, instead of piecemeal and shortterm interventions. The chapter by Mita Choudhury and A. K. Shiva Kumar examines trends and patterns of health spending (both public and out of pocket expenditure) with a focus on equity and efficiency issues. The authors call for a more detailed analysis of the levels of per capita public health spending and their composition that may offer useful insights into provisioning of public sector health care in terms of adequacy of staff and facilities, reach and quality. In their view, health outcomes will be affected not merely by the levels of expenditures in health, but also by complementary investments in sectors other than health (such as basic education, nutrition, physical infrastructure, water and sanitation). The chapter by Santosh Mehrotra provides a preliminary estimate of the cost of financing of the Right to Education (RTE) over the next eight-year period or so, that is, until the end of the Twelfth Five Year Plan (2012–17). This article very briefly sketches some of the key provisions of the RTE and examines the costs of achieving universalization of quality elementary education. He argues that the challenges faced by the educationally backward states, especially in the northern and eastern states are daunting, and hence, need special financial provisions for universalization of compulsory quality elementary education. li

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As should be evident to the readers, while stating the core concerns relevant to the contributions in the present volume, I have refrained from commenting on them. This is because of the rich canvass covered by the authors in their high-quality chapters. Brief commentaries on these may well be an unjustified audacity and an uncalled-for mediation between our eminent authors and the readers. Although, I hope to have imparted a flavour of the rich fare that the volume offers in drawing attention to the contours of a progressive fiscal policy at the current juncture. References Antunes, Ricardo. 2001. ‘Fiscal Policy, Redistribution and Social Security’. Available online at http://webcache.googleusercontent.com/search?q=cache: gMrkwRadiyoJ:fiscal.socioeco.org/archives/2001-02/doc00002. doc+&cd=1&hl=en&ct=clnk (accessed on 30 May 2010). Chandrasekhar, C. P., and Ghosh. 2002. The Market that Failed: A Decade of Neoliberal Economic Reforms in India. New Delhi: Left Word Books. Chenery, H., Ahluwalia, M. S., Bell, C. L. G., Duloy, J. H. and Jolly, R. 1974. Redistribution with Growth. Oxford: Oxford University Press. Keynes, John Maynard. 1936. The General Theory of Employment, Interest and Money. London: Cambridge University Press. Patnaik, P. and Chandrasekhar, C. P. 1995. ‘Indian Economy under “Structural Adjustment”’, Economic and Political Weekly, 25 November, XXX (47): 3001–13. Patnaik, Prabhat. 2006. ‘What is Wrong with “Sound Finance”’, 4 November, Economic and Political Weekly, 41 (43, 4): 4560–64. Planning Commission. 1964. Report on Committee on Distribution of Income and Levels of Living. New Delhi: Government of India.

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Section

I

Overall Macroeconomic Policy Regime and Its Linkages with Fiscal Policy

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1 Finance Capital, Fiscal Deficits and the Current Global Crisis Prabhat Patnaik

One of the central paradoxes in economics relates to the hostility that financial interests in a modern capitalist economy systematically display towards any policy of enlarged state expenditure financed by borrowing. One can understand their hostility towards larger tax-financed state expenditure, since a substantial part of these enhanced taxes ‘appears’ at first sight to fall upon them and reduce their post-tax income. True, this appearance is entirely deceptive: if we assume for instance that, starting from some initial situation of less than ‘full employment’ output,1 the government increases its expenditure by a certain amount and raises this entire amount through additional taxes, and that there is no change in net borrowing from abroad, then domestic private savings must remain unchanged for any given level of private investment. This conclusion follows from the identity: (I – S) + (X – M) + (G – T) = 0. Further, if domestic private savings depend entirely upon posttax profits (or surplus, which is an overstatement but not without 1 I use the term ‘full employment’ throughout this chapter in the sense of output being supply-constrained. Hence, ‘full employment’ output refers also to full capacity output, and output that is limited by the availability of wage goods in a situation of downward inflexibility of real wages.

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rationale) then these must also remain unchanged, implying that ‘larger tax-financed government spending does not reduce post-tax profit incomes by an iota’. In short, finance capital has nothing to fear from larger tax-financed public expenditure. Nonetheless, even though the total post-tax surplus remains unchanged, within the group of surplus earners some may gain and some may lose as a result of this entire operation. So, some degree of apprehension on this score, and hence hostility to the move, from the side of finance capital is understandable. However, in the case of borrowingfinanced increases in public expenditure, such hostility appears totally incomprehensible on economic grounds, though, as we shall see, it is very much there.

I Let us first examine briefly the economic consequences of a larger borrowing-financed public expenditure programme. Suppose such a programme is not accompanied by any increase in net external indebtedness. Then, corresponding to the increase in government borrowing, there must be an equivalent increase in the excess of private savings over private investment. Since private investment expenditure is more or less given in any period, a result of past investment decisions, a rise in government borrowing creates an equivalent increase in private savings. Assuming (again for simplicity, but not without rationale) that these savings depend exclusively upon post-tax profits (surplus), there is an increase in post-tax profits (surplus), which is some multiple, greater than or equal to one, of the rise in government borrowing. In other words if, say, one half of post-tax private profits (surplus) is habitually saved, then a rise in government borrowing by `100 at base prices will raise post-tax private surplus by `200 at base prices. In a situation of less than full employment, this will occur through an increase in output and employment, while the base prices themselves remain more or less unchanged. In a situation of ‘full employment’ (or supply constraint) this will happen through 4

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profit inflation squeezing out ‘forced savings’ from the workers. But even in the latter case, though the current prices will rise above the base prices, both nominally as well as in terms of the ‘wage unit’, the basic proposition that if borrowing-financed government expenditure rises by `100 at base prices then post-tax surplus will rise at base prices by `200 will still hold. In other words, the capitalists in their totality earn an additional amount that is a multiple of the increase in government borrowing. In his book, How to Pay for the War, John Maynard Keynes had called this additional profit of the capitalists ‘a booty’ that fell into their laps. He was talking about increased government borrowing to finance war expenditure in a situation where the scope for raising output and employment was limited, and he assumed that the whole of the additional profits accruing to capitalists was saved, that is, the additional profits were equal to the increase in the government expenditure. In such a case, if government expenditure rose by `100, then, while the actual resources for meeting this expenditure came from the workers whose consumption was reduced by an equivalent amount, the capitalists’ wealth increased by `100 despite their having done nothing. It is as if the government snatched away `100 from the workers, put it in the lap of the capitalists, and then borrowed `100 from them. The real ‘sacrifice’ for the war in other words was made by the workers, while the capitalists’ wealth went up gratuitously. The unfairness of this prompted Keynes to argue that even if the government had to snatch away `100 from the workers, the capitalists must not be handed this amount as ‘booty’, that is, war expenditure must be financed through taxes. This would still put the burden of financing the war on the shoulders of the workers no matter where the tax was imposed, but the fiscal deficit not increasing would mean that the capitalists would not be handed over a ‘booty’. But this brings us back to the question that if a borrowingfinanced increase in government expenditure hands over a ‘booty’ to the capitalists that is some multiple (greater than or equal to one) of this expenditure increase (in Keynes’ discussion mentioned above, this multiplier was equal to one), then why are financial interests 5

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opposed to such an increase? Why, for instance, do they favour the principle of ‘sound finance’ and insist on the passage of Fiscal Responsibility Legislation everywhere to limit the size of the fiscal deficit? The argument advanced in the case of tax-financed increases in government expenditure, namely that while in the aggregate capitalists do not stand to lose by such increases, some particular groups may lose even as others gain, thereby making all of them apprehensive, does not apply in the case of borrowing-financed increases in government expenditure. Here, since capitalists gain in the aggregate, the possibility of some capitalists becoming worse off scarcely arises. What then explains their opposition to borrowingfinanced increases in government expenditure? Before proceeding further let us look at the theoretical argument that can be advanced in favour of their position. This states that larger government borrowing ‘crowds out’ private investment through an increase in the interest rate. In its pristine version, which was put forward in a White Paper in 1929 by the British Treasury (because of which this position was referred to as the ‘Treasury View’), there is a pool of private savings in any economy in any period which is used for three distinct purposes: for private investment, for net private lending to the government and for net private lending abroad. The demand for savings for these purposes is equated to this fixed supply of savings by the interest rate. If the government borrows more, that is, takes more out of this pool, to affect larger public expenditure, then, assuming away net private lending abroad for the present, private investment must fall by an equivalent amount through a rise in the interest rate. Even if we move away from the ‘pool of savings’ view, and assume instead that private savings are an increasing function of the interest rate, then again ignoring net private lending abroad, an increase in government borrowing from the private sector will crowd out private investment, but only partially: an increase in such government borrowing, by raising the interest rate, will cause both increased private savings and reduced private investment, by amounts which together add up to itself. 6

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This entire view, however, is logically flawed since savings depend not only on the interest rate but also on the level of income. Treating savings as dependent on the interest rate alone as this entire tradition does, amounts to treating income as being given, at full employment presumably. In other words, all these theories assume full employment or supply-constrained output even though the theory itself has no mechanism to ensure the fulfilment of this assumption. Of course, if all savings are always sought to be held in the form of produced commodities, that is, there are no alternative forms for holding wealth other than produced commodities, then ipso facto whatever is produced will be demanded and the economy will always be at full employment. But if wealth can be held either in the form of produced commodities (or claims on produced commodities), or in the form of money, then the possibility of a deficiency in the aggregate demand for produced commodities arises. But in such a world, in addition to the flow equilibrium which ensures that the demand and supply of produced goods are equal, there has to be a stock equilibrium as well which ensures that the demand and supply are equal for each of the alternative forms of holding wealth. These two equilibria are ensured through adjustments in both the level of income and the interest rate, which means that the interest rate is not determined by the flow equilibrium alone, unlike what all theories of crowding out, including Denis Robertson’s ‘Loanable Funds’ theory, postulate. It follows then that the ‘crowding out’ hypothesis is logically untenable. At any given interest rate as the Keynesian–Kaleckian revolution had pointed out, investment generates an amount of savings equal to itself (assuming no change in the current account of the balance of payments), whence it follows that a fiscal deficit creates an amount of excess of private savings over private investment equal to itself. Since private investment depends on the interest rate (in all these theories), this excess comes about through changes in output and employment in a situation of less than full employment, and in profit margins, that is, in prices relative to the money wage rate, at full employment, as argued earlier. 7

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Of course, enlarged government expenditure financed by borrowing may increase the interest rate and squeeze out private investment for an altogether different reason, namely if the money supply is kept fixed even as the demand for money rises because of the increased government borrowing and spending. But this can happen only if the monetary authorities allow the interest rate to increase, that is, only if they choose to pursue a restrictive monetary policy deliberately, and not because of the logic of functioning of the economy, as the crowding out theory postulates. Looking at it differently, for increased borrowing-financed government expenditure to crowd out private investment, there must be some ‘resource’ that is scarce, of which the government now takes a larger chunk leaving less for the private sector. The crowding out theory held that ‘savings’ were such a resource, which is wrong since ‘savings’ get augmented as demand in the economy rises through increased government expenditure. The alternative view which holds that ‘money supply’ is such a scarce resource is also wrong since money supply is a matter of policy and can be augmented at will; if it is not augmented, and the interest rises as a result, then that has to be attributed to monetary policy rather than to any crowding out.2 The claim that the crowding out theory is fallacious may come as a surprise to many since the theory appears to be based on sound common sense at first sight: if the government issues more bonds in the market, then the total supply of bonds must increase, causing a fall in bond prices, that is, a rise in the interest rate, which in turn must squeeze out some private investment. How can this obvious phenomenon be held to be fallacious? This is because there is a fundamental difference between ‘savings’ and ‘finance’. The argument of this paragraph presupposes, as in Keynes’ original discussion, that money supply is a policy variable, while the interest rate gets determined by the market. In fact, in a modern capitalist economy, it is the interest rate that is typically the policy variable while money supply adjusts to the demand for it at this interest rate, in which case even this particular possibility of ‘crowding out’ via monetary stringency ceases to exist. 2

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Just as the floating of additional government bonds adds to the supply of bonds, the larger government expenditure made possible by such floating generates larger savings which also create a larger demand for bonds. True, before such expenditure is made possible, there must be some initial absorption of government bonds which puts purchasing power in government hands and sets the process going, but this requires ‘finance’ not ‘savings’. As long as finance is available to absorb more government bonds immediately as they are floated, the floating of such bonds adds not only to the supply of bonds but also to their demand, and does so to an exactly equal extent, since the magnitude of fiscal deficit is matched by an exactly equal increase in the excess of private savings over private investment. The ‘commonsense’ view is based on the notion that income does not increase. It therefore ignores the ‘demand side’ altogether, that is, the increase in the demand for bonds is caused by the increase in borrowing-financed government expenditure; and consequently it is fallacious. All this therefore brings us back to the original question: If the ‘crowding out’ theory is fallacious and if increased borrowingfinanced government expenditure actually enlarges private profits, private savings and hence private wealth, then why do financial interests oppose it?

II The fact that they do oppose such expenditure is scarcely in doubt. Indeed, the currency that theories of ‘crowding out’ enjoy despite their logical flaw is precisely because they are the theoretical expression of this opposition, and hence are assiduously promoted by finance capital, which is why Joan Robinson called such theories, and others advocating ‘sound finance’ (i.e., the virtues of balancing budgets), ‘the humbug of finance’ (1965). Finance capital systematically trots out this ‘humbug’ to oppose increases in borrowing-financed government expenditure. And the human cost extracted by such ‘humbug’ is usually exorbitant. 9

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Indeed the Great Depression of the 1930s could have been much shortened in the absence of this ‘humbug’. In 1929 itself, when a proposal worked out by Keynes was advanced by Lloyd George, the Liberal Party leader and former Prime Minister, for starting public works in Britain financed by government borrowing, it was promptly shot down by the British treasury under pressure from financial interests in the City of London. This Treasury View, which has already been discussed above, held that since employment expansion caused by government expenditure would be offset by employment contraction caused by the decline in private investment, public works for stimulating employment were altogether futile. So, nothing was done, and the unemployment figure in Britain, which was already one million in 1929, doubled by 1933. Subsequently, during the Depression itself, a number of plans were put forward, such as the Kindersley Plan, the Keynes Plan, the Blanqui Plan and others, which advocated a coordinated fiscal stimulus by a number of governments in capitalist countries acting in concert to overcome the Depression. But no serious efforts were made to explore this option, since the coordinated increase in borrowing-financed government expenditure that such a stimulus would have entailed, was anathema for the economic orthodoxy which believed in ‘sound finance’ (Kindleberger, 1973). When a stimulus was provided in the United States under President Roosevelt’s ‘New Deal’, it did succeed in reducing unemployment. This very fact was, however, used to mount pressure— since unemployment had come down, the government should once more reduce the fiscal deficit and get back to the principles of ‘sound finance’. Roosevelt succumbed to this pressure and cut the fiscal deficit in 1936; the result was the 1937 recession. Capitalist economies other than the fascist ones, Germany and Japan, came out of the Depression finally only because of the Second World War. Although, the prolonged nature of the Depression and the emergence of Fascism itself, which was bred by unemployment could have been avoided if the opposition of financial interests to increased government expenditure had been overcome. 10

Finance Capital, Fiscal Deficits and the Current Global Crisis

In the more recent period, the opening up of economies, like that of India, to the movements of globalized finance has forced the enactment of Fiscal Responsibility Legislation limiting the size of the fiscal deficit relative to Gross Domestic Product (GDP). One consequence of this has been the curtailment of government expenditure in rural areas, which has restricted the purchasing power in the hands of the rural population, resulting in a reduction in foodgrain absorption per capita (Patnaik, 2007). The decade of the 1990s was the first since independence in India when the per capita foodgrain output actually declined over the decade. But so sharp was the restriction in purchasing power in the hands of the working population, especially in the rural areas, that the per capita absorption of foodgrains declined even more sharply for the entire population, as did the per capita calorie intake in rural India. The other side of the coin was a buildup of 63 million tonnes of foodgrain stocks by mid-2002. The pursuit of ‘sound finance’ under pressure from the global financial interests had thus a direct bearing on the increase in hunger among the Indian people. The opposition of financial interests to increased borrowingfinanced government expenditure is particularly intriguing in the midst of a depression when such expenditure can make all classes better off. The workers will have larger employment and incomes; the capitalists will have larger surplus value, savings and wealth and since the financial interests derive their incomes from surplus value, they too will be better off, not to mention the fact that the capital gains arising from a revival of financial markets, which a government-stimulated recovery will initiate, will give them additional benefits. Why then do they oppose such expenditure?

III One can give certain obvious economic explanations. The first is the fear of inflation. Larger government expenditure by raising the level of aggregate demand will cause inflation which will lower the real value of all financial assets, something which finance capital 11

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obviously dislikes. This explanation is not without weight, but it fails to explain why the opposition to borrowing-financed government expenditure should persist even in the midst of a depression when the increase in aggregate demand is likely to cause almost exclusive output adjustment with very little impact on prices. True, this is not the way that orthodox theory, in terms of which financial interests look at the economy, analyzes the effect of borrowing-financed government expenditure. Its analysis rather is as follows: if larger government borrowing is not monetized then it causes ‘crowding out’, while if it is monetized then it causes inflation via the increase in money supply.3 We have seen that if monetary authorities hold the interest rate constant and allow money supply to adjust to the demand for money, then there need be no crowding out via any ‘shortage of money’. But precisely under these conditions there will be no inflation either, since output will increase from a demand-constrained situation, and the increase in money supply will be only as much as is required for meeting the transaction demand for money at the higher level of income (apart from whatever may be the additional ‘finance’ demand for money).4 Thus, in a situation of depression (or more generally of demandconstraint), there is no earthly reason why financial interests should be assailed by fears of inflation and oppose increased borrowingfinanced government expenditure on this score. The same holds for the other possible economic reason that can be adduced for their opposition, namely a fear of worsening of balance of payments and hence of a depreciation of the currency. The fear of such a depreciation will induce finance to flee the country, if it is allowed to do so, which in turn will precipitate an actual depreciation, retrospectively justifying, as it were, the fear This is the exact argument put forward by the Prime Minister’s Economic Advisory Council in India under the National Democratic Alliance (NDA) government. For a detailed critique of the argument see Patnaik (2001). 4 The concept of a ‘finance demand for money’ was introduced by Keynes after the publication of the General Theory, and he saw it as a revolving fund. This concept has already been referred to above. 3

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which had prompted the flight in the first place. On the other hand if finance is not allowed to flee, that is, if there are controls over financial flows, then it will oppose increased government expenditure in anticipation of the capital losses it will incur in terms of other currencies. Finance in short will exert pressure either through its feet (by fleeing) or its voice (if it cannot flee) against government stimulation of the economy. But precisely in situations where financial flows are controlled, which are the only relevant situations where finance will oppose increased government expenditure, rather than just reacting to it, there is a wide range of measures, ranging from import controls to increased external borrowing, which are available to the government that is stimulating the economy. These measures can keep the fear of any currency depreciation at bay and hence negate the opposition of finance capital, especially when there are no domestic inflationary pressures. The fear of currency depreciation in short cannot also be an adequate explanation. It follows then that economic explanations for the opposition of finance to increased borrowing-financed government expenditure are inadequate. The real basis of the opposition is political. As Kalecki (1971) had once remarked, profits are not everything for the capitalists; their class instincts too are important. And these class instincts tell finance capital that a proactive expenditure policy of the state, even if for the sole purpose of demand management, is detrimental to the long-term viability of the system in general, and of the financial class in particular. The mythology propagated by capitalism is that the unfettered functioning of the system gives rise to a state of full employment where the resources are efficiently allocated. This myth of course cannot be sustained, since even the most die-hard believer of the ideology of capitalism cannot deny the real-life existence of occasional depressions and the virtually perennial state of demand-constraint that afflict the system. The perennial state of demand-constraint is therefore passed off as merely a ‘natural rate of unemployment’, which is supposed to be a state of de facto full employment, since the unemployment occurring in it is either 13

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voluntary, or frictional or search unemployment; if perchance an excess of unemployment over the natural rate is recognized, then it is attributed to institutions (such as trade unions) that prevent the labour market from clearing. And depressions are usually explained in terms of a setback to the ‘state of confidence’ of the capitalists. It follows that if a capitalist economy is doing poorly then the remedy for it lies in providing greater support and concessions to the capitalists so that their ‘confidence’ will revive, and with it the economy. But if government expenditure can be used to revive the economy, then ‘the state of confidence’ of the capitalists ceases to be of paramount importance. The very fact of the economy’s revival will itself, if anything, bolster their ‘state of confidence’; and even if their ‘state of confidence’ is not revived fully, the government can still stabilize the economy close to full employment. And what is more, since the adverse effect of government measures for reducing income and wealth inequalities in society, like profit taxation or property taxation, on the ‘state of confidence’ of the capitalists, can be counteracted by government expenditure so that unemployment need not result from such measures, the government can adopt them with impunity. In short, a government that can use public expenditure to sustain the level of activity in the economy need not bother much about the ‘state of confidence’ of the capitalists and hence can bring about far-reaching changes in the system, including, where necessary, the induction of public enterprises. There is no reason why such public enterprises should be any less ‘efficient’ than private enterprises in an engineering sense, that is, in terms of physical input use; but even if perchance they are, an economy with public enterprises functioning close to ‘full employment’ will still have a larger vector of goods at its disposal for a given set of input endowments than a free market capitalist economy. In short the ‘social legitimacy’ of capitalism gets seriously compromised by the fact that state expenditure can take the economy to near-full employment irrespective of the ‘state of confidence’ of the capitalists. 14

Finance Capital, Fiscal Deficits and the Current Global Crisis

In a modern capitalist economy the barometer for the ‘state of confidence’ of the capitalists is the degree of exuberance in the stock market, that is, the state of euphoria of financial interests. If state expenditure can sustain a near-full employment level of activity in the economy, then the exuberance of the financial capitalists ceases to be a matter of much concern. Governments can pursue whatever policies they consider socially desirable without having to concern themselves with the impact of such policy on the exuberance of the financial capitalists. True, the maintenance of the economy at near-full employment may cause accelerating inflation by destabilizing the wage unit via the exhaustion of the reserve army of labour, but governments, under working class pressure, may become emboldened to attempt to resolve such problems through even more radical measures, such as prices and incomes policies, nationalizations, workers’ management of factories, etc. Once the ‘state of confidence’ of the capitalists is given short shrift, then there is nothing to prevent the economy’s ideological ‘slide’ to radical social engineering and even to socialism. It is therefore vital for finance capital that the ideological weight of the proposition that the ‘state of confidence’ of the capitalists is crucial for the well-being of society is not diminished one iota, for which the proposition that state expenditure can boost employment with impunity must be attacked, no matter how flawed in logic the attack may be. It is true of course that if full employment is reached through borrowing-financed government expenditure, then at full employment (or with supply-constrained output) there will be a large liquidity overhang which can have inflationary consequences via excess-demand–engendering speculation (Baran, 1957; Patnaik, 1997). But this is a question of the appropriate mix of taxes and borrowing for financing government expenditure aimed at achieving full employment, and also of price management at full employment; it has nothing to do with the view that borrowing-financed government expenditure is harmful for the economy under all circumstances, which is what the ‘humbug of finance’ holds. 15

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IV This ‘humbug’ is currently affecting even the prospects of recovery from the ongoing capitalist crisis. To see this, let us first discuss briefly the most effective strategy for recovery. The need for increasing government expenditure for overcoming the current recession is widely recognized. And it is better for recovery if this increase in government expenditure is coordinated across the major countries rather than being sequentially undertaken. The reason is as follows. When such expenditure increase is undertaken in one particular country, part of the stimulus leaks out to other countries through increased imports. The original country therefore finds its external debt increasing for the sake of creating jobs in other countries, and is tempted to be more protectionist. This then induces other countries to also adopt protectionist measures as they increase their own government expenditures. We thus end up with a scenario of sequential uncoordinated fiscal stimulus packages, each accompanied by protectionism. Such ‘beggar-my-neighbour’ protectionism across major countries makes recovery more difficult. The reason is simple. For any given vector of money wages across countries, a regime of protection—by making goods and services more expensive than they would otherwise have been—entails a lower vector of real wages. It entails, in other words, a shift of income distribution away from wages to profits or tax revenue. Since autonomous expenditure (like government expenditure and private investment) may be considered to be given in any period, determined by decisions taken earlier and unaffected by currently accruing taxes or profits, the marginal propensity to spend out of wages—rather than out of profits or taxes—is higher in the short run. Such a regime of protection then has the effect of lowering the impact of the Keynesian ‘multiplier’ within each country. If each country had an identical ‘multiplier’ value to start with, then this means an overall demand-compressing effect on the world economy. For given levels of government expenditure, private 16

Finance Capital, Fiscal Deficits and the Current Global Crisis

investment and other autonomous expenditure across countries, a regime of protection causes a lower level of world output and employment than would be the case without such protection. Of course, the ‘multiplier’ values are not identical across countries to start with, so that if protection results in a shift in the distribution of world output among countries, then this could conceivably offset the demand-reducing effect of a lower multiplier value within each country. But if the resort to protectionism is pervasive among major countries, then its effects in this respect will cancel one another out. No significant net shift of aggregate world output across countries can therefore be expected in the short run, in which case it has an unambiguously demand-reducing effect. The reduction in the vector of real wages arising from protectionism is not only undesirable in itself, but should be particularly shunned for its demand-reducing effect during a recession. Hence, any accentuation of protectionism in the midst of the crisis only makes it that much more difficult to get out of the crisis. Two clarifications are necessary here. What we have been talking about here is ‘beggar-my-neighbour’ protectionism among major economies. The initial pre-crisis, or base level, trade policy regime in the world economy was by no means optimal, characterized as it was by pervasive non-tariff barriers, a plethora of unfair trade practices, and by the imposition of unfavourable trade policies on developing countries with limited bargaining strength. The need for a change in the base-level regime itself—including the need for greater protectionism in less developed economies to ensure food security or to develop new productive capacities and capabilities— is not being questioned here. Rather, what is being questioned is the likely increase in protectionism by the major economies, typically the richer countries of the world, which should be spearheading the fiscal effort to overcome the crisis. Secondly, since recessions are typically associated with price crashes in the world market for small producers of primary commodities, efforts by national governments to protect such producers by offering guaranteed ‘procurement prices’, backed by appropriate tariffs, must not be prevented in the name of preventing increased 17

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protectionism. On the contrary, in the case of all commodities whose prices in the world market are ‘demand-determined’—as opposed to being ‘cost-determined’ (to use a distinction introduced by Kalecki)—national price support efforts should be internationally supported. After all, the producers concerned belong to the world’s poorest, and any increase in their incomes is likely to have significant multiplier effects, since their ‘propensities to consume’ at the margin are very high. The apprehensions expressed about protectionism above do not refer to them. On the contrary, if protectionism among the major economies raises, through costpush effects, the prices of a whole range of commodities produced in these economies and demanded by small primary commodity producers, then the terms of trade shift against such producers would be even greater. Protectionism in major economies would therefore be against the interests of small primary commodity producers. In short, the concern here is with an increase in protectionism over the base level in the major economies of the world undertaking fiscal stimulus efforts sequentially. Such protectionism blunts the impact of the fiscal stimulus efforts, makes recovery from the crisis that much more difficult, adversely affects the real wages of the workers within these economies, and turns the terms of trade against primary commodity producers to an extent even greater than would have been the case without such protectionism. Such protectionism, which has already been initiated in the United States, must be prevented. The only way this can be done is by having a coordinated fiscal effort among the major economies, rather than individually and sequentially undertaken fiscal efforts by particular countries. The fact that such efforts would be simultaneous, if they are coordinated, will ensure that no country will be unduly concerned with the leakage of demand through imports; each country will know that while part of its demand is leaking out to others, part of the increased demand of the others will be leaking into its own economy. And the fact that such efforts would be coordinated would mean that any residual fears on this score would be allayed beforehand. 18

Finance Capital, Fiscal Deficits and the Current Global Crisis

Of course, even with a coordinated and simultaneous fiscal effort, there will be increased current account surpluses and deficits. But such deficits need not tempt countries into protectionism if a suitable arrangement for recycling the corresponding surpluses to use them for further stimulating demand is put in place, which ensures that there are no additions to foreign exchange reserves starting from the base level. With an imaginative recycling arrangement, current account deficits and surpluses will be continually tending to disappear; indeed, if the recycling is fast enough, then there will be no increase in the net external indebtedness of any country on account of a coordinated fiscal stimulus. But the problem with this entire strategy, and even with the distinctly second-best option of significant, sequentially administered, fiscal stimulus measures across major countries, is that it goes against the ‘humbug of finance’. While in the immediate aftermath of the financial crisis, in September and October 2008, there was much talk of a coordinated fiscal stimulus, such talk has died down now. As a result, at the G-20 meeting conducted in endMarch 2009 there was no mention of any fiscal stimulus, let alone of any coordinated fiscal stimulus. By the time of the G-20 summit of September 2009, there was even talk of winding down the fiscal stimuli that had been initiated in the developed countries. In the case of the United States, which is perceived to have announced a very sizeable fiscal package, the actual stimulus (as distinct from the increase in fiscal deficit caused by the maintenance of government expenditure in the face of a decline in tax revenue) is quite small.5 By contrast, the currently estimated ‘bail out’ package to the financial system in the United States is likely to exceed $10 trillion.6 The strategy at present therefore seems to be to sustain This is because much of the increase in federal government expenditure announced by the Obama administration as part of its stimulus package will merely offset the curtailment in government expenditure in the various states of the United States on account of the decline in their tax revenues. 6 Matt Renner writes in www.truthout.org of 13 May 2009, ‘The current block of tax-payer money that has been pledged by the US government and 5

19

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the financial system and wait for the next ‘bubble’ to appear rather than to revive the real economy directly through fiscal stimuli. The consequence of this strategy will be a prolonged period of recession and unemployment with much human suffering; but this only underscores the power of the financial interests in contemporary capitalism, where even a crisis of this magnitude engendered by their functioning leaves this power undiminished. References Baran, P. A. 1957. The Political Economy of Growth. New York: Monthly Review Press. Kalecki, M. 1971. ‘Some Political aspects of Full Employment’, reprinted in Selected Essays on the Dynamics of the Capitalist Economy. Cambridge: Cambridge University Press. Keynes, J. M. 1940. How to Pay for the War: A Radical Plan for the Chancellor of the Exchequer. London: Macmillan and Co. Ltd. Kindleberger, C. P. 1973. The World in Depression 1929–1939. London: Allen Lane: The Penguin Press. Patnaik, P. 1997. Accumulation and Stability under Capitalism. Oxford: Clarendon Press. Patnaik, U. 2007. ‘The Republic of Hunger’, in The Republic of Hunger and Other Essays. Delhi: Three Essays Collective Publications. Robinson, J. 1965. Economic Philosophy. London: C. A. Watts and Company.

the Federal Reserve to prevent the (financial) system from collapsing, according to an analysis by Bloomberg News, is roughly $12.8 trillion as of March 31’ (accessed on 20 September 2009).

20

2 Liberalization as a Constraint on Fiscal Policy Some Lessons from the Indian Experience C. P. Chandrasekhar

When confronted with demands for increased expenditure on programmes to accelerate employment growth, alleviate poverty and address the worst forms of human deprivation, a common response of policy makers and others is: ‘Where will the money come from?’ Implicit in that rhetorical question (which is often not looking for an answer) is a combination of two sets of ideas that form part of the ideology of liberalization. The first is that the surplus resources in the system that are available for allocation to such expenditure are limited. The implicit perception is that if the government seeks to tax away a larger part of available surpluses to finance social expenditure, it would create disincentives for private investment and adversely affect growth. The second is the view that, taking the current tax–Gross Domestic Product (GDP) ratio as given (which it is not) or at least given in the short to medium term, it would be wrong on the part of the government to finance additional social expenditure with additional borrowing. The decision to pass the Fiscal Responsibility and Budget Management (FRBM) Act despite the widespread unemployment, underemployment and 21

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deprivation in the country, and to force the government to reduce to pre-specified levels the ratios of revenue and fiscal deficits to GDP, is the obvious result of such a view. The prevalence and influence of this perspective has had two consequences: the first is that even when there is recognition of the urgency of adopting and implementing certain kinds of social policies such as provision of social security to unorganized workers, the policy is not advanced with confidence or is diluted, for fear of a ‘drain on the exchequer’. The second is that even when policies are adopted they are implemented tardily or not at all, because of the fiscal conservatism that grips most sections of government. As a consequence, for example, many of the objectives that India’s Eleventh Five Year Plan document identifies are likely to remain unrealized unless the prevailing fiscal mindset is changed and the FRBM Act modified or repealed. But this does not appear to be on the agenda. For example, at a meeting of the National Development Council in 2006 to approve the Approach to the Eleventh Plan, Prime Minister Manmohan Singh reportedly said: ‘We cannot escape the fact that the Centre’s resources will be stretched in the immediate future and an increasing share of the responsibility will have to be shouldered by the States’ (Singh, 2006). He further argued that much of the investment needed for rapid growth would have to come from the private sector, which in his opinion called for a sound macroeconomic framework, an investor-friendly environment and a strong and innovative financial sector capable of responding to the needs of new entrepreneurs. Implicit in this position is the view that reliance on the private sector to deliver investment and growth will not imply an inequalizing and less inclusive path of development, especially if private initiative is combined with social expenditure financed by the government. However, it has been persuasively argued that the crisis in agriculture and exclusion of large sections of the population from the benefits of growth are at least partly the result of the shift to a private sector-led strategy of growth. Indeed, in the process of creating an investor-friendly environment—which in practice implies substantial tax concessions and reduced tax rates—the 22

Liberalization as a Constraint on Fiscal Policy

central government may engineer a future situation in which it becomes resource-constrained to finance even crucial capital and social expenditures without large increases in fiscal deficits, which would then encourage it to call upon state governments to take a larger share of the responsibility. In this context, this chapter seeks to examine the effects of economic liberalization on fiscal policy and offers some alternatives. Mobilizing Resources for Development

The idea that ‘surpluses are limited’ challenges what was for long considered sound economic judgment. In the 1950s and the 1960s, economists concerned with development had concluded that national savings and government revenues in most developing countries were as low as they were not because these countries were poor, but because their governments had failed to adequately tax the rich in their countries. This meant that tax revenues of the government were lower than warranted. Further, since these richer sections allocated a significant share of their incomes to consumption that would be considered nonessential at the levels of average income recorded in these countries, savings rates were also below their potential. A striking feature of the period since 1989–90 (which also marked the beginning of ‘economic reform’) till the early years of the current decade was that, despite evidence of higher growth rates and signs of growing inequality, there was no improvement in the Centre’s ability to garner a larger share of resources to finance expenditures it considered crucial. Even when corporate profits and managerial salaries were reported to be rising sharply, taxes were not buoyant. In fact, Central tax–GDP ratios in India were declining for much of this period (Figure 2.1). This failure to significantly improve the tax–GDP ratio, in a period when there had also been a widening of the tax net through various means, was largely due to the tax concessions provided during the years of liberalization. While inequality increased, marginal 23

C. P. Chandrasekhar Figure 2.1:â•…Tax–GDP Ratios

Source: Compiled from the data given in Indian Public Finance Statistics, Ministry of Finance, Government of India; various issues.

tax rates have come down sharply during the liberalization years. In 1985–86, the top marginal rate of taxes on personal income was brought down from 62 per cent to 50 per cent and the corporate tax rate from around 60 per cent to 50 per cent. In the budgets of the early-1990s, especially those of 1992–93 and 1994–95, the marginal rates were further reduced to 40 per cent. Today, they stand at around 33 per cent. The tax–GDP ratio in India was also low by international standards, including those of many developing countries (Tableâ•¯2.1). The ratio of Central Government tax receipts to GDP was only 7.9 per cent in 1989–90; by 2001–02 it had fallen to a miserable 5.9 per cent. Even if taxes levied by the State Governments are included, the total tax–GDP ratio was still only 15.9 per cent in 1989–90 and fell to 13.8 per cent by 2001–02 (Figure 2.3). This compared poorly with tax–GDP ratios in most developed and 24

Liberalization as a Constraint on Fiscal Policy Table 2.1:â•…Tax–GDP Ratios by Country Country name Lesotho Cyprus New Zealand Seychelles Algeria Denmark Norway Jamaica Trinidad and Tobago South Africa United Kingdom Iceland Israel Malta Ireland Jordan Belgium Australia Mongolia Luxembourg Bulgaria Netherlands Croatia Qatar Italy Bosnia and Herzegovina Fiji Morocco France Belarus Macau, China Portugal Finland St Kitts and Nevis Cape Verde Slovenia Chile Tunisia Ghana Hungary

Year 2006

Country name

58.3 47.8 33.3 32.4 32.4 31.1 29.7 29.2 29.1 28.8 28.5 28.1 27.9 27.0 26.8 26.2 25.8 25.3 24.3 24.0 23.6 23.4 23.3 23.2 22.8 22.8 22.7 22.4 22.4 22.2 22.1 22.1 21.9 21.9 21.3 21.0 20.6 20.6 20.5 20.0

Poland Bolivia Thailand Russian Federation Estonia Benin Korea, Rep. Zambia Latvia Egypt, Arab Rep. Mali Georgia Honduras Peru Côte d’Ivoire Kazakhstan Czech Republic Togo Sri Lanka Lebanon Armenia Philippines Kyrgyz Republic Costa Rica Slovak Republic Canada El Salvador Spain Singapore Uganda Paraguay United States Burkina Faso Guatemala Colombia Romania India Germany South Asia Niger

Year 2006 17.3 16.8 16.8 16.6 16.5 16.3 16.3 16.1 15.9 15.8 15.7 15.4 15.4 15.0 15.0 14.9 14.7 14.7 14.6 14.5 14.4 14.3 14.2 14.0 13.8 13.8 13.4 13.2 12.9 12.3 12.1 12.0 12.0 11.9 11.8 11.4 11.3 11.3 11.0 10.8

(Table 2.1: continued)

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C. P. Chandrasekhar (Table 2.1: continued) Country name Maldives Austria Greece Turkey Moldova Uruguay Mauritius Lithuania Ukraine Nicaragua Kenya

Year 2006 19.9 19.8 19.7 19.7 19.6 19.3 18.2 18.1 17.7 17.5 17.4

Country name Madagascar Switzerland Pakistan China Nepal Cambodia Bangladesh Iran, Islamic Rep. Afghanistan Bahrain Kuwait

Year 2006 10.7 10.5 9.4 9.4 8.8 8.2 8.2 7.4 5.8 3.8 0.8

Source: World Bank, World Development Indicators Online.

developing countries. India is by no means an over-taxed country, but has much fiscal space to expand its revenues. It is true that in the case of India and many developing countries internationally quoted figures are not comparable with that for the developed countries because they exclude taxes collected by state or provincial governments. But the figures quoted above which include state revenues do not tell a very different story. However, between 2001–02 and 2007–08 the tax–GDP ratio at the Centre rose from 5.9 per cent to 9.3 per cent. The aggregate taxGDP ratio of the Centre and the states rose even more sharply from 13.8 per cent to 19.1 per cent between 2001–02 and 2008–09. It must be noted that the period after 2002–03 was one in which profits in the organized sector rose sharply, the ratio of profits to value added also rose significantly and saving and investment rates in the corporate sector recorded sharp increases. This was therefore a period when high growth was accompanied by significantly increased inequalities in the organized sector, leading to the rise in the tax–GDP ratio. Not surprisingly, there has been a significant shift in the relative contribution of different components of taxes to the tax-to-GDP ratio at the Centre over the years. Liberalization, involving reductions in customs tariffs and rationalization of the indirect tax 26

Liberalization as a Constraint on Fiscal Policy

regime, resulted in a decline in the tax–GDP ratio between 1989–90 and 2001–02. Customs and excise duties contributed 86 per cent and 55 per cent respectively to the decline in the central tax-toGDP ratio during those years (Figure 2.2). However, subsequently corporate taxes, other income taxes and service taxes contributed 71, 25 and 30 per cent respectively to the increment in the central tax-to-GDP ratio between 2001–02 and 2008–09. Thus, higher tax collections from the industrial sector and better off individuals and a widening of the tax net accounted for the improvement in the Centre’s revenue base (Figure 2.3). Does the pattern of movement of the different components of tax revenue suggest that the Centre has exhausted the possibilities of improving its tax revenues relative to GDP? It could be argued that the decline in customs revenues was inevitable, since that was an outcome of unavoidable trade liberalization. And since corporation, income and service taxes have increased, it could be said that the government had made an effort to partially neutralize the impact of reduced customs tariffs, but could not completely deal with the problem. Figure 2.2:â•… Contribution to Decline in Tax–GDP Ratio 1989–90 to 2001–02

Source: Compiled from the data given in Indian Public Finance Statistics, Ministry of Finance, Government of India; various issues.

27

C. P. Chandrasekhar Figure 2.3:â•… Contribution to Increase in Tax–GDP Ratio 2001–02 to 2008–09

Source: Compiled from the data given in Indian Public Finance Statistics, Ministry of Finance, Government of India; various issues.

There are a number of difficulties with that argument. To start with it does not question whether tariff reductions that have such a significant impact on revenues where justified. In fact, when tariff reductions where being made, one of the arguments was that trade buoyancy would ensure that revenue losses would be marginal. This has not really occurred. Second, it glosses over the fact that what was considered mere ‘rationalization’ of the excise duty structure, as part of a process of fiscal reform, has amounted in practice to the provision of significant excise duty concessions that have had extremely adverse effects. Third, it does not raise the question, which has been raised by the Planning Commission itself, whether there is any rationale for sharply curtailing the fiscal deficit, despite its extremely adverse impact on capital and social expenditures. Finally, it does not answer the criticism that the Centre has not gone even part of the way in tapping resources from direct taxes of various kinds, but has in fact doled out concessions that are unjustifiable. A striking example is the income earned from equity investment. There are two principal ways in which income is garnered through such investment: dividends and capital gains. Both of them have benefited from recent tax concessions. To start 28

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with, on the grounds that corporate taxes are already taxed so that taxing shareholder dividend income would amount to a form of double taxation, it was decided in 1999–2000, that dividends paid out to share holders should be made tax free. Being controversial, this decision was reversed in the budget for 2002–03, only to be reinstated again in the budget for 2003–04. What has been the fallout of this exemption? An extremely revealing analysis by B. G. Shirsat (2006) of 1,050 major dividend-paying, listed companies had found that dividends paid out during the three years ending 2005–06 amounted to `29,532 crores. Since the beneficiaries of these dividends were likely to be in the highest marginal tax bracket, if this dividend income had been subject to tax, the revenue earned by the government over those three years would have been an additional `10,000 crore (if we assume that the dividend pay out rate would have been the same even if the tax was effective). This is by no means a small sum. What is noteworthy is the inequality in the distribution of this tax benefit. It is known that a miniscule proportion of the domestic population invests in equity. But even among them, the distribution of dividends and therefore the benefit of the tax exemption tends to be highly skewed. For example, of the close to `30,000 crores of dividends paid out by these companies in 2005–06, `14,000 crores, or around 45 per cent accrued to the promoters of the companies themselves. In fact, small or so-called ‘retail’ shareholders received a relatively small share of this benefit. Over 90 per cent of the shareholders holding up to 500â•¯shares each received just over `4,000 crores of dividend income, while public shareholders with equity holding in excess of 500 shares garnered `7,575 crores as dividends. A significant amount of the dividend paid to public shareholders went to foreign investors. Foreign Institutional Investors (FIIs) received `12,808 crores of dividend income during this period and investors in Global Depositary Receipts (GDRs) and American Depositary Receipts (ADRs), Non-resident Indian (NRI) investors and other overseas bodies received `4,567 crores. In sum, a combination of promoters, high–net worth domestic investors and foreigners were the main beneficiaries of the dividend tax handout. 29

C. P. Chandrasekhar

There remains the argument that the exemption of dividends from taxes was not a handout but the redressal of an unjust scheme of double taxation. Even if this is accepted, there remains the fact that there is a high degree of inequality in the distribution of incomes in the country, which the accrual of record dividend incomes seems to aggravate substantially. If the government really wished to garner a fair share of the surplus for social and capital expenditure, then the removal of the tax on dividends should have been accompanied by an increase in the marginal corporate tax rate or the reduction/removal of various exemptions. The fact that the government did not choose such measures only strengthens the perception that it has failed to tax a section of the rich adequately and effectively. The evidence on unwarranted benefits to investors in equity does not end here. It is visible in the case of the other form of returns from equity holding—capital gains—as well. The budget for 2003–04 also decided that ‘in order to give a further fillip to the capital markets’, all listed equities that were acquired on or after 1 March 2003, and sold after the lapse of a year, or more, were to be exempted from the incidence of capital gains tax. Capital gains made on those assets held by the purchaser for at least 365 days were defined for taxation purposes as long-term gains. Up to that point in time, long-term capital gains tax was levied at the rate of 10 per cent. An analysis of share price movements of 28 Sensex companies found that if we assume that all shares purchased in 2004 were sold after 365 days in 2005, the total capital gains that could have been garnered in 2005 would have amounted to `78,569 crore. If these gains had been taxed at the rate of 10 per cent prevalent earlier, the revenue yielded would have amounted to `7,857 crore. That reflects the revenue foregone by the state and the benefit accruing to the buyers of these shares. It is indeed true that not all shares of these companies bought in 2004 would have been sold a year and one day later. But some shares which were purchased prior to 2004 would have been sold during 2005, presumably with a bigger margin of gain. This estimate relates to just 28 companies, so the 30

Liberalization as a Constraint on Fiscal Policy

actual revenues foregone were presumably much greater. Clearly, a more appropriate tax policy relating to dividends and capital gains could have yielded substantial revenues for the government. This is only one area. There are many more such avenues, which the central government could explore when looking for money to finance crucial expenditure. But what the instances quoted prove is that, in the effort not just to facilitate but ‘induce’ private investment with tax concessions, the government is engineering a fiscal situation which is by no means indicative of a macroeconomic framework that is ‘sound’ from a growth and equity point ofâ•¯view. The Exit Debate

Between 2001–02 to 2007–08, when the central gross tax revenueto-GDP ratio rose by 4.4 percentage points (from 8.21 per cent to 12.56 per cent), the fiscal deficit to GDP ratio fell by 3.5 percentage points from 6.2 per cent to 2.7 per cent. That is, much of the improvement in the fiscal position of the central government was because of a faster increase in its tax revenues relative to GDP. In 2008–09, not only was the rise in the tax–GDP ratio halted and marginally reversed (by 0.8 of a percentage point), but the ratio of expenditure to GDP rose by 1.8 percentage points on top of a one percentage point rise the previous year. As a result, the fiscal deficit to GDP ratio rose sharply, as noted earlier. What is remarkable is that whenever there is an increase in the fiscal deficit, the focus of attention is not on revenue but on expenditure. This was true after 2008–09 as well, when many began to argue that the rise in the fiscal deficit was a result of the fiscal stimulus put in place to deal with the downturn that followed the global economic crisis. The corollary was relatively simple and straightforward. Unusual times called for unusual measures, but as the economy returned to ‘normal’ growth the extraordinary expenditure had to be reversed to rein in the fiscal deficit. Besides the view that deficit financing per se is bad policy, there are three assumptions underlying this viewpoint. First, the fiscal stimulus 31

C. P. Chandrasekhar

resorted to in the wake of the downturn was large. Second, this stimulus was responsible for the increase in the deficit on the central government’s budget. Third, the only way to deal with the problem is to curtail expenditure. The notion that the fiscal stimulus in 2008–09 was large and responsible for the widening of the deficit on the Central budget was, in fact, promoted by the government. For example, in his budget speech delivered on 6 July 2009, Finance Minister Pranab Mukherjee endorsed this view when he said that ‘fiscal accommodation’ in response to the crisis had resulted in a sharp increase in the fiscal deficit from 2.7 per cent in 2007–08 to 6.2 per cent of GDP in 2008–09 and estimated that the total fiscal stimulus (equal to 3.5 per cent of GDP at current market prices) in 2008–09 amounted to `186,000 crore. This was, of course, a gross exaggeration, inasmuch as it presumed that all of the increase in the fiscal deficit in excess of the growth in nominal GDP was entirely the result of the stimulus motivated by the downturn in growth. It is indeed true that 2008–09 did see a significant increase in expenditure, with nonplan expenditure in particular rising by 23 per cent relative to the previous year. However, two heads of expenditure that accounted for the bulk of this increase, namely subsidies and the implementation of the VIth Pay Commission’s recommendations, had little to do with the stimulus motivated by the downturn. Though the exact figure of the burden imposed by the VIth Pay Commission’s recommendations is difficult to come by, the Commission itself had estimated that the payment of the new salaries and half of the arrears during 2008–09 would result in additional expenditure of about `21,500 crore, which amounted to around 18 per cent of the actual increase in non-plan expenditure in that year. Similarly, the huge increase in subsidies (resulting, among other things, from higher minimum support prices and larger procurement during that year) added another `59,500 crore or a little more than half of the increase in non-plan expenditure. So around 70 per cent of the increase in non-plan expenditure had little to do with the stimulus per se, rendering the Finance Minister’s generous estimation of 32

Liberalization as a Constraint on Fiscal Policy

the size of the stimulus completely wrong. The real impact of the downturn was to be seen in the slower rate of growth of revenue receipts, which fell to just 7.7 per cent in 2008–09 as compared with 24.7 per cent in 2007–08. This combined with the increase in non-stimulus-driven expenditure in 2008–09 to result in a sharp increase in the fiscal deficit. So in the middle of 2009, it was not a higher fiscal deficit resulting from an unavoidable fiscal stimulus that was the problem facing the Indian economy. The problem was that expenditure that was not easily reversible, if at all, such as higher salaries and higher subsidies, was responsible for the increase in the deficit. Nevertheless, pressure was mounting to reduce the deficit and adhere to the fiscal deficit to GDP ratio targets set by the FRBM Act. This pressure to ‘roll back the stimulus’ would adversely affect plan expenditures in general and capital expenditures in particular. In fact, the trend over a long period had been for the ratio of capital expenditure in the Centre’s budget to fall relative to GDP. Even in 2008–09, when revenue expenditure as a proportion of GDP rose sharply, capital expenditure fell. This hardly constituted an appropriate strategy from the point of view of ensuring recovery and sustained growth. If fiscal conservatives believed that the fiscal deficit was India’s most important economic problem, then they should have focused on ways of raising additional resources to finance unavoidable expenditure, rather than on ways of reducing government spending substantially. But the fear that this could encourage the government to increase tax rates, impose surcharges or reduce exemptions possibly explains, at least in part, the clamour in 2009 for an exit from the near nonexistent fiscal stimulus programme. If the tendency for the tax–GDP ratio to rise could be sustained through additional taxation measures, the fiscal situation was by no means dire. However, there is reason to believe there was a backlash against the tendency of the government to enhance its revenues by increasing resources garnered through taxes on profits and higher income group incomes. In what seemed to be an effort to compromise with that tendency, the central government had 33

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proposed in its new direct tax code a drastic scaling down of tax rates and a restructuring of tax slabs, arguing that this would simplify the direct tax regime and prove to be revenue enhancing because of reduced exemptions and better compliance. But in effect, many believed, this was merely a step towards reversing the rather remarkable increase in the direct tax-to-GDP ratio seen in recent years. The Stance on Resource Mobilization

Unfortunately, there are indicators to suggest that the government has traversed the road towards great leniency with respect to taxation. Consider, for example, the large arrears on past tax payments that remain to be collected. Even though tax collections vis-à-vis budget estimates have improved in the recent past (as also the tax to GDP ratio), the problem of tax arrears remains a major problem area for India. The Comptroller and Auditor General’s Report (2009) had this to say: Uncollected amount of `1,24,274 crore in respect of corporation tax and income tax comprised demand of `86,859 crore of earlier years and current demand of `37,415 crore for 2007–08. The uncollected amount of corporation tax increased from `55,098 crore in 2005–06 to `68,662 crore in 2007–08 and that for income tax from `40,289 crore in 2005–06 to `55,612 in 2007–08 respectively.

These are not small amounts, but magnitudes that can make a substantial difference to the revenue position of the government. The problem is not just one of failure to collect taxes, but also one of legally exempting unworthy tax payers. The case of removal of the capital gains tax was noted above. As noted by Amaresh Bagchi (2004): Since much of economic power accrues to asset owners in the form of rise in asset values, a tax system that fails to tax capital gains remains gravely deficient and creates a strong bias in favour of the rich. Not taxing capital gains also offends efficiency in that it discriminates in 34

Liberalization as a Constraint on Fiscal Policy

favour of activities like speculation, which beget large gains quickly, as against risk taking in ordinary business…exempting long-term gains from only listed equities, as is now proposed, offends not only fairness but also efficiency by discriminating against the unorganised corporate sector and unincorporated enterprises—the small and medium sector—where the bulk of our economic activities take place. In sum, there is no good reason to exempt long-term capital gains from taxation, and that too selectively for gains from listed equities, or for taxing short-term gains at a rate lower than applicable to other incomes, as has been proposed now. It will grievously damage the income tax base and offend both equity and efficiency. Can the transaction tax be a substitute for a tax on capital gains? The answer plainly is ‘no’…[It] can in no way replace the income tax any more than a sales tax can.

It is worth noting that even in the United States, most investors pay capital gains tax at the rate of 15 per cent with some categories of assets inviting capital gains tax of as much as 25 per cent to 28â•¯per cent. Rather than recognize the need to close these gaps in taxation, the government seems to be constantly seeking ways of providing further concessions to the corporate sector. Thus, in his speech elaborating Budget 2009–10, the Finance Minister was quite clear of the need to support the private sector: Private sector investment has been affected by the global macroeconomic conditions. Our Government is committed to creating a facilitating environment in which a competitive private sector can thrive and play its rightful role in the nation’s economic development. India’s high growth of 8.5% per annum from 2004 to 2008 was fuelled in very large part by private investment. I look forward to working closely with industry and our vibrant entrepreneurial community to address their outstanding concerns. (Mukherjee, 2010)

This perspective was reflected in the tax proposals of the budget for 2009–10. Despite the need to finance a burgeoning fiscal deficit, the Finance Minister imposed no additional taxation on the corporate sector other than raising the Minimum Alternate Tax (MAT) from 10 per cent to 15 per cent. This hurts only a few firms. The government’s own figures show that the average effective tax 35

C. P. Chandrasekhar

rate in financial year 2007–08 on 410,451 firms that had submitted tax returns electronically by 31 March 2009 exceeded 22 per cent and averaged 20.14 per cent to 24.04 per cent in different profit classes. Even though this is well short of the normal corporate tax rate (inclusive of surcharge and cess) of 33.99 per cent, it is well above the new level for the MAT. That is, on average firms in the government’s sample are in an effective tax rate range above the new MAT rate. There are a large number of firms (161,916 to be precise) that pay zero or less than zero taxes. But these are largely companies that make losses. Their share in the total profits of all sample companies is less than 2 per cent, even though they constitute 40 per cent of the sample in terms of number. There are, however, 16 per cent of firms accounting for 45 per cent of sample firm profits that were subject to an effective tax rate of 0–20 per cent in 2007–08. It is a few of these firms falling in the 0–15 per cent effective tax rate range that would be affected. It could hardly be argued that the fate of this set of firms influences corporate sentiment substantially. In fact, the corporate sector received a whole host of other benefits from the 2009–10 Budget, amounting to a bonanza. For example, the deduction from taxable income of the export profits of Software Technology Parks of India (STPI) units, and units in Special Economic Zones (SEZs), Export Processing Zones (EPZs) and Free Trade Zones (FTZs), which was originally available till 2008–09 and was then extended to cover 2009–10, was extended for one more year, till 2010–11. The major beneficiaries of this concession are the Software Development Agencies and the IT-Enabled Services Providers/Business Process Outsourcing Units, in whose case the effective tax rates are as low as 12 per cent and 15 per cent respectively. Revenue foregone under this head in 2008–09 was `20,366 crore. Overall corporate tax concessions have meant that the revenue foregone by the government stood at `68,914 crore in 2008–09, which was `6,715 crore higher than in 2007–08. This increase was substantially greater than the `6,375 crore increase in the fiscal deficit between these two years. 36

Liberalization as a Constraint on Fiscal Policy

In conclusion, it is evident that besides adopting measures to substantially increase the tax–GDP ratio, the government could find the much needed resources to finance social expenditure by stopping all further tax concessions, reversing a range of existing concessions that are completely unwarranted and plugging loopholes that encourage tax evasion and avoidance. It is not as if the government is unaware of this. Rather, experience suggests these measures have not been adopted because the government prefers not to adopt them. This defines the fiscal stance which then creates the often noted fiscal crunch. In fact, when revenues rise despite the government, as occurred between 2002–03 and 2007–08, the government begins to contemplate increasing tax concessions rather than enhancing much needed social expenditure. This is the inevitable consequence of the fiscal conservatism that accompanies neoliberal reform in the age of finance. It is that fiscal conservatism which declares that there is not enough money in the system every time demands for additional social expenditure in a society with extreme deprivation are made. References Bagchi, Amaresh. 2004. ‘Taxing Capital Gains: Unending Debate’, Business Standard, Mumbai, 21 July. Comptroller and Auditor General of India. 2009. Report No. CA 21 of 2009 (Compliance Audit) 2007–2008: Union Government (Direct Taxes), for the year ended March, 2008, Government of India, New Delhi. Mukherjee, Pranab. 2010. ‘Budget 2009–2010: Speech of Pranab Mukherjee, Ministry of Finance’, 6 July, Government of India. Available online at http:// indiabudget.nic.in/ub2009-10/bs/speecha.htm (accessed on 27â•¯September 2010). Shirsat, B. G. 2006. ‘Rich Dividend Pickings for Promoters in Three Years’, Business Standard, Mumbai, 14 July. Singh, Manmohan. 2006. ‘PM’s address at the Meeting of National Development Council 2006’, 9 December 2006, New Delhi. Available online at http:// pmindia.nic.in/speech/content.asp?id=464 (accessed on 19 December 2006).

37

3 Inclusive Growth in Neoliberal India A Mirage? Nirmal Kumar Chandra

Introduction

In contrast with the then ruling Bharatiya Janata Party’s (BJP’s) election slogan of ‘Shining India’, the United Progressive Alliance (UPA) led by the Congress Party came to power in 2004 with a Common Minimum Programme (CMP), promising a sustained Gross Domestic Product (GDP) growth of ‘at least’ 7 per cent to 8 per cent and generating in the process ‘employment so that each family is assured of a safe and viable livelihood’. The Eleventh Five Year Plan document was accordingly captioned, ‘Towards Faster and More Inclusive Growth’. In particular, the CMP made the following commitments:1 1. National Employment Guarantee Act that ‘will provide a legal guarantee for at least 100 days of employment to begin with on asset-creating public works programmes every year The text in the numbered list is from National CMP of the Government of India, May 2004. http://pmindia.nic.in/cmp.pdf (accessed on 20 April 2009). I have taken the liberty of correcting some obvious mistakes. 1

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Inclusive Growth in Neoliberal India

2.

3.

4.

5.

at minimum wages for at least one able-bodied person in every rural, urban poor and lower middle-class household. (Emphases added) The rural cooperative credit system will be nursed back to health. The UPA government will ensure that the flow of rural credit is doubled in the next three years and that the coverage of small and marginal farmers by institutional lending is expanded substantially. The UPA government pledges to raise public spending in education to at least 6 per cent of GDP with at least half this amount being spent on primary and secondary sectors. This will be done in a phased manner. The UPA government will raise public spending on health to at least 2 per cent to 3 per cent of GDP over the next five years with focus on primary health care. A national scheme for health insurance for poor families will be introduced. Household and artisanal manufacturing will be given greater technological, investment and marketing support. In the past few years, the most employment-intensive segment of SmallScale Industry (SSI) has suffered extensively. A major promotional package for the SSI sector will be announced soon. It will be freed from the Inspector Raj and given full credit, technological and marketing support. Infrastructure upgradation in major industrial clusters will receive urgent attention.

At the same time, ‘the UPA reiterates its abiding commitment to economic reforms with a human face…[to] stimulate growth, investment and employment’. To revive industrial growth and put it on a robust footing, the UPA will adopt: [A] range of policies including deregulation, where necessary. Incentives to boost private investment will be introduced. FDI [foreign direct investment] will continue to be encouraged…. The UPA government is deeply committed, through tax and other policies, to the orderly development and functioning of capital markets that reflect the true fundamentals of the economy. Financial markets will be deepened. 39

Nirmal Kumar Chandra

FIIs [foreign institutional investments in the capital markets] will continue to be encouraged while the vulnerability of the financial system to the flow of speculative capital will be reduced. (Government of India, 2004)

In pursuit of inclusive growth, the UPA government made some progress no doubt, if one goes by the popular verdict at the parliamentary elections in May 2009. For the first time in decades, an incumbent coalition came back to power with an enhanced majority. In states where the centre’s CMP was implemented with some seriousness, the ruling party(s), whether in the UPA or in the BJP-led alliance won popular mandate. Among the three Left-ruled states, only in Tripura did the Communist Party of India (Marxist) [CPI (M)] make serious efforts and retain its mandate. On the other hand, the party’s commitment to the schemes under CMP was quite lukewarm in traditional bastions like Kerala and West Bengal, which was reflected in the electoral outcome. It would be absurd to project this factor as sufficient explanation, but there is little doubt that people’s desire for ‘inclusiveness’ played a significant role in the election. On the other hand, the media and the business lobby saw in the UPA’s victory, despite the withdrawal of support from the Left parties, an endorsement of the reforms agenda. The stock market went into euphoria just before the budget of the new government, and felt ‘cheated’ after some of the expected changes did not materialize. Lin (2009) rightly remarked: ‘[A]s Mrs Gandhi knows, Congress was returned to power with a mandate that did not include liberal reforms, which most Indians mistrust.’ Hence an appraisal of the UPA’s performance on social welfare measures envisaged in the CMP in light of the overarching neoliberal macroeconomic policy is necessary. The present essay is such an attempt. On most issues I take a long-term view, going back to the 1970s or the 1980s for a proper appreciation of changes under the reform era. In Section I the vulnerability of the Indian economy is explored, in view of the twin deficits—fiscal and external payments. In section II the trends in the Centre’s tax collection are examined. The following section highlights the contraction in the 40

Inclusive Growth in Neoliberal India

Centre’s expenditure and the stagnation in social expenditure by the Centre and the states. I also probe separately two innovative schemes of the UPA government, namely employment guarantee and social security for the poor. Section IV is on bank credit to disadvantaged sectors, particularly, agriculture and the SSIs. The next section examines the high concentration of wealth and income in contemporary India, suggesting that a process of ‘inequalizing’ growth is the predominant characteristic of the present polity. In the concluding section, I offer some reasons why the CMP’s rather modest goal of ‘inclusiveness’ did not make much headway.

I India’s Vulnerability

A country can formulate a ‘sound’ fiscal policy suited to its own requirements only if it enjoys ‘economic autonomy’, and is immune to the dangers of a financial crisis, like the one faced by India in 1991 and numerous other emerging nations since the early 1980s to this day. One may recall that high levels of deficit in the Current Account Balance (CAB) of the Balance of Payments (BOP) and of Gross Fiscal Deficit (GFD) were cited by the International Monetary Fund (IMF) in 1991 as the two main reasons for imposing on the country the infamous package of ‘stabilization’ and ‘structural adjustment’ programmes. In November 2007, well before the global meltdown, (The Economist, 15 November 2007) sounded an alarm bell, looking at the fundamentals of several emerging economies, including India. The then governor of the Reserve Bank of India (RBI) took the unusual step of publicly refuting it; while the fundamentals might look bleak, the Indian policy makers were capable enough, he claimed, to tide over any crisis. I explored the ‘fundamentals’ at some length (Chandra, 2008). On the BOP side, I questioned the RBI’s contention that the quantum of Foreign Exchange Reserves (FER) was significantly higher than that of ‘volatile’ foreign capital 41

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employed in the economy, and hence a sudden outflow of such capital could not destabilize the economy. The major component of volatile capital, in my view, has been the size of Indian equity stocks held by FIIs. The RBI continues to value them at the ‘accounting’ or ‘historical’ cost of acquisition, while the US authorities (in their estimates of foreign investment) shifted to the more reasonable method of using current market prices. During a period of rising or falling market prices, historical costs give no indication of a country’s asset or liability on this score. At prevailing market prices, the FII stock at end-2007 stood at $255 billion,2 which was several times higher than that at historical cost. Adding to it NRI deposits ($41 billion) that can be withdrawn at a moment’s notice, the size of volatile foreign capital amounted to $296 billion, which was about 7 per cent higher than the FER of $276 billion on the same date.3 In response to the rising market capitalization of FII stock, the RBI increased FER from $199 billion at end-March 2007 to a peak of $315 billion at end-May 2008. By then, the Sensex was already falling, so that the market value of FII investment slipped to $180 billion by end-September 2008, and more drastically to $85 billion in April 2009 in my calculation. For the first time the Securities and Exchange Board of India (SEBI) released in mid-July 2009 figures on total assets managed by the FII; they fell from $260 billion at end-December 2007 to $93.4 billion at end-April 2009

2 It was calculated from the Prowess database of the Centre for Monitoring the Indian Economy (CMIE). The database gives the daily market price of equity stocks of all quoted companies in the Bombay Stock Exchange and the National Stock Exchange. Quarterly data on FII holding in each company is also provided. 3 This may explain why India did not set up a Sovereign Wealth Fund that became quite fashionable in 2007–08, though the Finance Ministry was positively inclined. While such Funds were launched by Singapore, the Gulf countries, China, Russia, etc. on the basis of surpluses in CAB, India’s FER was accumulated through net inflows in the capital account of the BOP, while deficits in CAB persisted.

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but rose to $131.5 billion at end-June 2009.4 In the meanwhile, the RBI liquidated $65 billion of FER in five months, May–October 2008, and kept it at a more or less constant level of $250 billion up to end-June 2009. Clearly, the latter value exceeds by far the quantum of volatile capital today. Since the RBI earns a maximum of 5 per cent on FER, why is it holding excess reserves to such a large extent? India’s external payment situation has been deteriorating over the past few years. The merchandize trade deficit galloped from $51.9 billion in FY 2006, to $91.6 billion two years later; more recently, it jumped by more than 50 per cent from $69.3 billion in April–December 2007 to $105.4 billion over the same months in 2008. Net earnings from ‘invisibles’, especially export of IT-enabled Services (ITeS) and private transfers, reduced the current account deficit to a very considerable extent. Nevertheless, the latter nearly doubled from $9.8 billion in FY 2007 to $17 billion next year; it rose markedly to $36.5 billion in April–December 2008 as against the previous year’s $15.5 billion. At the same time, the surplus on capital account vanished in the wake of the global crisis; in the boom phase, it rose steeply from $25.5 billion in FY 2006 to $45.8 billion and $110.8 billion respectively in the next two years; however, during April–December 2008 it became negative at –$11.3 billion, while the corresponding figure for 2007 was positive at $31.3 billion. As percentages of the GDP, as shown in Table 3.1, these deficits are also quite high by any standard. In view of falling exports and widening trade deficits in 2009, and little prospect of an increase in net capital flows owing to the global meltdown, India’s external vulnerability remains quite high. The argument is reinforced if one looks at the size of GFD in relation to the GDP (Figure 3.1). In the earlier paper (Chandra, 2008) I showed that since the mid-1980s, the consolidated GFD The Hindu Business Line, 21 July 2009. The small difference between my estimate and that of the SEBI for end-April 2009 may due to the fact the SEBI included assets other than the stocks of quoted companies. 4

43

Nirmal Kumar Chandra Table 3.1:â•…Trade, Current Account and Capital Account Balances as Percentages of GDP Key Indicators

Apr–Dec 2007

Apr–Dec 2008â•¯

–8.96 3.69 –2.00 –5.69 10.61

–12.95 4.31 –4.49 –8.80 1.88

Trade balance Transfer Current account net Excluding transfer Capital account net

Source: RBI, Macroeconomic and Monetary Developments in 2008–09, Table 27. Figure 3.1:â•… GFD as a Percentage of the GDP, 1981–2008

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

of the central and state governments was consistently high as a proportion of the GDP, though the level fluctuated. The five-year average stood at 9.09 per cent during FY 1987–91, came down subsequently, but shot up to 9.14 per cent in FY 1998–2002. Official data indicate a fall since then. However, off-budget items blurred the picture in later years. Under the Fiscal Responsibility and Budget Management (FRBM) Act 2003, the central government cannot borrow to finance capital expenditure or ‘usual’ revenue expenditure; all state governments, barring Left-ruled West Bengal and Sikkim, have passed similar laws and face the same constraints. As a result, major subsidies like those on oil and fertilizers were funded by the Centre through equivalent bonds offered to the suppliers; the interest payments on the bonds were paid out of the Centre’s revenue budget, while the much higher indirect taxes on these goods 44

Inclusive Growth in Neoliberal India

artificially boosted the revenue receipts. The magnitude of the hidden GFD in 2007 was at least 2 per cent The situation has taken a turn for the worse in the past couple of years. The Union Budget FY 2010 revised the Centre’s revenue deficit in 2009 to 4.4 per cent of the GDP as against the budget estimate of 1.0 per cent; the corresponding GFD figure was raised from 2.5 per cent to 6 per cent. Adding the states’ deficits and the off-budget items, analysts generally put the country’s GFD at about 12 per cent for the year 2009–10 and the following year (Goldman, 2009; The Economist, 2009). The current deficit level is worse than that of the crisis years of 1989–91, and is among the highest in the world. Fitch, a major Credit Rating Agency (CRA), recently gave India a rating of ‘BBB minus’, the lowest in the investment grade, ‘with a negative outlook’; other agencies have also cautioned along similar lines. With rising deficits, the percentage of government debt to the GDP went up as shown in Table 3.2. But S&P, the rating agency puts the current public debt to GDP ratio at 85â•¯per cent, significantly higher than the official figure. In any case, India’s debt level is one of the highest among the main emerging countries. Table 3.2:â•… Public Debts as Percentages to Gdp Year

Centre

States

Consolidated

1991 2001 2004 2005 2006 2007 2008

55.2 56.6 63.0 63.3 63.1 61.2 61.5

22.5 28.3 33.2 32.7 32.6 30.2 28.4

64.7 70.6 81.4 81.3 80.4 77.0 77.0

Source: RBI, Annual Report, 2008, Table 2.41.

It is interesting that in the decade after 1991, the Centre’s debt ratio was relatively stable, but that of the states went up by nearly 6 per cent. Many scholars have noted that the states were starved of resources, while their commitments on various social welfare schemes were far higher. In the three years of high-GDP growth 45

Nirmal Kumar Chandra

(2001–04) that led the BJP government to coin the slogan of ‘Shining India’, the ratio for the Centre rose by as much as 6.4 per cent, while that of the states increased by 4.9 per cent. Since the UPA government came to power in 2004, the Centre’s debt fell marginally, but that of the states fell by as much as 4.3 per cent. Isaac and Ramakumar (2008) provided an important clue. Following the FRBM Act, the states have to limit their fiscal deficits to 3 per cent of their respective state-level GDPs (GSDPs), while their market borrowings are also restricted by the Centre. As a result, in the recent past, the states have been holding huge cash surpluses that are invested in low-yield (maximum 5 per cent) shortterm treasury bonds, while they borrow funds from Centre (or its agencies) at 8.1 per cent to 9.5 per cent to meet their requirements. On 21 November 2008, the states’ cash surplus amounted to `70,000 crore as against a cash deficit of nearly `7,900 crore. Consequently, the states were obliged to reduce their deficits, but the Centre as the moneylender earned a fat income that boosted its revenue and thus reduced its own deficit! The size of the fiscal deficit, I must add, should not be a cause for undue concern in the absence of cross-border capital mobility; following Keynes, deficits should be significant in a situation of excess capacity, provided there is little ‘import leakage’. As the UPA government seeks to encourage two-way capital flows despite a chronic deficit in the CAB, it is perilous for it to follow the Keynesian prescription.

II Taxation

In recent official discourse, the government claims the credit for an improvement in the aggregate tax–GDP ratio. From Figure 3.2 one finds that the ratio has recovered from the trough of 1999–2001, and crossed the earlier peaks of the late 1980s in FY 2007 and 2008. The rise in the last couple of years has a windfall element. 46

Inclusive Growth in Neoliberal India Figure 3.2:â•…Tax Revenue as Percentage of Gdp and Na-gdp, 1971–2008

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

Thanks to high oil prices in the global market, the oil Public Sector Undertakings (PSUs) contributed in FY 2006 as much as `93,800 crore in direct and indirect taxes, amounting to more than 28 per cent of the total tax revenue of ` 345,972 crore. As noted earlier, off-budget subsidies should be deducted from the tax revenue; in that case, the overall tax–GDP ratio would be lower by 2 per cent, or below the peak of the 1980s. This argument is strengthened if one looks at the other line in the figure on the ratio of taxes to non-agricultural GDP (NA-GDP); it shows no improvement at all. Even with the windfall gains of the past two years, the percentages at 11.4 in 2007 and 12.2 in 2008 were below the 1988 level of 12.7. There are sound reasons to prefer NA-GDP over GDP as the denominator. Most taxes, direct or indirect, are collected from non-agricultural households and institutions. There is no income tax on agricultural income, although plantation companies form a minor part of the agricultural sector and contribute a small part of the Centre’s taxes. For direct sale in local or urban markets, a farmer pays no indirect tax. Indirect taxes on agricultural commodities are 47

Nirmal Kumar Chandra

levied when these enter the regional or national network of distribution and augment the incomes of non-agriculturists. Of course, farmers do purchase industrial inputs and consumer goods on which indirect taxes are levied. However, since the share of agriculture in the GDP has been steadily shrinking from 42.3 per cent in FY 1971 to 17.8 per cent in 2008, the contribution of agriculturists to indirect taxes should be negligible. Among the major central taxes, as shown in Figure 3.3, the percentage share of indirect taxes fell steeply from well over 10.0â•¯per cent of NA-GDP during the late 1980s to an average of 5.7 per cent in 2001–07. As part of the reform agenda, import duties that accounted for a large part of the overall tax revenue were slashed drastically after 1991. Even if one grants that many earlier tariffs were too high, there are questions about the new rates; those on industrial inputs were often higher than on finished goods, including capital goods, and this led to excessive imports at the cost of domestic production. At the same time, to encourage the domestic Figure 3.3:â•… Personal Income Tax, Corporate Tax and Indirect Taxes as Percentages of Non-agricultural GDP, 1971–2008

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

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consumption of durables and other consumer goods (barely purchased by the masses), excise and other taxes on these items were also lowered significantly, while the tax burden on food and other items of ‘basic necessity’ remained unchanged. By contrast, direct taxes appear to be a success story. As a proportion of NA-GDP, personal income tax collection rose dramatically from 0.35 per cent in 1998 to 2.43 per cent in 2008, as against an earlier peak of 0.56 per cent in 1989, which was a year of tax amnesty that led to large-scale, voluntary tax disclosures. But the ratio is still quite low. On the positive side, the number of individual taxpayers has increased at a fast pace thanks to a new scheme that allowed traders and others who were self-employed to pay a fixed (modest) sum with an unwritten assurance that no probes would be conducted. As a result, the number of individual assesses, which was quite low at 3.5 million in 1991, jumped to 18.6 million in 1999, and further to 30.0 million in 2003. Since then it stagnated, reaching 31.9 million in 2007. On the other hand, tax rates were reduced in tune with neoliberal tenets; as a result, ‘tax payable’ as a proportion of total income of all assessees fell precipitately from 18.2 per cent in 1991 to just 8.3 per cent in 2000; the corresponding percentages for the top group with a taxable income above 1.0 million were 45.3 and 21.4 over the same years. In 2002 the corresponding percentages were 10.6 for all assesses, and 32.0 for the top group. It is a sad commentary on tax administration that data for later years remain unpublished.5 While the government claims that corporate income tax yields have gone up sharply in recent years, a closer look at the figures hardly supports the view. As a percentage of NA-GDP it fell from 1.9 in the early 1980s to 1.6 at the end of the decade, thanks to tax cuts in the middle of the decade; thereafter it fluctuated, rising to a peak of 3.9 in 2008. However, NA-GDP is not the appropriate denominator for this indicator. A better one, though far from ideal, is the national accounts statistics data on the ‘Operating Surplus’ (OS) Indian Public Finance Statistics 2004–05, Ministry of Finance, Delhi, Table 7.1. Also see, www.indiastat.com for the last year (accessed on 20 April 2009). 5

49

Nirmal Kumar Chandra

of the ‘organized sector’. The latter comprises of companies in the private or public sector, the cooperatives as well as public administration, including defence. By definition, the last has no OS. However, the OS for the organized sector includes ‘mixed income’, namely the income of proprietors as well as the income of the selfemployed in proprietary firms. The self-employed may be paying personal income tax. Hence the denominator may not be perfect, but is still the best available to examine the efficacy of corporate tax. From Figure 3.4, one finds that the ratio of corporate tax to the OS averaged almost 14 per cent in 1981–84, then fell to a low of 9.8 per cent in 1994; despite some improvement in later years it was still 13.3 per cent in 2006, the latest year for which data are available. Figure 3.4:â•…Corporate Income Tax as a Percentage of OS of the Corporate Sector, 1981–2006

Source: RBI, Handbook of Statistics on Indian Economy, 2008 and CSO website.

The low yield from various taxes can be explained by tax cuts and widespread tax exemptions. The Union Budget FY 2010 estimated that owing to various exemptions, the effective tax rate for a sample of over 400,000 companies in 2008 was only 22.2 per cent as against the statutory 33.0 per cent. The figures on ‘revenue foregone’ (RF) under the main heads of central taxes for the two years FY 2008 and 2009 were as follows (Table 3.3): 50

Inclusive Growth in Neoliberal India Table 3.3:â•…Revenues Forgone (` in crore) and Share (Per cent) in Aggregate Tax Collected, FY 2008 and 2009 Items Corporate income tax Personal income tax Excise duty Customs duty Total Less export-related Adjusted total Adjusted total as % of aggregate tax collected

2008 62,199 38,057 87,468 153,593 341,317 56,265 285,052 48.16

2009 68,914 39,553 128,293 225,752 462,512 44,417 418,095 68.95

Source: The Union Budget 2010, Government of India.

There are good reasons to exclude export-related exemptions in respect of indirect taxes, as these are meant to create a level playing field for Indian exporters and their foreign rivals. But the exemption of profit from exports that was introduced in the late 1980s has little justification and is hence a simple gift from the exchequer (Chandra, 1986). Most of India’s manufactured exports consist of labour-intensive products, and the same is true for IT and related services. Exports in these cases are limited not by the size of investment, but that of the foreign markets. Adjusted RF in 2008–09 exceeded two-thirds of total tax revenue, up from 48 per cent in the previous year. This is a big increase, and may go further up. For, in spite of the precarious fiscal position, new tax sops are being offered by both the Centre and the states to investors, while the latter clamour for more. Among the most controversial of these is the Software Technology Parks of India (STPI) Expansion required for ITeS firms, which was to have ended in 2007, but has been extended. The Special Economic Zone (SEZ) scheme was also hotly contested. The Ministry of Finance estimated in 2005 that this would lead to the loss of central taxes of around `102,600 crore in the subsequent five years against the projected investment of `100,000 crore (RBI, 2006). In the wake of the appreciation of the rupee in 2007–08, Indian exporters of labour-intensive manufactures found their competitiveness eroded; 51

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the Centre not only announced a slew of new subsidies but also requested the states to offer more. Most of these remained even when the rupee depreciated from `39 to around `50 per US dollar, with the changed argument that exports are falling owing to the global meltdown and such sops are needed as stimulants. That reminds one of a favourite motto of many alcohol lovers—one must drink to beat the heat, and one must not forget to celebrate the arrival of rains! Moreover, India’s tax–GDP ratio is one of the lowest among the major developing countries. In trying to prevent the public sector from ‘crowding out’ private firms, on the basis of the neoliberal prescription, the central and state governments have for all practical purposes become tools in the hands of big capital, both foreign and domestic. The official claim of an overall gain in tax efficiency after 1991 is hollow from a macroeconomic perspective, but is quite true if one looks at the world through the prism of the so-called ‘wealth creators’—the affluent and the rich across borders. Neoliberal tax concessions for individuals and corporations across the world, including in India, have followed from two interrelated premises. One, the lower the tax rate, the greater is the incentive for tax compliance, and hence the tax yield goes up. The Indian experience summarized above flatly contradicts this assertion. Moreover, with deregulation in various sectors and de facto transition towards free cross-border capital flows, there is evidence that in recent years millionaires everywhere, including India, have found offshore tax shelters to avoid paying any tax at all. Two, neoclassical theory posits that a firm’s investment depends on its post-tax income. Generally, this has not been true, as loan capital and equity capital raised in the market place across countries and historical periods contributed far more to firms’ investments. Perhaps the best counter-examples are those of Japan and South Korea in their years of high-speed growth, when the investment rates reached dizzying heights although profit rates were minimal by Anglo-American standards. It is ironical that the theory got wide currency in the 1990s when a frenzy of M&A (mergers and acquisition) activity was sweeping through the United States and West Europe, largely with 52

Inclusive Growth in Neoliberal India

funds borrowed from financial institutions. As the US financial meltdown revealed, some of the iconic firms in investment banking had a debt-equity ratio exceeding 30:1. Since 2007, several Indian firms (Hindalco, Tata Steel, Tata Motors, etc.) went for big-stick acquisitions in Europe and America on the strength of massive foreign currency loans at a low cost as against domestic loans. At the time of writing, the equity shares of all these companies have nosedived in the stock market, the international credit market is very tight and the Indian firms may not be able to pay back the creditors through own profits or obtain fresh loans to meet their obligations. Such tax cuts and tax sops for big business have three drawbacks. First, these have hardly any justification from a socioeconomic perspective and are hence an uncalled for transfer of resources from the national exchequer to private investors. Second, these sops encourage big firms to invest recklessly, and the costs are eventually borne by the taxpayers. Last but not the least, tax sops lead to excess capacity as the cost of capital is in effect subsidized; at the same time, production becomes highly capital-intensive to the detriment of employment.

III Budgetary Expenditure

Coming to the expenditure side of the central budget, Figureâ•¯3.5 shows trends in total expenditure as a proportion of GDP. For FY 2008 the book transfer of the shares of the State Bank of India from Centre to the RBI for a sum of `35,000 crore was shown as capital expenditure in the budget. It has been excluded in this computation, thereby reducing both capital and total expenditure. Total expenditure as share of GDP increased more or less steadily from 13.1 per cent in 1971 to a peak of 22.2 per cent in 1987, stayed around 20 per cent in the next four years, and fell gradually, with fluctuations, to lows of 15.4 per cent in 2007 and 15.7 per cent in 2008. The decline is remarkable for two reasons. First, the ratio 53

Nirmal Kumar Chandra Figure 3.5:â•…Centre’s Total Expenditure as a Percentage of Gdp, 1971–2008

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

is now one of the lowest among the major developing countries. Second, India is following literally the neoliberal prescription of squeezing the public sector for the benefit of the private segment, while in Organisation for Economic Co-operation and Development (OECD) countries there has been no such trend since 1980. The lion’s share of the Centre’s expenditure now consists of revenue expenditure, with the share rising steeply over the years from 57 per cent in 1971 to around 88 per cent in the last few years, as shown in Figure 3.6. The share of interest payments rose even faster from 11 per cent of total expenditure to a peak of 30.5 per cent in 2001, but has since come down to 25.6 per cent in 2008. As a consequence, capital expenditure has witnessed a big fall—from 44 per cent of the total in 1971 to just 12 per cent to 13 per cent during 2006–08. Ever since the economic reforms of 1991, the opposition, comprising of the Left parties, and, depending on which party is in power, the BJP or the Congress, harshly criticized the neglect of the social sectors in successive budgets. The CMP of 2004, one may recall, envisaged ‘public spending’ on health, as a proportion of the GDP, to rise over the next five years to at least 2 per cent to 3 per cent, and that on education to increase in a ‘phased manner’ to at least 6 per cent. Since a very large part of outlays in these sectors are made by state governments, one must consider the combined 54

Inclusive Growth in Neoliberal India Figure 3.6:â•…Revenue Expenditure, Interest Payments and Capital Expenditure as Percentages of Centre’s Total Expenditure, 1971–2008

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

outlays of the Centre and the states. Since consistent time series could not be found from the Annual Reports of the RBI or from Ministry of Finance sources, this exercise relies on data from the CMIE. Figure 3.7 depicts expenditure on revenue and capital account of the Centre and the states on ‘all social services’, covering (a) education, including sports, art and culture; (b) medical, including medical and public health, family welfare, water supply and sanitation; (c) housing; (d) urban development; (e) information, publicity and broadcasting; ( f ) welfare of Scheduled Caste (SC), Scheduled Tribe (ST) and Other Backward Classes (OBC); (g) labour and employment; (h) social security and welfare; (i) nutrition; (i) relief against natural calamities; (k) ‘other’ social services and (l ) secretariat—social services. The coverage in CMIE is somewhat less than that of the ‘social sectors’ in the Annual Reports of the RBI; the latter as a percentage of GDP was 7.8 in 2007, somewhat higher than 7.2 for ‘social services’ in Figure 3.6. However, the trends are quite similar. In fact, all the ratios in the chart moved within a narrow band over the years 1987 to 2007, and changed very little since the end of the BJP rule in 2004. The subject has been explored at much greater depth by Ramakumar (2008). 55

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In Table 3.4 are reproduced the RBI data for the last five years on social sector spending by the Centre and the states as percentages of GDP. The total outlay in the budget for FY 2009 is almost 1 per cent higher than in 2006, but those on education and health are way below the CMP targets. One may now discuss two flagship schemes of the UPA, namely, employment guarantee and social security for workers in the unorganized sectors. Table 3.4:â•…Expenditure of Central and State Governments on Social Sectors as Percentages of GDP Social services Year 2005 2006 2007 2008 RE 2009 BE

Total

All

Education

Medical and public health

7.4 7.6 7.8 8.2 8.5

5.7 5.8 5.8 6.5 6.8

2.7 2.7 2.8 2.9 3.0

0.8 1.3 1.3 1.4 1.4

Source: RBI, Annual Report; various years. Figure 3.7:â•… Percentage share in GDP of Central and State Government Outlays on Social Services, including Education and health, 1986–2006

Source: Prowess database of CMIE.

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Employment Guarantee

Soon after passing the National Rural Employment Guarantee Act (NREGA), the UPA government began to implement it from 2006 in 200 districts. Two years later, the scheme covered the whole country. Under the Act, the state is obliged to provide work at the statutory minimum wage for up to 100 days in a year for every rural family that demands the job; if the administration fails to find such employment, the applicant is entitled to compensation as a kind of unemployment benefit. Since this right to work is legally enforceable, it marks a radical departure from the old practice of ‘food for work’. In barely three years, the scheme, in regions where it has made significant progress, has two main merits. It has promoted grass roots democracy by raising the consciousness of the rural masses, and has somewhat improved their standard of living. The NREGA Survey 2008 found that 46 per cent of the sample workers from 10 districts in six northern states received the statutory minimum wage. In Rajasthan, an area of notable success, no contractors were engaged for executing the projects; elsewhere only 35 per cent of the workers reported the presence of contractors. In Rajasthan there was no use of machines at worksites; elsewhere, only 8 per cent of the workers reported the use of machines. As many as 71 per cent of all respondents across the states felt that the work opportunity was ‘very important’ for them, 69 per cent thought that it helped them to escape hunger, 57 per cent could avoid migration, 47 per cent could cope with illness thanks to the extra earnings and 35 per cent could stay away from demeaning or hazardous occupation. In short, the scheme led to empowerment of the beneficiaries. Further, official figures up to January 2009 for the country as a whole show that women accounted for 48.1 per cent of person-days and the percentage shares of SC and ST participants were 29.6 and 25.1 respectively (NCEUS, 2009). On the other hand, even in regions of success, the survey noted, that there are ‘miles to go’. The situation is much worse elsewhere

57

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with workers not getting their dues and many other types of corruption. It makes little sense, however, to throw the NREGA baby out while cleansing the dirty bath water. The flaws in the system should be combated politically. For the country as a whole, the achievement of the scheme so far is quite meagre. During 2008–09 about 36 million persons worked on average 22.6 days, totalling 808 million person-days. This is just a tiny fraction of the potential demand, as noted below. One must admit that it is a daunting task for the state machinery of the centre, the states and the panchayats to plan and implement local level schemes under the Act. On the other hand, the centre did not nudge the states sufficiently, and allocated rather small sums in the budget to contain its own fiscal deficit. Ambasta et al. (2008) made a cogent estimate of the costs of the scheme for the whole country, considering only rural labour households. The latter constituted 40 per cent of all rural households, the estimated number being 64.2 million in April 2008; of these 80 per cent, or 50 million approximately, would demand work, the authors assumed. From the official data, the weighted average wage across the states came to ` 70 per day. Hence the aggregate labour cost would amount to `35,000 crore. Adding all other expenses like materials used (20 per cent), professional management (9 per cent) and administration (1 per cent), amounting to 30 per cent of the total, the full cost of the scheme was put at `55,000 crore. Ambasta et al. did not explain why they considered only labour households, ignoring the majority of other rural families. One may recall that National Commission for Enterprises in the Unorganized Sector (NCEUS) found that out of the unorganized sector workforce, rural and urban, of 362 million, including 235 million agriculturists and 127 million outside agriculture, an overwhelming majority of 77 per cent or 323 million earned less than `20 a day. According to the NREGA Survey 2008, 98 per cent of sample workers wanted full 100 days’ work. Further, not all workers in the survey came from labour households; for instance, some respondents used their wage earnings to purchase agricultural inputs. This is 58

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corroborated by the official data on the proportion of agricultural labour households that were provided employment up to January 2009. While the national average was 92.4 per cent, the percentage in several states was well above 100—Himachal Pradesh (1,938), Rajasthan (1,043), Jharkhand (274), Assam (262) and Uttarakhand (147) (NCEUS, 2009: Table 9.1). Hence it is more reasonable to presume that 75 per cent of all rural households (160 million in 2008) could avail of the opportunities under NREGA, so that the potential demand for work is 12,000 (= 160 × 0.75â•¯×â•¯100) million person-days. Aggregate labour cost at the currently stipulated wage of `100 per day would then be `120,000 crore; including nonlabour costs at 30 per cent of the total, the overall outlay would amount to about `170,000 crore, or 3 per cent of the FY 2009 GDP of `4,933,183 crore. By contrast, the July 2009 Union budget allocated a mere `39,100 crore in 2009–10, barely 10â•¯per cent above the revised figure of `36,750 crore in the previous year. There is every reason to doubt whether expenditure in the near future will come anywhere the ‘full cost’ just estimated. While the NREGA is confined to the rural areas, the CMP had promised opportunities for ‘every rural, urban poor and lower middle-class household’. Though NCEUS did not provide a rural– urban breakup of 127 million non-agriculturists in the unorganized sector, I assume that a large proportion would be urban. There are several problems in estimating the probable number of workers and the overall costs of an urban employment guarantee scheme (UEGS). If the daily wage is fixed at, say, `125, nearly all unskilled urban workers would seek a job card, as they generally earn much less and are rarely engaged round the year. On the other hand, there are few labour-intensive schemes off-the-shelf to build public assets in urban India today. Most activities like road or building construction are now highly mechanized and executed by big private contractors. It would require major, almost revolutionary, institutional and policy changes to design and execute socially useful projects without contractors. It is no wonder that Keynes could think of nothing better than digging trenches to fill them up repeatedly to provide jobs in a deep depression. NCEUS (2009) has proposed 59

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measures like training, but their effectiveness has to be proved at the ground level. In any case, a job guarantee scheme for urban areas could require higher budgetary outlay than NREGA. Politically, opposition to NREGA came from vested interests in local areas that did not have cohesive bodies organically linked to established political parties in different states. On the other hand, UEGS will threaten big private contractors who have virtually monopolized the infrastructural sector through ‘public–private partnerships’. As Rajan (2008) observed, these entrepreneurs have a major voice in policy making at the centre and the states across the political spectrum. Thus, UEGS is unlikely to see the light of day owing as much to the fiscal problem of the present government as to the opposition from within and outside the major parties. Social Security

NCEUS was set up by the UPA, as promised in the CMP, to suggest measures for the social security of workers in the unorganized sectors. In its recommendations, NCEUS (2006a) proposed a National Minimum Security for 300 million of such workers, including 69 million BPL (below the official poverty line) and 145 million APL (above the poverty line) persons. For each worker the premium per day would be `3, to be paid in equal amounts by the worker, the employer and the government; in the absence of an identifiable employer, the government would make up the shortfall. The annual premium of `1,095 would be broken up as follows: (a) `380 would be earmarked for health insurance of the earner, including a maximum of 5 persons in the family, entitling them to hospitalization costs not exceeding `15,000, and maternity benefits of `1,000 per delivery; (b) `180 would go towards life insurance of the earner and the family would receive `25,000 for accidental death and (c) the balance of `565 would be set apart as old-age ( > 60 years) pension of `200 per month for a BPL earner; for APL workers the sum would go into a Provident Fund. NCEUS proposed that the scheme be introduced gradually over 60

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five years, 2007–11; in the final year all workers would enjoy social security and the cost for the central and state governments, including administrative expenses, would be `25,401 crore. Let me suppose for the moment that there would be no bottlenecks in implementation and the full scheme was introduced in 2007; the fiscal burden would have been just 0.7 per cent of the GDP—by no means an extravagant figure. How did the government respond? It introduced a draft bill that went to a parliamentary committee. The latter not only endorsed the proposal of NCEUS, but suggested the inclusion of unpaid family workers in unorganized sectors among the insured. The Unorganized Workers Act, 2008 ignored, however, major points of the two reports. The act merely authorizes the government to formulate future programmes (NCEUS, 2009). From 1 April 2008, a Scheme called the Rashtriya Swasthya Bima Yojana to provide health cover to unorganized BPL workers was introduced, covering in each case a family of five persons, and facilitating cashless/paperless transaction (against a smart card) up to `30,000 per annum. One million cards were issued till Januaryâ•¯2009. The government has also introduced life insurance for rural landless households. As the coverage of these two schemes is limited, budgetary outlays would be a fraction of what NCEUS proposed. Clearly, the government has been dragging its feet in view of the fiscal deficit. In my view, the scheme proposed by NCEUS no doubt represents a big improvement over the status quo, but may fail to attain the CMP’s objective: ‘To enhance the welfare and wellbeing of farmers, farm labour and workers, particularly those in the unorganised sector and assure a secure future for their families in every respect.’ Though I consider the compensation for accidental death and the quantum of pension for old age quite inadequate, I shall focus on health care here. If one takes the CMP literally, India’s aam aadmi surely deserve health facilities comparable, not to those in rich OECD countries or in socialist Cuba, but to those in neighbouring Sri Lanka. The small island has for long been acknowledged as having some of the best health indicators in the world, though 61

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it is nearly as poor as India, has an economic system quite similar to ours, and its government embraced a neoliberalism about a decade before ours did. India’s overall rank in Human Development Report 2007–08 was 129, well below Sri Lanka at 99. The human development indices, measuring the distance from the top country (with an index of 1.0) in each year, were respectively 0.450 and 0.656 for the two countries in 1980. By 2005, both had progressed, and the corresponding values were 0.619 and 0.743. India’s relative standing in 2005 was lower than Sri Lanka’s in 1980. From the data in Table 3.5 one finds that in 2005, per capita total health expenditure in current dollars was 42 per cent higher in Sri Lanka than in India, although private expenditure in India was $29, or $2 more than in Sri Lanka. At purchasing power parity (PPP), India’s shortfall was much larger. Now, the ratio of total health expenditure at PPP to that at current dollars was 3.71 for Sri Lanka and 2.78 for India; the numbers were respectively 3.67 and 2.71 for government expenditure, and 3.74 and 2.79 for private expenditure. These ratios suggest that one dollar (converted into local currencies at the market rate of exchange) of expenditure fetched more goods/services in these two countries than in the United States, the country of reference for PPP estimates; but the Sri Lankans had a significant advantage over Indians in respect of both government and private expenditure. Table 3.5:â•…Health Facilities and Per Capita Income in Sri Lanka and India Key Indicators

Sri Lanka

Densitya Hospital beds Physicians Nursing and auxiliary Pharmacists, etc. Other health services Per capita income ($ PPP)

29.0 6.0 17.0 <1.0 <1.0 5,010

India 7.0–8.0 6.0 13.0 5.00 7.0 3,800

Source: WHO Core Health Indicators, 2009. Note: aPer 10,000 population @ per capita. Data pertain to different years from 2000 to 2006.

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The main reason for this divergence is no doubt the much higher government share in total health outlay in Sri Lanka (47 per cent) than in India (19 per cent). Contemporary global experience amply confirms this hypothesis. Thus, the United States in 2004 spent 15.4 per cent of GDP on health against Canada’s 9.8 per cent, the per capita figures at PPP dollars being 6,096 for the United States and, nearly half that amount, 3,173 for Canada. As for the state of health, in 2005 life expectancy at birth (in years) stood at 80.3 in Canada and at 77.9 in the United States. West European countries, Japan, etc., with national health insurance, have figures comparable to Canada’s (UNDP 2008). The Economist (2009), for all its commitment to neoliberalism, wrote: ‘America’s health care is the costliest in the world, yet quality is patchy and millions are uninsured. Incentives for both patients and suppliers need urgent treatment.’ Specifically, it highlighted four shortcomings: (a) some ‘30 per cent of America’s health-care spending is sheer waste’; (b) the insurance business encourages overuse of medical facilities; (c) the incentives facing doctors are even more perverse, leading to far higher rates of doctors’ visits, specialist referrals, scans and so on and (d ) there is no mechanism to evaluate the cost-effectiveness of new drugs, devices and treatments. In my view, all these drawbacks, with some variation, apply equally to the health insurance business in India, including hospitals, doctors and the firms supplying new and/or branded drugs and devices. The Economist strongly argued for universal health insurance covering all citizens, leaving open the choice between public and private agencies. Returning to our subcontinent, of the physical indicators of health services, the most striking difference is that per head of population Sri Lanka has nearly four times as many hospital beds as India. As for the health workforce, the World Health Organization (WHO) has nine categories of which one may ignore the five that have low ‘densities’ of less than 1 per 10,000 population in both these countries. Now, the two countries have the same density of physicians, but Sri Lanka has nearly one-third more of nurses and auxiliary staff than India. On the other hand, India (per head of 63

Nirmal Kumar Chandra

population) engages five times as many pharmaceutical personnel, and the density of ‘other health service providers’ is less one in Sri Lanka, and as high as 7.0 in India. For these last four categories together, the density is around 24 in Sri Lanka and 32 in India. Despite the higher overall density of health personnel in India, the health ‘outcome’ is inferior to that of Sri Lanka. From a medical perspective, a good part of the Indian workforce may be parasitic in nature, if not counterproductive. The fault line is obviously the health system in India. The dominance of private profit motive leads to a massive waste of resources both in the public and in the private sector. Just enhancing budget allocation to augment the number of hospital beds several fold and to finance insurance schemes along the lines proposed by NCEUS may not meet the health needs of the deprived sections of the population, especially in rural areas. Thus, a higher number of hospital beds need not lead to higher occupancy. Across the country there are many hospitals that had once a good reputation but have hardly any patients today. Many primary health centres all over rural barely function owing to the prolonged absence of doctors and the non-availability of essential medicines. Routinely, a large proportion of patients in government hospitals are advised to seek treatment in private establishments, and those who stay in government hospitals often buy medicine from private stores. Despite repeated attempts over the years to centralize purchase of the WHO’s list of essential medicines to minimize the cost for the consumer, vested interests at various levels have thwarted them. The paradox is that India is known for cheap, world-class generic drugs, and the retail prices for many of these are higher than what the British National Health Service pays. India’s health insurance companies, public or private, follow the American model, allowing all expenses, medically justified or not, for hospitalization and for medicines within the overall limit for each person. They do not question the appropriateness of the fees charged by hospitals, laboratories or specialists. In this milieu, health insurance for 300 million persons in India’s unorganized sectors at an annual premium of just `380 may bring some relief to some, 64

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but a good part of the payout from insurance companies is likely to be wasteful. In short, if ‘health for all’ is the guiding objective, there is no alternative to universal health insurance through government and other not-for-profit hospitals, clinics, etc. that are professionally managed and socially audited. A profit-oriented private sector may exist on the sidelines for the affluent and the rich as in West Europe, Japan or Canada. Unfortunately, such a radical overhaul of the health system is not on the agenda of India’s political parties with a parliamentary presence. On the other hand, in the health sector (as in many others), the buzzword in government circles of UPA or BJP or Left parties is ‘public–private partnership’. The market forces, it is believed, can deliver health care for all with appropriate government subsidies. It is a neoliberal illusion that actually helps to widen the scope of private profiteering, taking the focus away from the need to galvanize the state-owned health sector.

IV Credit to agriculture and SSI

Modern financial institutions since their inception in India in the early decades of the nineteenth century were designed to serve rich individuals, large firms in various sectors and the government, leaving the mass of cultivators and other petty producers to the care of traditional sources like traders, moneylenders, ‘friends’ and relatives. In the past two centuries the economy has changed vastly. Banks and insurance companies expanded enormously and now account for 7 per cent of the GDP, that is only a little less than 10.3 per cent of ‘registered’ manufacturing. Yet economic units engaging over 90 per cent of the country’s workforce cannot reach the portals of financial institutions. Nationalization of private domestic banks in 1969 was aimed at altering this landscape. Credits were extended to many sections of 65

Nirmal Kumar Chandra

the population that were previously reckoned ‘unbankable’. Two groups deserve special attention, namely agriculturists and those in SSIs. NCEUS (2006b) estimated that out of the national workforce of 397 million in 2006, only 35 million were in the ‘organized’ sector of medium and large businesses, administration, etc., while 362 million were in the ‘unorganized’ sectors, including 235 million in agriculture and 127 million in non-agricultural activities; within the latter were 29 million in SSI. In June 1969, just before the bank nationalization, the percentage shares of agriculture and SSI in total bank credit were 1.3 and 8.5, respectively; for other ‘unorganized’ sectors employing 98 million workers, no data exist on bank credit. Moderate progress was made in providing credit to them over the next two decades, followed by a reversal after the economic reforms of 1991. Although the reform in the financial sector was aimed at removing the distortions in the credit market caused by state directives so that credit would flow to all clients at a ‘single’ price, the reality was very different. By the early years of this century, a crisis emerged. Realizing the gravity of the situation, the CMP proposed, as noted above, to nurse back to health the rural cooperative credit system, double the flow of rural credit in the next three years and ensure a substantial rise in institutional credit to small and marginal farmers. As for the ‘most employment-intensive’ segment, namely SSI that suffered extensively in the past few years, the CMP promised ‘soon’ a major initiative with ‘full credit, technological and marketing support’. How far were these objectives realized? The trends in credits to agriculture and SSI as percentages of non-food gross bank credit from 1980 to 2008 are shown in Figure 3.8. Let us first look at agriculture. Historically, the farmers never obtained from banks their ‘due’ share of credit, if one goes by the sector’s contribution to the GDP. However, there was a perceptible improvement in the ’80s when the percentage rose from 14.5 in 1980 to a peak of 18.4 in 1987; thereafter it fell over the years to a low of 11.9 in 2003. However, the absolute size of credit to agriculture rose dramatically from over `90,000 crore in 2004 to over `273,000 crore in 2008. 66

Inclusive Growth in Neoliberal India Figure 3.8:â•…Share of Agriculture and SSI in Bank Credit, 1980–2008 (per cent)

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

Yet the sector’s percentage share at 12.4 was still 4.0 per cent below that of 1987. After a detailed analysis of data, Shetty (2008) observed that the bulk of the incremental credit during the threeyear period, 2005–07, have been: (a) in the form of indirect credit for input suppliers, etc.; (b) credit extended by urban and metro-politan branches and (c) large size loans with credit limits of `1 crore and above. Agricultural credit is classified by RBI as either ‘direct’ that goes to cultivators, or ‘indirect’ that is channelled to private firms, commission agents, non-banking financial institutions, etc. to finance agricultural activities. In Figure 3.9 are shown the trends in the share of the two components in credit from all scheduled banks, cooperatives, regional rural banks and the Rural Electrification Corporation during 1972–2006. Over the entire period there was a drastic fall for direct credit from 83 per cent to 54 per cent, and a corresponding rise for indirect credit. There were two sharp breaks in the series—during 1993–95 when the share of direct credit nosedived from 79 per cent to 61 per cent, and again during 1999–2001 when it fell from 60 per cent to 45 per cent. There was a partial recovery in the next five years to 2006. 67

Nirmal Kumar Chandra Figure 3.9:â•… Percentage Shares of Direct and Indirect Credit in Total Bank Credit to Agriculture, 1972–2006

Source: RBI, Handbook of Statistics on Indian Economy, 2008.

How far indirect credit helps the mass of farmers is open to question. Ramakumar and Chavan (2007, Table 3.5) noted that, in 2005, more than 84 per cent of indirect credit went to big accounts ( > `1 crore), while small loans ( < `25,000) accounted for a mere 0.9 per cent. It is unlikely that a substantial part of the big loans was eventually transmitted to small farmers. Before 1991 the Public Sector Banks (PSB) were directed to expand rural branches for the benefit of depositors and borrowers, especially the small ones. The policy was abandoned in the early 1990s as part of financial reforms with its accent on banks’ profitability. As a result, the number of rural branches was reduced from `35,360 in 1993 to 30,561 in 2007 (NCEUS, 2009: p 290). Recently, the focus in official policy shifted to microfinance institutions to meet the needs of the rural poor. PSBs with their high manpower costs, it was argued, can hardly offer loans of a few thousand rupees to millions of small borrowers, and ensure timely repayment. On the other hand, if there are some reputable NGOs to assist the small farmers as intermediaries, the PSBs can entrust them with loans to be passed on to the small borrowers. The self-help groups (SHG) with a collective responsibility for the loans are ideal for the purpose. Indeed, the model SHG, Grameen Bank of Bangladesh, 68

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claimed grand success, and Mohammed Yunus, the founder, was awarded the Nobel Peace Prize. Critics claim that the accounts of the Bank were never scrutinized by an independent auditor; they also allege that the high repayment rate for loans is explained by fresh loans offered to clients, avoiding default. Besides, the interest rates charged by the Bank may not have been low. In India the RBI facilitated the growth of microfinance institutions, including SHG, by encouraging ‘no-frills’ accounts to be opened at PSBs; there was a rider—there would no ceiling on interest rates charged on loans to the depositors. The RBI also seemingly approved the range of annual interest rates fixed by the SHG. A survey by an RBI affiliate for 2005 indicated the following percentages: Andhra Pradesh 17.0–32.5, Karnataka 12.0–40.0, Orissa 14.0–24.5, Rajasthan 16, and Uttar Pradesh 13.0–26.0. The upper limit in most cases is not very different from those extracted by moneylenders. What is more, as Shetty (2008) ruefully observed, the RBI suggested the mainstreaming of the private money lending activities and strengthening of the synergies between the formal and informal segments, ostensibly by eliminating its negative characteristics and usurious rates of interest. It is doubtful if the RBI or PSBs can effectively monitor and supervise the intermediaries in their dealings with small borrowers. The distribution of direct credit is also skewed in favour of the bigger landholders as shown in Table 3.6. Thus, marginal farmers ( < 2.5 acres) constituting 41 per cent of borrowers obtained only 25 per cent of the total, while the corresponding figures for the small (2.5–5.0 acres) and the medium-large groups ( > 5.0 acres) were 30 per cent and 49 per cent. The contrast is sharper when one looks at the latest National Sample Survey (NSS) data on the distribution of operational holdings; the proportion of farms in bottom group was 70 per cent, while that for the top group was 14 per cent. More than 95 per cent of marginal cultivators and nearly 88â•¯per cent of all cultivators had no access to bank loans. Ramakumar and Chavan (2007, Table 3.7) sought to underline the highly unequal distribution of direct credit. The percentage 69

Nirmal Kumar Chandra Table 3.6:â•…Credit to Farmers According to Different Size and Classes of Landholding and the Overall Distribution of Landholdings Category of Holdings Marginal Small Medium-large Total

Number of Credit to farmers in Land holdings farmers 2005–06 2002–03â•¯â•¯ % No. in million % No. in million % ` in crore 5.004 40.5 16,823 25.1 71.0 70.0 3.670 29.7 17,619 26.2 16.0 16.0 3.670 29.7 32,682 48.7 14.0 14.0 12.344 100 67,124 100.0 101.0 100.0

Source: RBI, Handbook of Statistics on Indian Economy, 2008, Table 5.9; and NSS Report No. 492, table 3.4.

share in the total of small loans ( < `25,000) improved from 58.2 in 1985 to 66.1 in 1990, but fell steeply after 1995 to 18.1 in 2006, while that of big loans ( > `1 crore) jumped from 1.5 in 1990 to 8.9 in 2006. However, over a long period of high inflation a fixed threshold in terms of rupees is less and less meaningful over the years; one should continuously revise the thresholds, but RBI does not offer such tabulation. Taking inflation into account, the authors’ inference on the pre-1995 period is strengthened, but that for later years needs further probing. However, among the recipients of direct credit, as shown in Table 3.5, the distribution was far less skewed than in the case of indirect credit. It followed that an increase in direct rather than indirect credit is generally more beneficial for the small farmers. The squeeze on direct credit (after adjusting for inflation) during the period 1995–99 created a crisis. One witnessed numerous indebted farmers across the states committing suicide, stirring the nation’s conscience. A study by Nagaraj (2008) put the number of such suicides, mostly from Maharashtra, Andhra Pradesh, Karnataka, Madhya Pradesh and Chhattisgarh, at nearly 200,000 between 1997 and 2006. The UPA government offered a palliative by waiving `60,000 crore of small farmers’ loans taken from the PSBs. Dogmatic neoliberals dismissed it as dangerous populism that would encourage ‘moral hazard’. They conveniently ignored numerous tax exemptions and other bounties for the rich and the corporate sector 70

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amounting every year to several times the one-off loan waiver. The previous governor of RBI, Reddy (2006) also lamented the neglect of farmers by commercial banks in their lending. Although credit flow increased as promised in the CMP, suicides by farmers continue to this day, and as many as 1,267 deaths were reported in Vidarbha during 2000 (www.tehelka.com, 2009). One major factor behind the farmers’ distress has been the resurgence of moneylenders in the countryside as the PSBs retrenched rural branches. This is vividly brought out in Table 3.7, based on the decennial All-India Debt and Investment Surveys. In 1951, the percentage share of moneylenders in the outstanding debt of cultivating households was as high as 69.7 as against 0.9 held by the banks. Just after the 1969 nationalization of banks, the latter’s percentage share in 1971 was still meagre at 2.4, while that of moneylenders had come down to 36.1. By 1991, the banks’ share reached a plateau of 35.2 per cent, while moneylenders had 17.5 per cent of the total. The decade of financial reforms put the clock back. By 2002, moneylenders raised their share to 26.3 per cent, while that of banks shrank to 26.8 per cent. And now efforts are made in official circles, as seen above, to whitewash the business of money lending. Table 3.7:â•…Distribution of Outstanding Loans of Cultivators from Different Sources (Percentages) Non-institutional

Institutional

Year

Total

Moneylenders

Total

Banks

1951 1961 1971 1981 1991 2002

92.7 81.3 68.3 36.8 30.6 38.9

69.7 49.2 36.1 16.1 17.5 26.8

7.3 18.7 31.7 63.2 66.3 61.1

0.9 0.6 2.4 28.8 35.2 26.3

Source: Report on Currency and Finance 2006–2008, Table 6.4.

Satish (2007) dealt with this issue in an article with the very apt title: ‘Agricultural credit in the post-reform era: A target of systematic coarctation’. The Concise Oxford Dictionary defines 71

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coarctation as the congenital narrowing of the aorta, that is, the main artery of the body, supplying oxygenated blood to the circulatory system of a human being. Satish showed how drying up of bank credit from the early-1990s contributed to the protracted crisis of agrarian India, affecting in particular small and marginal farmers. Coming to SSI, Figure 3.8 (see p. 67) depicts a trend that is as disturbing as that for agriculture. By 1980, the SSI share of bank credit at 13.8 per cent had improved considerably from 8.5 per cent in 1969, and there was a further rise to a peak of 15.9 per cent in 1987 and 1988. Then followed an almost unbroken stretch of years of decline, and it was more precipitate since 2000. Under the UPA regime, as the CMP had promised, bank credit (in `crore) to SSI did jump from about 66,000 in 2004 to nearly 156,000 in 2008, but the percentage share in total bank credit fell actually fell from 9.0 to 7.1 over the same years. The inadequacy of bank credit to SSI comes out clearly when one compares it to that for medium and large industry. The latter belongs to ‘organized manufacturing’ that contributed 11.3 per cent to the GDP in 2008 as against 5.0 per cent coming from ‘unorganized’ manufacturing. In the same year, bank credit to ‘industry’ was 39.6 per cent; excluding the SSI share of 7.1 per cent, medium and large industries cornered 32.6 per cent, or nearly three times their GDP share. Unfortunately, the available data on credit to SSI (which are also used in this paper) are not comparable over the years. The upper limit on investment in plant and machinery for an SSI unit was regularly enhanced by the authorities over the years—from 7.5 in 1970, to 10 in 1975, 20 in 1980, 35 in 1985, 60 in 1991 and to 300 in 1997, all figures being in ` lakh. In 1999, the limit was for once scaled down to `100 lakh. In 2006, the old system was replaced. The Micro, Small and Medium Enterprises Act created three new categories, namely, micro (25), small (500) and medium (1,000) enterprises, the figures in parentheses being the respective thresholds in ` lakh as before. The Act also extended the scope of SSI to include units producing services; the upper limits on the value 72

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(in ` lakh) of investment in equipment were 10 for micro, 200 for small, and 500 for medium enterprises. One must note that under the new Act, manufacturing units with investments of `1–5 crore came under the ambit of SSI; moreover, units in the service sector were included in SSI for the first time. A good part of the unprecedented 2.4-fold rise in credit allocation between 2004 and 2008 should have been due to the definitional changes, implying that the SSI share under the pre-2006 definition fell more than Figure 3.8 suggests. The definitional changes came about after a sustained campaign against the SSI in the reform era. On the one hand, the reservation (under industrial policy) of many industrial product lines for the SSI sector over the decades up to 1991 was blamed for the reluctance of successful small units to expand and realize the benefits of scale economies; for, they could lose the benefits of SSI units. At the same time efficient large units, many of them export-oriented, found their growth path blocked by such reservation. Consequently, several hundred products, out of an earlier list of 869 at the peak, were ‘de-reserved’, and simultaneously, the official definition of SSI became more elastic over the years. The distribution of credit to SSI by size classes in 2007 is given in Table 3.8, in which ‘artisans and village and tiny industries’ and ‘other SSIs’ are clubbed together. While over 1.5 million or 83 per cent of borrowers with credit limits up to `2 lakh obtained 6 per cent of total credit, the top 0.9 per cent of borrowers with credit limits above `1 crore received 47.4 per cent of the total. The top group of six borrowers received one quarter of the amount that went to the bottom group of almost one million borrowers. In view of this astounding skewness in distribution, the percentage of SSI in overall bank credit hardly reveals the status of myriads of petty producers. An NCEUS Task Force made a comprehensive report on the economics of the unorganized sector. Two of its findings on the credit scene may be highlighted (NCEUS, 2007: chapter III): (a) not more than 5 per cent of such enterprises had access to bank finance and about 96 per cent of these borrowed money from friends, 73

Nirmal Kumar Chandra Table 3.8:â•…Distribution of Credits to SSIs by Size of Credit Limits, March 2007 No. of amount Size groups ` in Lakh < 0.25 0.25–2 2–5 5–10 10–25 25–50 50–100 100–400 400–600 600–1,000 1,000–2,500 > 2,500 Total

Accounts Nos 984,378 547,426 120,720 74,444 62,497 30,793 18,268 13,485 1,542 1,117 438 6 1,855,114

Outstanding ` in cr 964 3,666 3,463 4,638 8,420 8,922 10,322 19,881 5,807 6,371 4,152 240 76,843

Cumulative percentage No. of amount Accounts Outstanding 53.1 82.6 89.1 93.1 96.5 98.1 99.1 99.8 99.9 100.0 100.0 100.0 100.0

1.3 6.0 10.5 16.6 27.5 39.1 52.6 78.4 86.0 94.3 99.7 100.0 100.0

Source: RBI, Basic Statistical Returns of Scheduled Commercial Banks in India, March 2007, Table 5.4.

relatives and moneylenders and (b) the banks in 2007 charged around 15 per cent as interest from the SSI, as against 7 per cent to 8 per cent from large-scale industries owing to the latter’s high creditworthiness. It is true that that the ratio of Non-Performing Assets (NPA) to the total loans is somewhat higher for the SSI, but the absolute size of their NPA is also much smaller than for bigger borrowers. Regarding the micro and small enterprises just defined, their percentage share in bank credit fell from 4.2 in 2003–04 to 1.8 in 2007–08, while that for the micro group dropped from 2.2 in 2002–03 to 1.2 in 2006–07, and recovered partially to 1.6 in 2007–08 (NCEUS, 2009: p 283). NCEUS recommended the creation of a statutory body, National Fund, with a capital of ` 500 crore to cater to the needs of the micro or tiny enterprises. It is yet to be implemented by the government. Sarma and Nikaido (2007) have explored some policy factors behind the declining share of SSI in bank credit. The Bank for International Settlement (BIS), regarded as the Central Bankers’ Bank, 74

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evolved the ‘Basel norm’ on capital adequacy for a commercial bank and India has adopted it. It is measured by the ratio of capital to risk-weighted assets held by a bank. While Treasury bills carry a zero risk, loans to private sector borrowers carry varying risk-weights from 20 per cent to 100 per cent or more. ‘Independent’ CRAs assess the risk weights. In the wake of the sub-prime credit crisis in the United States, the reliability of the agencies has been questioned widely, the public has lost confidence, and yet the agencies flourish! In any case, they add to the cost of borrowing that is a severe drawback in our context. If a borrower does not approach a CRA, and few SSI units or small farmers can afford their fees (even though the government subsidises 75 per cent of the fees), banks assign 100 per cent risk to the loan. Ceteris paribus a bank would prefer lending to a solvent client with a risk factor of 50 per cent. It is also argued by many that the SSIs have a high default rate that increases the quantum of NPA held by banks. But the NCEUS rightly noted that though the proportion of SSI accounts in the red may be high, in terms of loans outstanding the proportion of NPA may be smaller for SSI than for big accounts. Given the stress on capital adequacy, profitability and low NPA for banks, it is no wonder that banks minimise their exposure to the SSI and the weaker sections. This in turn led to an increase in the stranglehold of private moneylenders, as noted earlier. A piquant situation has arisen for Indian banks after the global meltdown. RBI intervened through a variety of measures to inject liquidity into the financial markets and reduce the policy rates—just as the authorities in the United States and Europe did. Yet, barring China, banks everywhere are reluctant to lend, preferring to hoard cash or invest in low-yield government securities. While in the United States or Europe the central banks’ lending rate has come down to almost nil, those from commercial banks remain higher than before. After adjusting for the inflation rate, the ‘real’ rate in India has also been kept quite high to attract foreign portfolio capital. Moreover, our banks have become more cautious about lending. On the other hand, ‘business confidence’ has tanked, and private sector investors, domestic and foreign, have abandoned a large proportion of 75

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ongoing or planned projects. As a result, their demand for bank loans has also shrunk. Table 3.9 indicates the commercial banks’ incremental deposits, credits and investments. From March to December 2008, commercial banks had an incremental credit-deposit ratio of 76.5 per cent; during the month of January 2009, it turned negative at –9.6 per cent, implying a contraction in the volume of fresh credit. The situation improved in February 2009; even then the incremental ratio as against December 2008, was extremely low at 12.6 per cent. What did the banks do with fresh deposits? They invested in safe government securities. While in March–December 2008 just 32â•¯per cent of new deposits were invested in such securities, during December 2008 and January 2009 it shot up to 82.4 per cent; it came down sharply to 18 per cent in the next month, but was still unusually high at 56 per cent over the period of December 2008 to February 2009. Clearly, RBI played a supporting role by keeping up the ‘reverse repo rate’, that is, the interest on the idle funds parked by banks with RBI. In the absence of such facility, the banks would be compelled to lend to somewhat riskier and/or less profitable clients. EPWRF (2009) has shown that in the recent past, RBI targets for bank loans to agriculture, SSI and the weaker sections remained unfulfilled to the tune of ` 70,000 crore; if one adds to it, as the NCEUS proposed, an additional target of 10 per cent of bank Table 3.9:â•… Incremental Deposit, Credit and Investment in Government Papers of Commercial Banks, March 2008–February 2009 March 08– March 08– Dec 08– Dec 2008 Feb 09 Jan 09 Increase in a)â•‡ Deposits (` cr) b)â•‡ Credit (` cr) c)â•‡ Investment (` cr) Ratio B/A (%) Ratio C/A (%)

3,729 2,853 1,185 76.5 31.8

5,389 3,062 2,115 56.8 39.2

Source: RBI Bulletin, April 2009.

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986 –95 812 –9.6 82.4

Jan– Feb 09

Dec 08– Feb 09

675 303 118 44.9 17.5

1,661 208 930 12.6 56.0

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credit earmarked for these groups, the total shortfall is as high as `180,000 crore—roughly 8 per cent of non-food credit outstanding as at the end of March 2008. Just this small amount of bank credit disbursed to the informal sector would greatly help to widen the demand base of the economy as such sectors account for the employment and liveliÂ�hood of over 80 per cent of the country’s population. This is by no means an extravagant suggestion. RBI (2007: Box IV.4) has approvingly cited one estimate of the credit needs of India’s poor households at `450,000 crore. The banks’ reluctance to lend to these sections can be overcome only through firm policy directives along with some meaningful penalty for non-compliance. But that runs counter to the neoliberal mantra of de-regulation.

V Concentration of wealth and income

Since the turn of the century there has been a growing concern about the excessive concentration of income and wealth in most countries and at the global level. One may cite among many others the studies by Milanovic (2002) and by Davies et al. (2006) from the World Institute for Development Economics Research (WIDER). These are based on household income surveys for developing countries and income tax returns in industrial countries, and all point to a rising Gini coefficient. In many countries it is currently above 0.4—generally reckoned as a ‘danger’ mark for social stability. India does not have any reliable and comprehensive statistics on the distribution of household or individual incomes. Most authors, including the multilateral institutions like the World Bank, calculate the Gini coefficient from the NSS data on the distribution of household consumption. From its inception NSS focused on consumption rather than income for the simple reason that the rich are unlikely to reveal their actual income for a variety of reasons—in particular, to avoid the attention of income tax authorities. It is also 77

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widely known that the proportion of net savings in total income rises almost monotonically with the level of income. Clearly, the Gini coefficient from consumption should be significantly lower than that from income. Moreover, almost any sampling formula covering a large population cannot but understate the income or consumption levels of the top group since the distribution among the latter tends to be highly skewed. Indeed, one finds that aggregate consumption estimated from NSS has fallen increasingly short of household consumption as revealed in the official national accounts statistics. In the absence of a reliable Gini coefficient for income one has to look at alternatives. At the global level, a dramatic picture emerges if one looks at the top of the pyramid. As world financial markets are getting more and more integrated, Global Asset Management Companies (AMC) have sprung up to help clients, rich individuals and firms, move their financial assets from one location to another to minimize tax payments. Boston Consulting Group, a leading firm, estimated that the global wealth of the ‘affluent’ individuals (minimum assets of $100,000) and large firms in different countries rose from 85.3 to 97.9 (in $ trillion) between 2004 and 2006. No country-wise breakup is available. The total may be contrasted with the Central Intelligence Agency (CIA) estimate of world GDP (at the nominal exchange rate) of $51.0 trillion in 2006. Thus, private wealth was nearly twice as high as world income. Since 1996, Capegimini, an AMC, has been putting out annually World Wealth Report on HNWI (high net worth individuals with assets of at least $1 million). The number of such persons increased from 4.5 to 10.1 million during the 11 years, 1996–2007, and their aggregate wealth in $ trillion rose from 18.6 to 40.7 over the same years. The HNWI are mostly in the United States and West Europe, though the emerging countries have become more prominent in recent years. In India their number increased annually by about 15 per cent a year since 2000 to reach 123,000 in 2007. The size of wealth is not revealed for individual countries. Assuming a lower average wealth of $3.0 million for India as against the world average 78

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of $4.0 million, the HNWI wealth for the country comes to $369 billion. Allowing for a modest 10 per cent rate of return on assets, the annual income of the HNWI would be 3.7 per cent of India’s GDP in 2007. On the other hand, the average HNWI income as a multiple of per capita GDP was 302 for India, and only 48 for the world. By this measure, the degree of inequality in India is extremely high at more than six times the world average. More frequently cited in the media is the annual list of the global rich published by the Forbes magazine. In 2005, it reported 920 dollar billionaires across the world who had a net worth of $4.38 trillion; Davies et al. (2006) found it close to their econometric estimate. For 2006, Forbes identified 49 billionaires resident in India with an aggregate wealth of $280 billion; this is consistent with my estimate derived from Capegimini’s figures. The Indian capitalists have been playing a major role in the formulation of policies by major Indian parties even before independence, and have continued to do so. Immediately after 1991 many of them were openly critical about the reform. But the government managed to regain their confidence through a variety of concessions. In recent years there is an intimate collaboration between the government and big business. The situation is aptly captured by Raghuram Rajan (2008), former Chief Economist at the IMF, in an interview. He observed that Germany and India had the same number of billionaires, though the former’s GDP is four times higher than India’s. ‘We have extremely efficient private banks and telecom companies that obtained their start from a government contract or licence… If Russia is an oligarchy, how long can we resist calling India one?’ Conclusion

Recapitulating the earlier discussion, India remains vulnerable to external shocks thanks to her high fiscal and external payments deficit, despite her enormous foreign exchange reserve. The reserves, yielding low returns, were accumulated through capital inflows, 79

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and the country may be losing 3 per cent to 5 per cent of its GDP to ensure the inflow of foreign capital in various forms.6 Yet India’s current rating by the global CRAs is the lowest in the investment grade, and may fall if the fiscal deficit widens. A ‘negative’ signal from the agencies is likely to reduce FDI and FII investments in India, and also affect adversely Indian firms’ bid to raise funds through equity and debt issues in international capital markets. Clearly, the government cannot afford fiscal deficits beyond a certain level. Although the government has claimed to have substantially raised the aggregate tax–GDP ratio in recent years, it does not bear a close scrutiny. The low rates for direct taxes as well as liberal rules for permissible deduction from taxable income and, more importantly, legal exemptions under various heads from taxation of incomes earned has led to an almost negligible tax burden for affluent individuals and companies. Any attempt to raise the effective tax rates would encounter strong opposition from these quarters and a negative reaction from the CRAs. In the wake of the recent global meltdown, tax revenue had to fall, but various tax concessions as part of the stimulus package the revenue dwindled more steeply. Central government expenditure as a proportion of the GDP remains well below the peak of the late 1980s. At the same time, the share of revenue expenditure in the total has risen from less than 60 per cent in early 1970s to well above 80 per cent in recent years, while that of capital expenditure nosedived from over 40â•¯per cent to just 12 per cent over the same period. As for social sectors like education, health and so on, the combined outlays by the Centre and the states have remained sticky at 6 per cent to 8 per cent of the GDP from mid-1980s to the present, with no significant increase since the advent of the UPA government in 2004. In fact, fulfilment of the CMP agenda on inclusiveness would require a manifold increase in such outlays. That would lead to much larger fiscal deficits, since the main item of government expenditure, namely 6

The argument is elaborated in Chandra (2008).

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revenue expenditure cannot be compressed nor can tax revenue be enhanced. Thus, India’s policy autonomy in this sphere is severely circumscribed. One comes to a similar conclusion from an analysis of bank credit to agriculture and SSI. The two groups along with other branches of the unorganized sector (for which no comprehensive data on bank credit exist), contribute the lion’ share of the GDP, but receive a small fraction of total credit. Further, a disproportionate share of bank loans to agriculture and SSI go to big borrowers. As a result, the petty producers depend largely on traditional sources like moneylenders. Actually, the aggregate credit needs of the former are quite substantial at `450,000 crore or about 20 per cent of gross bank credit at end-March 2008. Not to speak of foreign or private banks, the large PSBs aiming at a global status can hardly seize the opportunity, given their high overheads and profit orientation. Drawing on the East Asian experience, Justin Lin (2009), the World Bank’s Chief Economist, called for the creation of a large number of small local banks to meet the credit requirements of small producers. On the other hand, our policy makers are hell bent on mergers of PSBs and disinvestment of large chunks of their equity capital in the teeth of opposition from trade unions. It is not difficult to decipher the motive. Big business, Indian or foreign, can at a later date buy a relatively small part of a PSB and acquire control. If a large number of small local banks come into being, the market share of the PSB behemoths may fall significantly, making the latter less attractive for private investors. That may explain why the National Fund for unorganized sectors proposed by NCEUS has yet to see the light of day. As shown in the final section of this chapter, the super rich from India have entered the Forbes magazine list, and have an important voice in the formulation of government policies. Naturally, they push for measures to expand the turf for private enterprise, which has been the major objective of economic reforms in India as in the United Kingdom or the United States.

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Some ‘moderate’ steps towards inclusive growth should be welcomed by an enlightened private sector. Over the entire postindependence era, the domestic market for manufactured goods and ‘modern’ services has failed to match the growth of productive capacities. Since the mid-1980s, the Centre lowered the tax burden for the upper crust, raised the salaries and perquisites of civil servants, and lifted restrictions on the remuneration of employees in the private sector. These ‘incentives’ for the affluent must have contributed in a major way to the acceleration in GDP growth over the last quarter century. Many officials in high positions believe that such concessions have gone too far and need to be contained, if not reduced. On the other hand, as NCEUS showed, 70 per cent to 80 per cent of households in the country are to this day either poor or vulnerable and they lack income for nonessential, discretionary purchases (Sengupta et al., 2008). Ignoring for a while the outlets for export, capital cannot expand in the long run unless new markets are found within the country. ‘Inclusive’ growth can provide such an opportunity. The NREG scheme does not fit the bill for several reasons noted earlier. On the contrary, recognition of an individual’s right to work for 100 days and the stipulation of minimum wages might lead to an escalation of labour costs in both rural and urban areas. It is no wonder that the Centre has gone slow in its implementation, and has so far made no move to start a similar scheme for urban areas. More attractive for the private sector is the proposal of the Planning Commission (2006) for state funding through vouchers of the tuition fees for poor students at expensive private schools. Presently, the government is also contemplating a large-scale expansion of higher educational institutions for which the bulk of capital expenditure will come from the exchequer, but the management will remain in private hands. In the name of public–private partnership, the government has, in fact, been offering over many years subsidized land to private medical and educational institutions, and has recently inducted private investors to manage, wholly or in part, state-owned hospitals. 82

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On vouchers for private schools, Bagchi et al. (2006) raised several objections. How does the state ensure that the management does not charge ‘extras’ from the poor students that may not be reimbursed by the state? There are few regulatory bodies for educational institutions, and two major ones in higher education, namely the Universities Grant Commission and the All India Council for Technical and Engineering Education are mired in controversy. Bagchi et al. raised another issue. The voucher scheme would widen the chasm between elite private schools and public schools, and their respective products. Thanks to the scheme, the former would expand and attract a larger pool of talented teachers at the expense of public schools. If the money allotted for vouchers are used instead to improve the infrastructure of public schools, the outcome in terms of educational attainment of all school-going children could be far superior. The same arguments apply to public– private partnership in the domain of health, as discussed earlier. As for the quality of services, all the acclaimed institutions in higher education are in the public sector. In secondary education, a good proportion of the best schools across the country are run by the government. The same is true for hospitals. Is there is a strong case for such examples to be replicated on a much larger scale? Obviously, that would not serve the interests of the private sector. Hence the latter pushes for various types of public–private partnership to enlarge the market for privately produced goods and services. It follows that the CMP’s agenda of inclusiveness is likely to remain an icing on the neoliberal cake to make it more attractive for the aam admi. References Ambasta, P., P. S. Vijay Shankar, and Mihir Shah. 2008. ‘Two years of NREGA: The road ahead’, Economic and Political Weekly, 43(8): 41–50. Bagchi, A. K., D. Banerjee, and A. Chakraborty. 2006. ‘A critique of the Approach Paper to Eleventh Plan’, Economic and Political Weekly, 41(31): 3346–51. Chandra, N. K. 1986. ‘Modernisation and export-oriented growth: A critique of recent Indian policy’, Economic and Political Weekly, 21(29): 1236–75,

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reprinted in N. K. Chandra. 1988. The Retarded Economies: Foreign Domination and Class Relations in India and Other Emerging Nations. Bombay: Sameeksha Trust and Oxford University Press. Chandra, N. K. 2008. ‘India’s foreign exchange reserves: A shield of comfort or an albatross?’, Economic and Political Weekly, 43(14): 39–51. Davies, J. B., S. Sandstrom, A. Shorrocks, and E. N. Wolff. 2006. The World Distribution of Household Wealth, World Institute for Development Economics Research, 5 December, Helsinki. The Economist. 2007. ‘Emerging economies: Dizzy in Boomtown’, The Economist, 15 November, London. EPWRF. 2009. ‘Stimulus packages facing institutional constraints’, Economic and Political Weekly 44(4): 23–29. Government of India. 2004. ‘National Common Minimum Programme of the Government of India’, May 2004. Available online at http://pmindia.nic. in/cmp.pdf (accessed on 20 April 2009). Isaac Thomas, T. M., and R. Ramakumar. 2008. ‘Challenges to fiscal policy in India in the context of the global financial crisis’, paper presented at the Conference on towards Progressive Fiscal Policy, organized by the Centre for Budget and Governance Accountability, Delhi, December 8–9. The Economist. 2009. ‘New Fund, Old Fundamentals’. Available online at online http://www.economist.com/research/articlesBySubject/display.cfm?id=526 358&startRow=16&endrow=30 (accessed on 30 April 2009). The Economist. 2009. ‘India’s Budget’, The Economist, 11 July. Lin, Justin. 2009. ‘Walk, don’t run’, The Economist, 11 July, London. Milanovich, B. 2002. ‘The World Income Distribution, 1988 and 1993: First Calculation Based on Household Surveys Alone’, The Economic Journal, vol. 112 (January). Nagaraj, K. 2008. ‘Farmers’ Suicides in India: Magnitudes, Trends and Spatial Patterns’. Available online at http://www.macroscan.org/anl/mar08/ anl030308Farmers_Suicides.htm (accessed on 18 April 2009). NCEUS. 2006a. Social Security for Unorganised Workers: Report, report submitted to National Commission for Enterprises in the Unorganised Sector, New Delhi, May. NCEUS. 2006b. Task Force Report of NCEUS on Definitional and Statistical Issues, report submitted to National Commission for Enterprises in the Unorganised Sector, New Delhi. NCEUS. 2007. Reports on Financing of Enterprises in Unorganised Sector and Creation of a National Fund for the Unorganised Sector (NAFUF), report submitted to National Commission for Enterprises in the Unorganised Sector, New Delhi.

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NCEUS. 2009. The Challenge of Employment in India: An Informal Economy Perspective, Vol I—Main Report, report submitted to National Commission for Enterprises in the Unorganised Sector, New Delhi, April. Planning Commission. 2006. ‘Towards faster and more inclusive growth: An approach to the 11th Five Year Plan’, New Delhi: Planning Commission, Government of India. Rajan R. 2008. ‘Interview’. The Economic Times, 12 September. Ramakumar, R. 2008. ‘Levels and composition of public social and economic expenditures in India, 1950–51 to 2005–06’, Social Scientist, 36 (September– October): 48–94. Ramakumar, R. and P. Chavan. 2007. ‘Revival of agricultural credit in the 2000s: An explanation’, Economic and Political Weekly, 42(52): 57–63. RBI. 2006. RBI Annual Report 2005–06, Box 1.2, Reserve Bank of india, Mumbai. RBI. 2007. Trends and Progress of Banking in India, report submitted to Reserve Bank of India, Mumbai. Rediff.com. 2009. ‘India’s fiscal deficit to be highest in the world: Goldman’, PTI, 20 February. Available online at http://www.rediff.com/money/ 2009/feb/20bcrisis-india-fiscal-deficit-to-be-highest.htm (accessed on 10 November 2010). Sarma, M. and Y. Nikaido. 2007. ‘India’s capital adequacy regime’, Economic and Political Weekly, 42(43): 66–71. Satish, P. 2007. ‘Agricultural credit in the post-reform era: A target of systematic coarctation’, Economic and Political Weekly, 42(26): 2567–75. Sengupta, A., K. P. Kannan and G. Raveendran. 2008. ‘India’s common people: Who are they, how many are they and how do they live?’, Economic and Political Weekly, 43(11): 49–63. Shetty, S. L. 2008. ‘India’s economic structure and financial architecture: A growing mismatch’, paper presented at conference organized by the International Development Economics Associates (IDEAs), New Delhi, September 12–13. UNDP. 2008. Human Development Report 2007–08. New York: UNDP, www. tehelka.com on 11 July (accessed on 18 August 2009).

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4 Growing Inequality A Serious Challenge to the Indian Society and Polity S. L. Shetty

I The Theme

It is my considered view that developments in the Indian economy, policy and society are rapidly dipping towards that threshold level of economic inequality and social deprivation that it is likely to threaten the very social fabric, political stability and economic progress of India. This is the challenge I am seeking to pose in this chapter. I am aware that the subject of the link between growth and equality is a complex one and that some short-term increase in inequality is to be expected in a liberalizing economy. The literature has also propagated the idea of an inverted U curve, implying the possible scope for inequality to recede after certain stage in the growth process. But, the comparable Chinese experience of sharp and sustained increase in economic inequality over a period of 30 years after market-oriented reforms were initiated in the latest 1970s, fails to inspire confidence in the above proposition. And this has occurred in a society which had undergone intense socialist reconstruction and purposeful land reforms—measures 86

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which helped many Southeast Asian economies to acquire more equitable distribution of incomes and wealth. Be that as it may, my theme in this paper is quite different; it is that while some form of inequality may be an essential accompaniment of the growth process, repulsively gross inequality may constrict the size of the domestic market and arrest the process of social and economic advancement, particularly in the form of the market for manufactured goods and support for industrialization. Also, inherent in economic inequality will be the narrower spread of the benefits of education, health and other social infrastructure—a spread that is an essential foundation for more rapid growth, as endogenous growth theorists have hypothesized. A scientific way of approaching this subject would have been to provide a quantitative measure of the threshold level of inequality which would be so threatening, but the subject being so complex it is not capable of being reduced to a credit rating type of measurement in terms of unique numbers. We also do not have any data on the distribution of incomes in society. What is being attempted, therefore, is the presentation of a number of qualitative and quantitative indicators of growing social deprivations and economic inequality in the recent period. The factors leading to this can be a serious subject of enquiry. But it can be argued that the policies and programmes themselves are inherently inegalitarian in scope and content and they invariably give rise to the accentuation of multiple forms of disparities: rural–urban, agricultural–nonagricultural, unorganized–organized sectors, backward–advanced regions and poor–rich classes. A number of indicators presented below buttress this argument that public policies in general have been unfavourable to the goals of egalitarianism, and also suggest that the development interventions in favour of the poor have been grossly inadequate and half-hearted. Failure to Reform the Governance System

The second glaring cause for the growing social and economic deprivations and inequality is to be found in the failure to 87

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implement the general programmes of development as designed and to enforce the performances under development interventions directed towards the poor. Sloppiness in execution and corruption, leakages and denial of benefits to the poor are rampant in both the sets of programmes. It is true that V. M. Rao (2008) has forcefully argued that it is wrong to place the blame at the door of implementation. According to Rao (2008: 104), in a democratic polity, ‘there is ceaseless activity of lobbying and bargaining by the organised groups leaving little scope for the government to look at the long-term development issues and at the basic needs of these in the unorganised sector.’ But, once we accept representative democracy (as opposed to even direct democracy) as the only sustainable form of government, it is incumbent on the powers that be to design institutional checks and balances, strive to curb the machinations of vested interests and get the policies and programmes enforced. We cannot throw up our hands in helplessness; we need to seek answers to such maladies in systemic reforms. Effective decentralization is considered as one such necessary instrument of instituting such checks and balances. Historically, the Indian society has been an unequal and oppressive society insofar as the masses of the poor, the downtrodden and backward communities are concerned. What is required to correct the malaise, as has been accepted by umpteen numbers of committee reports and intellectual discourses, is to reform the state’s three key organs of governance: the bureaucracy; the police or the forces of law and order and the justice system. The conviction that ‘good governance is perhaps the single most important factor in eradicating poverty and promoting development’ (Kofi Annan quoted in http://www.arc.gov.in/reforms.htm), leads to a consideration of what has been done in recent years in these three areas. Many recommendations for the reform of the judiciary and the justice system have remained unimplemented. Despite repeated National Police Commission (NPC) recommendations, substantive reforms of the police administration remain to be done. There is a comprehensive review of the criminal justice system with a massive report and 289 recommendations made in May 2003 88

Growing Inequality

(Mukherjee, 2003) but the incidence of corruption and the police-criminal-politician nexus continues to be rampant. As for the reform of the administrative structure, some radical steps such as the Right to Information Act 2005 and e-governance plan for 27â•¯major areas have been taken. The Second Administrative Reforms Commission, with wide terms of reference, has been asked to suggest measures to improve governance at all levels of government; it has submitted six reports and several more are expected. In central budgetary programmes, a shift in focus from inputs to outcomes has been accepted as a reform for accountability. Effective decentralization and strengthening Panchayati Raj institutions with effective devolution of functions, finances and functionaries have been emphasized. Reexamination of the system of centrally sponsored schemes is underway. To promote better accountability, All India Service Rules have been amended to provide for certain fixed tenures for specified posts to be notified by the central and state governments. There are thus excellent paper programmes but the system of implementation is left to the deeply entrenched bureaucracy. Therefore, every reform programme is influenced by the same bureaucratic, tardy and inefficient, and at times, biased and unresponsive system. The time has come for fresh thinking, particularly on the role of the so-called colonial Indian Civil Service (ICS)-inspired steel-frame Indian Administrative Service (IAS) and for widening the executive wings with participation by experienced professionals at least for the implementation and monitoring of administrative and organizational reforms. The bureaucratic set up has become a stumbling block for social change; it has to be shaken at its roots. Dynamic inputs from professionals and socio-political functionaries are a crying need of the hour. Hence a mix of IAS officers and professionals has to be accepted as the desideratum in the administrative structure with some lateral entries all along the line of hierarchy.

89

S. L. Shetty

The Naxalite Challenge

Before I conclude, I must make a reference to the government’s attitude towards the Naxalite movement—a government that is headed by a social scientist. The Planning Commission’s 16-member expert group made a fervent plea for treating the Naxalite movement as a social problem and addressing developmental and redressal measures over repressive ones; it at the same time called for strengthening and modernization of the security apparatus in the Naxal-dominated areas as part of its ‘multipronged’ approach. Nevertheless, the government now overwhelmingly treats the problem as the ‘most serious internal security threat’. An objective observer who has studied the Naxalite movement in-depth sums up the picture thus: [A]divasis as a whole have gained least and lost most from six decades of democracy and development in India. There is evidence that they are even more deprived than the dalits. However, unlike the dalits, they have been unable to effectively articulate their grievances through the democratic and electoral process. The failures of the state and of the formal political system have provided a space for Maoist revolutionaries to move into. After analysing the reasons for the rise of ‘Naxalite’ influence, the essay concludes that there is a double tragedy at work in tribal India. The first tragedy is that the state has treated its adivasi citizens with contempt and condescension. The second tragedy is that their presumed protectors, the Naxalites, offer no long-term solution either. (Guha, 2007: 3305)

II Disturbing Levels of Poverty and Social Deprivation

According to the Eleventh Five Year Plan (2007–2012) document, and as shown in Table 4.1, the Head Count Ratio (HCR) of poverty declined from 54.9 per cent in 1973 to 27.5 per cent in 2004. However, there have been significant critical comments on these official estimates and their interpretation. Ray and Lancaster 90

Growing Inequality Table 4.1:â•… Percentage of People Below Poverty Line in India (1973–2004) Years

Rural

Urban

Combined

1973–74 1977–78 1983–84 1987–88 1993–94 1999–2000 2004–05

56.4 53.1 45.7 39.1 37.3 27.1 28.3

49.0 45.2 40.8 38.2 32.4 23.6 25.7

54.9 51.3 44.5 38.9 36.0 26.1 27.5

Source: Planning Commission (2008c).

(2005), for instance, employ alternative estimates of nutrient prices and ‘balanced diet’ of nutrients and come to the conclusion that ‘poverty situation in India today is much worse than that revealed by the official poverty lines’ (p. 55). Conceding the point made earlier, the Planning Commission (2008c) writes: Thus, 60 years after independence, over a quarter of our population still remains poor. There is growing consensus that the poverty line (Rs 356 monthly per capita consumption expenditure for rural areas and Rs 539 for urban areas in 2004–05) in India is much too low, and continues to be based on a consumption basket that is too lean. If the poverty line was higher, the share of the population below the poverty line would be accordingly higher.

Also, over time, while HCR fell, the number of the poor remains at over 300 million—a number that has barely declined over the last three decades of planning (Table 4.2). Table 4.2:â•… Number of Persons Below Poverty Line in India (1973–2004) (in Lakh) Years

Rural

Urban

Combined

1973 1983 1993 2004

2612.90 2519.57 2440.31 2209.24

600.46 709.40 763.37 807.96

3213.36 3228.97 3203.68 3017.20

Source: Planning Commission (2008c).

91

S. L. Shetty

Inter-state and Inter-regional Disparities

The absolute numbers of the poor actually increased in Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh (BIMARU) states as well as in Maharashtra, while the four southern states and West Bengal, Assam and Gujarat experienced fall. Just the former five states account for 55 per cent of the total number of the poor, as shown below. But there are many other smaller states like Orissa (46.4 per cent) which have very high incidence of poverty. Interestingly, the number of the poor in rural areas has declined from 261.3 million in 1973 to 220.9 million in 2004–05, that is, by 40.4 million over a 31-year period or by 1.3 million per year, but the urban number has gone up, increasing from 60.05 million to 80.8 million, driven partly by rural-urban migration (The total number of migrant workers in 1999–2000 was 102.7 million—a staggering number). Even so, the rural share in the total number of the poor was 73.3 per cent, which was slightly higher than the rural population share of 71.4 per cent (Table 4.3). The degree of urbanization in India has been one of the lowest in India at 27.8 per cent of the total population compared with 32â•¯per cent in China, 37 per cent in Indonesia, 78 per cent in Japan and 83 per cent in South Korea (Planning Commission, 2008c). Large concentration of the urban population—68.9 per cent in Class I cities with population over one lakh—reflects the ‘push’ factors that have operated in urban migration due to rural poverty in contrast to the process of urbanization promoted by a natural Table 4.3â•… Ratio of Poverty across Major States (Rural and Urban in 2004–05) States Uttar Pradesh Bihar Madhya Pradesh Rajasthan Maharashtra Total

State-wise share of poverty in 2004–05 (%) 19.60 12.23 8.30 4.47 10.50 55.10

Rural–Urban (2004–05) poverty numbers Rural 220.9 million (73.3) Urban 80.8 million (26.7) 301.7 (100.0)

Source: Planning Commission (2008c).

92

Growing Inequality

extension of rural growth. The forced urbanization has created appalling living conditions for the vast segments of the city population: 50.3 per cent of the urban population had no piped water within their premises, 44 per cent were devoid of sanitation facilities and 14.12 per cent lived in urban slums (2001 census). Slipping into Poverty

And added to all these is now the revelation that there can be situations of certain persons, who were above the defined poverty line earlier, slipping below poverty. Survey results have been reported at the micro level in the Indian states of Rajasthan (Krishna, 2003) and Andhra Pradesh (Krishna et al., 2004). Broad sets of factors associated with pushing people below the poverty line in both the cases are stated thus: Falling into poverty in this region is associated not with any single cause but usually with a combination of causes, including poor health, large expenses on (poor quality) health care, social functions associated with deaths and with marriages, and high-interest loans taken out from private sources to meet these unaffordable and often crippling expenses. (Krishna, 2003: p. 538; Krishna et al., 2004: 3252)

Migration into urban areas and growing slum population are another cause of such slipping into poverty. As shown below, a large chunk of the poverty-stricken people are at the margin, say between $1.0 a day to $1.25 a day of expenditure; in such cases, simple shocks are enough to make them slip below the poverty line. The World Bank Estimates of Poverty

The World Bank’s latest estimates place the poverty level in India at 42 per cent of the population based on $1.25 a day of consumption in 2005 (at 2005 PPP prices). Twenty-five years ago in 1981, the corresponding proportion was 60 per cent, thus showing progress. But, the number of people living below $1.25 a day has risen from 421 million to 456 million (Table 4.4). 93

42.1 37.6 35.7 33.3 31.1 28.6 27.0 26.3 24.3

Year (1)

1981 1984 1987 1990 1993 1996 1999 2002 2005

296.1 282.2 285.3 282.5 280.1 271.3 270.1 276.1 266.5

Number of poor people in million (3)

Source: Chen and Ravallion (2008).

Head count index (percentage below the poverty line) (2)

India

73.5 52.9 38.0 44.0 37.7 23.7 24.1 19.1 â•‡ 8.1

Head count index (percentage below the poverty line) (4)

China

US $1.00 per day (2005 PPP)

730.4 548.5 412.4 499.1 444.4 288.7 302.4 244.7 106.1

Number of poor people in million (5) 59.8 55.5 53.6 51.3 49.4 46.6 44.8 43.9 41.6

Head count index (percentage below the poverty line) (6)

India

420.5 416.0 428.0 435.5 444.3 441.8 447.2 460.5 455.8

Number of poor people in million (7)

84.0 69.4 54.0 60.2 53.7 36.4 35.6 28.4 15.9

Head count index (percentage below the poverty line) (8)

China

US $1.25 per day (2005 PPP)

Table 4.4:â•… Proportions and Numbers of Poor People as per International Poverty Lines: China and India

835.1 719.9 585.7 683.2 632.7 442.8 446.7 363.2 207.7

Number of poor people in million (9)

Growing Inequality

Using the $1.0 line, the number of the poor has fallen from 296 million in 1980 to 267 million in 2005. It is interesting that between $1.25 and $1.0 a day of consumption, the number has thus risen from 124 million to 189 million. In other words, a large share—17 per cent of India’s population or over 70 per cent of the $1.0 poverty level—falls within the narrow $0.25 a day interval, which indicates the vulnerability of the poor against minimal deprivations and extraneous shocks. It is worth noting that while India has a population share of about 17 per cent in the world, its share of the world’s poor (at $1.25 a day) is double—near 34 per cent (Table 4.5). Table 4.5:â•… Regional Breakdown of the 2005 Headcount Index and Number of Poor for Various Poverty Lines A. Headcount index (percentage living below poverty line) Poverty line in 2005 prices Region $1.00 $1.25 $1.45 $2.00 $2.50 East Asia and Pacific 9.3 16.8 22.8 38.7 50.7 Of which: China 8.1 15.9 16.6 36.3 49.5 Eastern Europe and Central Asia 2.2 3.7 5.0 8.9 12.9 Latin America and Caribbean 5.6 8.4 10.5 16.6 22.1 Middle East and North Africa 1.6 3.6 6.2 16.9 28.4 South Asia 23.7 40.3 52.3 73.9 84.4 Of which: India 24.3 41.6 53.9 75.6 85.7 Sub-Saharan Africa 39.9 51.2 58.9 73.0 80.5 Total 16.1 25.2 32.1 47.0 56.6 B. Number of poor (millions) East Asia and Pacific 175.6 316.2 429.8 728.7 955.2 Of which: China 106.1 207.7 216.5 473.7 645.6 Eastern Europe and Central Asia 10.2 17.3 23.5 41.9 61.0 Latin America and Caribbean 30.7 46.1 58.0 91.3 121.8 Middle East and North Africa 4.7 11.0 19.0 51.5 86.7 South Asia 350.5 595.6 772.3 1091.5 1246.2 Of which: India 266.5 455.8 590.3 827.7 938.0 Sub-Saharan Africa 304.2 390.6 449.0 556.7 613.7 Total 876.0 1376.7 1751.7 2561.5 3084.7 Source: Chen and Ravallion (2008).

95

S. L. Shetty

Social Composition of the Poor

Poverty is obviously getting concentrated in agricultural labour and artisanal households in rural areas and amongst casual labour households in urban areas. Agricultural labour households account for 41â•¯per cent of the rural poor; in urban areas, the casual labour households accounted for 62.6 per cent in 1993–94 and 56.5 per cent in 2004–05 (Planning Commission, 2008). Amongst social groups, Scheduled Castes (SCs), Scheduled Tribes (STs) and backward castes accounted for 80 per cent of the rural poor in 2004–05, considerably more than their share in the rural population. Sundaram and Tendulkar (2003) note that ‘in terms of changes in poverty in the 1990s, it is found that while scheduled caste, agricultural labour (rural) and causal labour (urban) households experienced declines in poverty on par with the total population, scheduled tribe households fared badly in the both the segments’. That was the position up to the year 1999–2000; subsequent situation shows no improvement in respect of the SC population too (Table 4.6). Table 4.6:â•… Population Living Below Poverty Line: SCs and STs 1993–94

1999–2000

2004–05

Categories

Rural

Urban

Rural

Urban

Rural

Urban

All households SCs STs

37.3 48.1 51.9

32.4 49.5 41.1

27.1 36.3 45.9

23.6 38.5 34.8

28.3 36.8 47.3

25.7 39.9 33.3

Source: Collated from five-year plan documents.

Social Deprivation

There is now increasing realization that measuring of poverty based on only conventional nutritional norms is not enough; instead, it is necessary to take into account the minimum aspirations of the poor in terms of improved quality of life based on their basic needs such as improved nutrition, drinking water availability, shelter, hygiene, 96

Growing Inequality

clothing and health and educational facilities. Detailed work done in this manner by Guruswamy and Abraham (2006) has placed the poverty level at `840 per capita per month as against the Planning Commission norm of `368 for rural areas and `559 for urban areas for 2005–06. Based on this exercise, the authors have said that ‘nearly 69% of India’s total population is below the poverty line, which is over two and a half times the present official poverty rate of 26.1%’ (p. 2539). For rural India, the situation is much worst at over 84 per cent (against 28 per cent of official estimates), while it is at 42 per cent for urban poverty [against the official figure of 27 per cent (Table 4.7). These appear plausible because the World Bank’s norm of $2.0 per day places the poverty level for India at 78.4 per cent for 1999 and 75.6 per cent for 2005 (Chen and Ravallion, 2008). Table 4.7:â•… Poverty Ratio Using a Holistic Poverty Line Area

Percentage

Rural Urban Weighted average

84.6 42.4 68.8

Source: Calculated by Guruswamy and Abraham (2006).

Social Sector Development

Amartya Sen (1994) has noted, ‘The biggest barrier is, I believe, India’s social backwardness in education, healthcare, and land reforms. In each of which we remain well behind where China or East Asia was when they went in for rapid integration with the world economy.’ Detailed reviews of physical achievements under social services (essentially health and education) suggest that the progress has been slow, much slower than targeted, and what is more, all programmes have suffered from inadequacy in quality and equity. One of the important factors has been the failure to provide the targeted amounts of budgetary allocations to primary social sectors, 97

S. L. Shetty

education and health. With a view to honouring the country’s commitments under the National Common Minimum Programme (NCMP), the Millennium Development Goals (MDGs) and ‘Education for all’, there was the target of 6 per cent of Gross Domestic Product (GDP) as education expenditure to be achieved by 2008–09; likewise, the expenditure on health was to reach 3 per cent of GDP. Instead, as shown in Table 4.8, there has hardly been any increase in this expenditure to GDP ratios since 2002–03. The Eleventh Five Year Plan (pp. 4–61) document lists various as pects of the deficiencies in the delivery of educational and health services. To cite a few examples: 1. The fact that children drop out of school early or fail to acquire basic literacy and numeracy skills partially reflects poor quality of education. The average school attendance was around 70 per cent of the enrolment in 2004–05. 2. Teacher attendance, ability, and motivation appear to be the weakest links of elementary education programmes. Lack of universal pre-schooling (Early Childhood Care and Education, ECCE) and consequent poor vocabulary and poor conceptual development of mind makes even enrolled children less participative in the class, even for learning by rote. 3. The dropout rate at the elementary level (Classes I–VIII) has remained very high at 50.8 per cent (Tables 4.9.1 and 4.9.2); it is much higher at 57 per cent to 66 per cent for SCs and STs. 4. There are glaring inter-state and intra-state variations in enrolment, dropouts and access to secondary and higher secondary schools. 5. The comparative picture with regard to health indicators such as life expectancy, Total Fertility Rate (TFR), Infant Mortality Rate (IMR) and Maternal Mortality Ratio (MMR) points that countries placed in almost similar situations such as Indonesia, Sri Lanka, and China have performed much better than India. 98

786,212 153,454 75,607 33,504 44,343 28.54 5.57 2.74 1.22 1.61

28.32 5.77 2.9 1.23 1.64

2003–04 Actual

695,203 141,740 71,298 30,184 40,258

2002–03 Actual

Source: Budget Documents of Centre and State Governments, RBI, 2008.

Centre and states (`crore) Total expenditure Expenditure on social sector Education Health Others As percentage of GDP: Total expenditure Expenditure on social sector Education Health Others

Items

27.29 5.49 2.67 1.19 1.62

859,545 172,812 84,111 37,535 51,166

2004–05 Actual

26.81 5.70 2.69 1.27 1.74

959,855 203,995 96,365 45,428 62,202

2005–06 Actual

Table 4.8:â•… Trends of Social Sector Expenditure by General Government (Centre and State Governments Combined)

27.71 6.19 2.88 1.36 1.95

1,148,824 256,521 119,199 56,378 80,944

2006–07 RE

27.91 6.27 2.84 1.39 2.04

1,309,897 294,412 133,284 65,158 95,970

2007–08 BE

S. L. Shetty Table 4.9.1:â•… Secondary Education—Enrolment and Dropout, 2004–05 No.

Enrolment (in crore)

1

Secondary (IX–X)

2

Higher secondary (XI–XII)

3

Secondary and higher secondary (IX–XII) Dropout (%) rates (I–X)

4

Boys 1.42 (57.39) 0.74 (30.82) 2.16 (44.26) 60.41

Girls

Total

1.01 (45.28) 0.53 (24.46) 1.54 (35.05) 63.88

2.43 (51.65) 1.27 (27.82) 3.70 (39.91) 61.92

Source: Selected Educational Statistics (2004–05), MHRD Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Vol II: Social Sector, pp. 5, 15. Note: Figures in the parenthesis are gross enrolment ratio (GER). Table 4.9.2:â•… Dropout Rates by Social Composition, 2004–05 Primary (I–V)

Elementary (I–VIII)

Categories

Boys

Girls

Total â•¯

Boys

Girls

Total

SCs STs All

32.7 42.6 31.8

36.1 42.0 25.4

34.2 42.3 29.0

55.2 65.0 50.5

60.0 67.1 51.3

57.3 65.9 50.8

Source: Selected Educational Statistics, 2004–05 (see Table 4.9a).

6. As for MMR, there has been a substantial decline during the seven-year period of 1997–2003. However, the pace of decline is insufficient. At the present rate of decline, it will be difficult to achieve the goal of 100 per one lakh live births by 2012, the end of the eleventh plan (Table 4.10). 7. Likewise in IMR; the rate has declined from 72 per 1,000 live births in 1997 to 58 in 2005 and this pace of decline is said to be insufficient to bring it down to 30 by 2012. 8. The public health care system in rural areas in many states and regions is in shambles. Extreme inequalities and disparities persist both in terms of access to health care as well as health outcomes. This large disparity across India places the burden on the poor, especially women, SCs and STs. Inequity is also reflected in the availability of public resources between the advanced and less-developed states. 100

Maternal mortality rate (per 100,000 live births)

Population with sustainable access to an improved water source, rural (%) Population with sustainable access to an improved water source, urban (%) Population with access to sanitation urban (%) Population with access to sanitation rural (%) Deaths due to malaria per 100,000 Deaths due to TB per 100,000 Deaths due to HIV/AIDS

â•‡ 9

10

1991 1991 1994 1999 2000

1991

1991

1991

1990 1990 1990 1990 1990–91 1990–91 1988–92 1990

Year

47.00 9.48 0.13 56.00 471.00

81.38

55.54

437.00

37.50 62.20 54.80 64.30 0.71 0.49 125.0 80.00

Value

Sources: CSO (2005), Millennium Development Goals India Country Report 2005, December.

12 13 14 15 16

11

Proportion of population below poverty line (%) Undernourished people as % of total population Proportion of under-nourished children Literacy rate of 15- to 24-year-olds Ratio of girls to boys in primary education Ratio of girls to boys in secondary education Under five mortality rate (per 1,000 live births) Infant mortality rate (per 1,000 live births)

â•‡ 1 â•‡ 2 â•‡ 3 â•‡ 4 â•‡ 5 â•‡ 6 â•‡ 7 â•‡ 8

Indicator

2001 2005 2004 2003 2004

2001

2005 2005

2005 1998

1999–2000 1999–2000 1998 2001 2000–01 2000–01 1998–2002 2003

Year

Table 4.10:â•… Progress towards Achieving MDGs in India

63.00 32.36 0.09 33.00 1114.00

82.22

26.10 53.00 47.00 73.30 0.78 0.63 98.00 60.00 56.00 (UNDP) 407.00 450.00 (UNDP) 90.00

Value

72.00 72.00 – – –

94.00

80.50

109.00

18.75 31.10 27.40 100.00 1.00 1.00 41.00 27.00

MDG target value (2015)

S. L. Shetty

9. Thus, even though there is a concentration of health care facilities in urban areas, the urban poor lack access; initiatives in the country to date in providing such access have been limited and fragmented. Progress under MDGs

In recent years, social sector development has become a live subject in the context of the MDGs. These goals are apparently too meagre for India, for they have been prescribed essentially keeping in view the needs and potentialities of poorer countries in Africa and south Asia. Even so, the progress made by India is so slow that in many cases of social development, we will find it extremely difficult to attain even the MDGs. Some of these targets, as presented in Table 4.10, were achieved by some South Asian countries long ago (Table 4.11). Table 4.11:â•… Some Health Parameters: India and Its Neighbours Life expectancy at birth (years)

Maternal Under-five mortality rate Infant mortality mortality rate (per 1,000 live rate (per 1,000 (per 100,000 live births) births) live births)

Countryâ•¯

1990 2000–05

1990

2005

1990

2005

1990

2005

China India Nepal Pakistan Sri Lanka Bangladesh

70.1 59.1 52.2 57.7 70.9 51.8

42 142 189 158 35 180

27 74 74 99 14 73

30 94 123 104 26 114

23 56 56 79 12 54

95 570 1,500 340 140 850 551/(512 exc. India)

45 450 830 320 58 570

South Asia

72.0 62.9 61.3 63.6 70.8 62.0 62.9

80

60

Source: UNDP, Human Development Report, 2007–08 and other various reports. Note: Figures shown for India are at variance with the official figures of the Office of Registrar General of India (RGI) for MMR and IMR. Data shown in the table are as per the methodology and adjustment made by United Nations Development Programme (UNDP).

102

Growing Inequality

III Employment–Unemployment Scenario

Some of the features of employment–unemployment in the recent period are well known. Using the most inclusive concept of Current Daily Status basis (CDS), the Eleventh Five-Year plan document has set out the facts as in Table 4.12. The document makes the following points: 1. First, population growth, labour force growth, and workforce growth have decelerated during the decade 1993–94 to 2004–05, but despite this, as the employment growth has been slower, the unemployment rate has risen from 6.1 per cent in 1993–94 to 8.3 per cent in 2004–05. There was thus an addition of near 15 million to the unemployed labour force from 20.3 million to 34.7 million in the 11-year period. Consequently, the age-old problem of the backlog of unemployment persists, and the objective of creating about 50â•¯million job opportunities in a five-year period or 100 million in a 10-year period so as to catch up with the past backlog remains a distant dream. 2. Slower growth in aggregate employment in the decade 1993–94 to 2004–05 is associated with a sharp drop in the generation of work opportunities in agriculture. This is not entirely due to a natural drift, for agricultural investment and growth have been relatively slower. 3. The quality of employment has made a distinct shift in favour of the unorganized, with implications for reduced average incomes and poor job or social security benefits. As Table 4.13 indicates, informal employment has been growing in both unorganized organized sectors. Table 4.14 shows that there has occurred an absolute decline in ‘organized’ employment.

103

1999–2000

893,676 334,197 313,931 6.06 20,266 658,771 252,955 238,752 5.61 14,203 234,905 81,242 75,179 7.46 6,063

718,101 263,824 239,489 9.22

24,335

546,642 206,152 187,899 8.85

18,253

171,459 57,672 51,590 10.55

6,082

2004–05

7,300

276,977 94,272 86,972 7.74

19,383

728,069 270,606 251,222 7.16

26,684

9,641

313,009 116,474 106,833 8.28

25,097

779,821 303,172 278,076 8.28

34,738

1,005,046 1,092,830 364,878 419,647 338,194 384,909 7.31 8.28

(’000 person years)

1993–94

3.14

2.78 2.51 2.46

5.32

1.68 1.13 0.85

4.69

1.98 1.47 1.25

5.72

2.48 4.32 4.2

5.30

1.38 2.30 2.05

5.42

1.69 2.84 2.62

2.64 3.33 3.25 4.31

–0.03

5.31

1.55 1.66 1.40

5.02

1.85 2.09 1.87

3.04 3.32 3.65

–2.36

1.79 1.97 2.31

–1.73

2.11 2.28 2.61

(% per annum)

1993–94 to 1999–2000 to 1983 to 1993–94 to 1999–2000 2004–05 1993–94 2004–05

Sources: Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Inclusive Growth, Vol I. Note: Estimates both on Usual Principal and Subsidiary Status (UPSS) basis and CDS basis are given in Annexure 4.1.

All India Population Labour Force Workforce Unemployment Rate (%) No. of Unemployed Rural Population Labour Force Workforce Unemployment Rate (%) No. of Unemployed Urban Population Labour Force Workforce Unemployment Rate (%) No. of Unemployed

1983

Table 4.12:â•… Past and Present Scenario on Employment and Unemployment (CDS Basis)

Growing Inequality Table 4.13:â•… Distribution of Workers by Type of Employment and Sector (Million) 1999–2000

2004–05

Sector

Informal

Formal

Total

Informal

Formal

Total

Unorganized sector Organized sector Total

341.28 (99.60) 20.46 (37.80) 361.74 (91.17)

1.36 (0.40) 33.67 (62.20) 35.02 (8.83)

342.64 (100.00) 54.12 (100.00) 396.76 (100.00)

393.47 (99.64) 29.14 (46.58) 422.61 (92.38)

1.43 (0.36) 33.42 (53.42) 34.85 (7.46)

394.90 (100.00) 62.57 (100.00) 457.46 (100.00)

Source: Estimates by NCEUS, Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Inclusive Growth, Vol. I. Note: UPSS basis. Figures in bracket indicate percentages. Table 4.14:â•… Growth in Organized Sector Employment (Per cent Per Annum) Sector

1983–94

1994–2005

1.53 0.44 1.20

–0.70 0.58 –0.31

Public Sector Private Sector Total Organized

Source: Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Inclusive Growth, Vol. I.

4. The high level of unemployment amongst the educated youth (with more increase in rural areas) (Table 4.15) and rising unemployment amongst the agricultural labour households (Table 4.16) as well as SCs and STs stand out. 5. There has occurred some deceleration in the growth of agricultural wages both for males and females. Table 4.15:â•…Unemployment Rate among Youth (Age Group 15–29 Years) (Per cent) (CDS Basis) Rural areas

Urban areas

Year

Male

Female

Male

Female

1993–94 1999–2000 2004–05

9.0 11.1 12.0

7.6 10.6 12.7

13.7 14.7 13.7

21.2 19.1 21.5

Source: NSSO Report No. 515 (61/10/1), Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Inclusive Growth, Vol. I.

105

S. L. Shetty Table 4.16:â•… Incidence of Unemployment among Rural Agricultural Households (CDS Basis) Year

Unemployment rate (percentage)

1983 1993–94 1999–2000 2004–05

7.73 9.50 12.29 15.26

Source: Planning Commission, Government of India (2008), Eleventh Five Year Plan 2007–2012, Inclusive Growth, Vol I.

6. Out of 460 million workers (UPSS), 94 million belong to the below the poverty line category. If this is the lot of the employed, the lot of the poor who are unemployed in the labour force must be worse. To be able to make a valid observation on the expectations of 58â•¯million job opportunities in the Eleventh-plan period, or 116 million during the decade of the Eleventh and Twelfth plan periods (as against 71â•¯million in the 11-year period 1993–94 to 2004–05), the sectoral investment programmes combined with the goals of institutional reforms and policy interventions for employmentintensive programmes have to be studied at great length. Admittedly, employment elasticity as a projection tool has its limitations. If the contents of public support programmes, essentially from fiscal and monetary and credit policies, are any guide, employment-intensity of development leaves much to be desired and hence there can be genuine misgivings regarding the possibilities of bridging the gap between labour force growth and work force growth and thus avoiding unemployment backlog during the Eleventh and Twelfth plan periods.

IV Indicators of inequality

There is a consensus view that whatever may have happened on the poverty reduction and employment fronts, different dimensions of 106

Growing Inequality

inequality are revealing a steady, and in some instances, sharp deterioration after the decade of the 1980s. The Planning Commission (2005) and many scholars have brought this out. We do not have data on the distribution of incomes based on reliable income surveys for the recent period. National Council of Applied Economic Research (NCAER) surveys conducted in the past showed, for instance, no deterioration in the pattern of income distribution between the two decadal periods 1975–76 to 1994–95 (Table 4.17). If at all, the picture of equality got better. This is probably explained by various policy interventions of the period such as the intensive rural development programme (IRDP), progressive taxation system and greater involvement of the public sector in development programmes. Table 4.17:â•… Patterns of Income Distribution as per NCEAR Surveys (in Per cent) Income deciles

1975–76

1994–95

Up to 10 10–20 20–40 40–60 60–80 80–100 All classes

2.30 3.50 9.90 14.20 20.80 49.30 100.00

2.32 3.60 9.70 13.92 21.28 49.18 100.00

Source: NCAER and EPWRF (2003: 25).

Contrariwise, data on a few indicators representing surrogates for changes in income distribution portray considerable deterioration after the mid-1990s. Trends in Rural-urban Income Disparities

We have the data on net domestic product (NDP) at factor cost current prices distributed between rural and urban areas for the various base year periods worked out by the Central Statistical Organisation (CSO). As shown in Table 4.18, the ratio of urban to rural per capita incomes declined between 1970–71 to 1980–81 and 1993–94 or remained almost unchanged between 1980–81 107

22,937 65,004 378,791 775,601

1970–71 1980–81 1993–94 1999–2000

13,850 45,336 319,201 830,042

(3) Urban 36,787 110,340 697,992 1,605,643

(4) Total 60.4 69.7 84.3 107.0

(5)

Urban–rural ratio (pecentage)

Source: CSO (2006): National Accounts Statistics and earlier issues.

(2) Rural

Total NDP (Rupees, Crore)

(1)

Year

529 1,245 5,783 10,683

(6) Rural 1,294 2,888 13,525 30,183

(7) Urban

Per capita NDP (`) (8) Total 680 1,625 7,834 16,040

Table 4.18:â•… Distribution of NDP at Current Prices between Rural–Urban Areas

2.45 2.32 2.34 2.83

(9)

Urban–rural ratio (pecentage)

Growing Inequality

and 1993–94, but there was a substantial jump in this ratio in 1999–2000, from 2.34 in 1993–94 to 2.83 in 1999–2000. All statistical indications suggest that this situation would have significantly deteriorated thereafter during the past eight to nine years. About 52 per cent of rural NDP was being contributed by agriculture and allied activities, which has grown by about 2.5 per cent per annum, that is, about one-third of the growth in the non-form sector. Greater Disparity in Agricultural—Non-agricultural GDP Distribution

We also have direct evidence on the growing disparity between agricultural and non-agricultural incomes. As shown in Tableâ•¯4.19, the ratio of non-agriculture per capita income to agricultural income has steadily risen during the whole period of the study. The disparity is palpable, for the growth process has involved a distinct shift of incomes in favour of non-farm sectors. Inter-state Disparities

A detailed study on inter-state disparities in the growth of State Domestic Product (SDP) [EPWRF (2003) and Shetty (2003) and updated up to 2005–06] suggests growing inequalities amongst states. First, it was observed that Gini coefficients worked out for the distribution of average per capita gross SDP amongst Indian states have experienced steady uptrend from 1980–81 to 2002–03 and some easing thereafter. Gini coefficients appear to be significantly lower for the 16 major states (possessing 90 per cent of the population) than for all the 27 states and Union territories, suggesting the presence of wider disparities amongst smaller states and between smaller states and major ones (Table 4.20). Second, the study showed an amazing constancy in the relative position of states in terms of their rankings based on per capita incomes during the period of two and a half decades. Even the spread between the top five and bottom six has widened over the period (Shetty, 2003: 5195–97). 109

18,192 47,312 229,172 446,515 695,424 782,597

(3) 24,789 85,208 562,978 1,340,010 3,094,639 3,538,295

(4)

Non-agricultural GDP (` crore)

Source: Derived from CSO and Planning Commission documents. Note: QE: Quick Estimates.

42,981 132,520 792,150 1,786,525 3,790,063 4,320,892

(2)

(1)

1970–71 1980–81 1993–94 1999–2000 2006–07 2007–08 QE

Total GDP

Year

Agricultural GDP (` crore) 1.63 1.80 2.46 3.00 4.45 4.52

(5)

Nonagricultural GDP ratio Per capita GDP (`)

476 1,066 4,213 7,875 12,352 12,171

(6)

1,559 3,626 16,178 30,878 55,360 71,481

(7)

agricultural Non-agricultural

3.28 3.40 3.84 3.92 4.48 5.87

(8)

Non-agricultural to agricultural per capita GDP Ratio

Table 4.19:â•… Distribution of GDP between Agricultural and Non-agricultural Sectors (at Current Prices)

Growing Inequality Table 4.20:â•… Gini Coefficients for the Annual Series of State-wise Real Per Capita GSDP â•¯ Year 1993–94c 1994–95c 1995–96c 1996–97c 1997–98c 1998–99c 1999–00c 2000–01c 2001–02 2002–03 2003–04d 2004–05e 2005–06

At 1993–94 pricesâ•¯

At 1999–2000 prices

All states

Major states

0.228 0.234 0.238 0.250 0.254 0.262 0.262 0.267 0.263 0.273 0.276 0.223 –

0.188 0.187 0.195 0.198 0.197 0.198 0.199 0.198 0.198 0.204 0.203 0.206 –

Year

a

â•¯ â•¯ â•¯ â•¯ â•¯ â•¯ 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06b

All states â•¯ â•¯ â•¯ â•¯ â•¯ â•¯ 0.237 0.244 0.242 0.250 0.244 0.236 0.248

Major statesa

0.187 0.188 0.187 0.192 0.186 0.188 0.193

Sources: EPWRF (2006), Domestic Product of States of India: Vol II: 1993–94 to 2004–05 (or 2005–06). Notes: a Major states include Andhra Pradesh, Assam, Bihar, Gujarat, Haryana, Himachal Pradesh, Karnataka, Kerala, Madhya Pradesh, Maharashtra, Orissa, Punjab, Rajasthan, Tamil Nadu, Uttar Pradesh and West Bengal. b Data with respect to Jammu and Kashmir, Mizoram and Nagaland are not available. c Excluding Mizoram. d Excluding Mizoram, Nagaland, and A&N Islands. e Excluding Mizoram, Nagaland, Tripura and A&N Island.

No doubt the situation relating to inter-state disparities is a dynamic one, in that the share of Gross State Domestic Product (GSDP) of the top five states has declined from over 50 per cent until the early 1990s to about 43 per cent during 2003–04 to 2005–06 implying that other states have captured a part of the gain. Urban Income Inequality

We have yet another evidence of growing inequality within the urban income-tax paying classes. A study on inter-class inequality in India by an MIT team (Banerjee and Piketty, 2003) concludes 111

S. L. Shetty

that the gradual liberalization of the Indian economy did make it possible for the rich (the top 1 per cent) to substantially increase their share of total income. This study was essentially based on individual income-tax returns data for the years 1956 through 2000. While in the 1980s the gains were shared by every set in the top percentile, in the 1990s it was only those in the top 0.1 per cent who gained the most. The study concludes: Our results suggest that the gradual liberalization of the Indian economy did make it possible for the rich (top 1%) to substantially increase their share of total income. The average income growth among the top percentile of the tax units was 71% in real terms between 1987–88 and 1999–2000, which is substantially more than average growth according to the national accounts. Moreover, the higher one goes within the top percentile, the higher the growth (up to +285% for the top 0.01% income facile). While in the 1980s the gains were shared by everyone in the top percentile, in the 1990s it was only those in the top 0.1% who were big gainers. (Banerjee and Piketty, 2003)1 Substantially Reduced Tax Burden at Different Income Levels

Extending the above study for the subject in hand, one important indicator, however crude, of possibly increasing inequality in incomes is the result arising from a minute interpretation of the income-tax revenue statistics for the available years; these cover the nature of increases in the number of assessees under different income brackets and the average income-tax burden on income-tax paying assessees. As shown in Table 4.21, between 1993–94 and 1999–2000, the number of assessees in the `2 lakh to `5 lakh income bracket increased fourfold, that in the `5 lakh to `10 lakh bracket increased 17-fold and in over `10 lakh bracket jumped 22-fold. More importantly, there occurred a sharp decline in the average taxes paid by all top income brackets from about 45 per cent in 1

This article was updated in Banerjee and Piketty (2003).

112

` 2 Lakh – 5 Lakh

412 556 643 1,108 712 783 826 1,770 1,705 1,752

1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000

73 66 88 152 413 419 481 879 965 1,039

` 5 Lakh – 10 Lakh

2,292 2,101 2,430 4,430 9,539 19,753 21,414 40,642 61,658 76,663

3,525,376 3,736,609 4,322,804 4,874,440 6,717,453 6,786,781 7,357,548 9,049,398 10,733,223 14,242,969

170 189 218 303 1,002 813 2,517 2,263 69,664 2,441

2818 3592 4116 5,388 7,809 6,734 9,237 11,055 77,468 10,377

Over All assessees ` 10 Lakh (including others)

1,564 2,321 2,685 3,471 5,543 9,469 10,265 20,058 595,765 78,109

All assessees Over ` 10 Lakh (including others)

No. of returns

` 5 Lakh – 10 Lakh

Source: Indian Public Finance Statistics (2004–05), Government of India. â•¯

` 2 Lakh – 5 Lakh

Income rangeYears

1990–91 34,357 1991–92 41,117 1992–93 47,564 1993–94 91,741 1994–95 76,392 1995–96 93,126 1996–97 100,958 1997–98 207,351 1998–99 309,281 1999–2000 373,129 Tax payable (`Crore)

Income range years

Over ` 10 Lakh

Income of returns (` Crore)

` 5 Lakh – 10 Lakh

All assessees (including others)

40.9 39.8 39.8 40.6 31.3 28.2 28.2 28.6 19.3 18.1

` 2 Lakh – 5 Lakh

46.6 43.0 49.6 51.0 30.5 30.5 30.5 31.4 22.7 20.7

` 5 Lakh – 10 Lakh

45.3 45.0 44.9 47.8 45.5 28.0 28.0 28.2 20.3 21.4

Over ` 10 Lakh

18.2 17.0 16.8 18.6 18.4 14.0 15.2 14.4 18.0 8.3

All assessees (including others)

1,009 157 376 15,490 1,397 154 421 21,170 1,616 177 486 24,485 2,732 298 634 28,994 2,276 1,354 2,202 42,469 2,778 1,372 2,905 48,256 2,931 1,575 8,988 60,811 6,178 2,799 8,038 77,030 8,851 4,251 343,889a 430,487 9,692 5,024 11,425 125,660 Tax burden (tax payable as percentage of income of returns)

` 2 Lakh – 5 Lakh

Table 4.21:â•… Classification of Income Tax Payable by Individuals and Average Taxes Payable—By Range of Income

S. L. Shetty

the early 1990s to 20 per cent to 21 per cent in the late 1990s (Figure 4.1). Figure 4.1:â•… Tax Burden (Tax Payable as Percentage of Income of Returns)

Source: Indian Public Finance Statistics (2004–05), Government of India.

One possible inference is that tax compliance has gone up radically, which is doubtful based on the impressionistic information on the unaccounted components in real estate dealings, etc. The most plausible interpretation of these data is that (a) the distribution of incomes has decidedly moved in favour of higher income classes and (b) the number of richer assessees amongst the organized sector employees—company executives including executives in the financial sector, IT and capital market dealers whose incomes are tax deductible at source and less amenable to tax evasion—has shot up after the 1990s. Finally, precisely during this period the tax rates have been drastically brought down. As a result, in 1999–2000, income tax assessees in the income bracket of over `10 lakh paid only an average tax of about 20 per cent to 21 per cent of assessed income (despite the marginal tax rate being 30 per cent or 33 per cent). It is apparently the lowest tax burden amongst the developed as well as key developing countries. 114

Growing Inequality

In an unequal society with considerably unequal natural and physical endowments, equality cannot be a natural process of development; it has to be brought about by policy interventions. If policies promote inequality, the end result cannot be but greater inequality, doubly so as a natural process of growth as well as policy-induced. Absence of Capital Gains Tax

Apart from the reduced tax rates on an unequal scale, an important factor contributing to the inequality pattern is also (a) the absence of capital gains tax on long-term assets and only 10 per cent on short term capital gains and (b) the very ineffective form of wealth tax. The wealth tax collected has been puny `150 crore on an average during the past 10 years or so. A decade ago in 1999–2000 when the capital gains tax was prevalent, as much as `800 crore were collected. The Late Amaresh Bagchi (2007), undoubtedly a pragmatic fiscal policy expert, questioned the logic of abolishing long-term capital gains tax and also advocated reimposition of tax on transfers—estates tax and gift tax—on considerations of equity. To quote him: (1) There are good reasons—on grounds of revenue, efficiency and equity—to reconsider the abolition of the capital gains tax. (2) Given that asset holding in India, as in most countries, is more sharply skewed than income and there is no transfer tax either at death or by gifts, the implication of the phenomenal surge in the stock price index is not hard to imagine. Even allowing for the fact that economic growth is often accompanied with some accentuation of inequalities, that should be a matter of some uneasiness to policymakers aiming at ‘inclusive growth’, and wanting to maintain some progressivity in the tax system in the interests of a stable society. (3) Notice should also be taken of the immense concentration of wealth that is occurring and consideration should be given to reimposing the tax on transfers—estates duty and gift tax. (Bagchi, 2007) 115

S. L. Shetty

Concrete evidence of this is to be found in the income and asset returns filed by candidates for contesting state legislature and parliamentary elections, wherein a majority of the cases wealth and asset holdings constitute a range of 10 to 100 times their annual incomes. Explosive Growth in Remuneration of Executives

The Economic and Political Weekly Research Foundation (EPWRF) has undertaken a study of recent trends in company executives’ remuneration, in the context of statements made by Prime Minister Manmohan Singh’s at the Confederation of Indian Industry (CII) National Conference on 24 May 2007, which urged corporates to ‘resist paying excessive remuneration to promoters and senior executives and discourage conspicuous consumption’. The Prime Minister (PM) said that profit maximization by companies should be within bounds of decency: In a country with extreme poverty, industry needs to be moderate in the emoluments levels it adopts. Rising income and wealth inequalities, if not matched by a corresponding rise of incomes across the nation, can lead to social unrest. The electronic media carries the lifestyles of the rich and famous into every village and every slum. Media often highlights the vulgar display of their wealth. An area of great concern is the level of ostentatious expenditure on weddings and other family events. Such vulgarity insults the poverty of the less privileged, it is socially wasteful and it plants seeds of resentment in the minds of the have-nots.

The PM felt that the industry should be proactive insofar as matters of affirmative action were concerned. He further said that ‘there is a limit to corporate greed’ and also said that ‘in a country with extreme poverty, industry needs to be moderate in the emolument levels adopted’. Fortunately, the Companies Act 1956 and the Companies (Particulars of Employees) Rules 1975 insist on details being published on the remunerations of directors as well as highly paid executives 116

Growing Inequality

in the company annual reports with details of their remunerations received, designations, etc. As per the extant regulations, as from the year 2002–03, the companies were expected to provide the list of directors and executives/employees drawing an annual remuneration of `2 lakh and above. Broadly, while remunerations of executives/employees include salaries and perks, those of CEOs and directors of company boards should include, in addition to salaries and perks, commissions received from their respective companies. For none of them there is any inclusion of European Science Open Forums (ESOFs). Tracing Problems

A preliminary review of the annual reports of top companies suggests that the number of directors and executives/employees deriving remuneration at or above the cut-off point has shot up dramatically in recent years (Table 4.22). Table 4.22:â•… Top Earners amongst Company Executives Year 1995–96 2000–01 2006–07 2007–08

Earning more than `50 lakh per annum

Earning more than `1 crore per annum Nil 38 600 841

< 100 1,488 2,118

Source: Business India (2007, 2008), ‘India’s Highest Paid Executives’ and ‘India’s Best Paid Executives’, 2 December and 30 November.

At least 277 executives employed in 151 companies drew `1â•¯crore or more per annum as remuneration in 2006–07. However, because of frequent changes in jobs and shifts from companies by the executive class, it is extremely difficult to locate individuals serving in different companies. Also, some executives have served some companies for only part of a year and hence their full annual remuneration was not found. In addition, there are a number of family concerns in which top executives constitute a 117

S. L. Shetty

part of the family-owning categories, in whose case it has been difficult to make a distinction between pure remuneration and boarddetermined commissions. Nevertheless, 277 executives with such high remuneration were found to be common to both the years 2002–03 and 2006–07, allowing for a study of the trends in their remuneration packages. In the year 2002–03, the aggregate annual remuneration paid to these executives was around `241 crore which rose to `791 crore in 2006–07, thus registering a sharp expansion of `550 crore or by 228 per cent in four years (Table 4.23), that is, at a compound rate of 34.6 per cent per annum. A cursory look at the data for the individual years suggests that the bulk of the rise took place in the years 2005–06 and 2006–07. Table 4.23:â•… Total Remuneration of 277 Executives Year 2006–07 2002–03

No. of companies

Total remuneration (`Crore)

Percentage rise in four years

151 151

791 241

228 –

Source: Compiled by EPWRF.

Table 4.24 indicates the distribution of executives by range of increases in remuneration. It shows that 122 executives or over 44 per cent have received remuneration increases beyond 250 per cent in four years. The annual remuneration of 21 executives has been augmented in the range of 501 per cent to 1,000 per cent and pay packages of 56 executives have increased in the range of 250 per cent to 500 per cent in 2006–07 as against their annual salaries in 2002–03. Around 45 executives received hefty pay packages in 2006–07, with explosive growth of more than 1,000 per cent in their annual remuneration compared to their earnings in 2002–03. The explosive nature of the increases in remunerations in recent years is also brought out by the fact that of the 277 executives drawing more than `1 crore per annum in 2006–07, only 67 executives were similarly earning more than `1 crore per annum in 2002–03 (Table 4.25). 118

Growing Inequality Table 4.24:â•… Percentage Increase in 2006–07 of Executives’ Salaries over 2002–03 Range of percentage increase

Number of executives

Percentage to total

5 57 93 56 21 23 18 4 277

1.8 20.6 33.6 20.2 7.6 8.3 6.5 1.4 100

Below 0 0–100 101–250 251–500 501–1,000 1,001–2,000 2,001–5,000 Above 5,000 Total Source: Compiled by EPWRF.

Table 4.25:â•… Range-wise Total Remuneration of Executives (Amount in ` Crore) Year Salary range Less than 100 lakhs 101–200 lakhs 201–500 lakhs 501–1,000 lakhs 1,000–2,000 lakhs Above 2,001 lakhs Total

2002–03

2006–07

No. of Total Percentage to No. of Total Percentage to executives amount total executives amount total 210 48 15 4 – – 277

100 65 46 30 – – 241

(41.6) (27.0) (19.1) (12.4) (100.0)

a

156 85 26 8 2 277

– 219 250 165 103 55 791

– (27.7) (31.6) (20.9) (13.0) (7.0) (100.0)

Source: Compiled by EPWRF. Note: a Cut-off point used for the study.

As per the present study, in 2002–03 there was not a single executive being paid more than `10 crore, whereas owing to dramatic increases in CEOs’ salaries in recent years, there were 10 executives earning above `10 crore per annum in 2006–07; of the latter, which two executives earned more than 20 crore each (Table 4.25). Table 4.26 presents the classification of 277 executives by their salary range in 2006–07 as well as the additions to their remunerations in four years after 2002–03. It is found that 156 executives getting remunerations of `1 crore to `2 crore each had earned a 119

S. L. Shetty Table 4.26:â•… Range-wise Increase in Total Remuneration of Executives (Range Sorted on the Basis of Remuneration in 2006–07) Salary range 101–200 lakhs 201–500 lakhs 501–1,000 lakhs 1,000–2,000 lakhs Above 2,001 lakhs Total

No. of executives

2006–07 (`Cr)

156 85 26 8 2 277

219 250 165 103 55 791

2002–03 Percentage (`Cr) Difference change 88 74 37 40 2 241

130 176 128 63 53 551

147.8 238.4 343.3 157.0 2747.3 228

Source: Compiled by EPWRF.

total salary of `88 crore in 2002–03 but their total earnings shot up to `219 crore in 2006–07—an increase of 148 per cent. The largest increase of 2,747 per cent occurred in the remunerations of two executives falling in the range of `20 crore and above. The next increase (343 per cent) took place in respect of 26 executives who fell in the income bracket of `5 crore to `10 crore; their earnings galloped from `37 crore in 2002–03 to `165 crore in 2006–07—bulging by 346 per cent. Chairman and Managing Director (CMD) of Reliance Industries, Mukesh Ambani, tops the list, with a compensation of `30 crore followed by P. R. Ramasubrahmaneya Rajha, CMD of Madras Cement with a pay package of `25 crore. Interestingly, Rajha’s base salary in 2006–07 was only `24 lakh while the commission paid was `24 crore on account of the surge in company’s net profit by 290 per cent to `308 crore in 2006–07 as against `79 crore in 2005–06. The CMD of Madras Cement was awarded 5 per cent of the net profit of `495 crore,2 amounting to `24 crore, in accordance with the section guidelines. According to statutory guidelines given by the Companies Act of 1959, commissions can be as high as 10 per cent of a company’s net profit.

2 Computation of net profits in accordance with Section 349 of the Companies Act, 1956, for the purpose of calculating Managing Director’s remuneration for the year ended 31 March 2007.

120

Growing Inequality

Here, it is worth noting that the proportion of remuneration to all employees as percentage of sales actually declined during the period 2002–03 to 2006–07. Also, the corporate sector has benefited a great deal in the form of reductions in interest cost and incidence of corporate taxation (Table 4.27). Table 4.27:â•… Non-government Non-financial Public Limited Companies— Selected Financial Ratios (in Percentages) Year 2006–07 2005–06 2004–05 2004–05 2003–04 2002–03 2003–04 2002–03 2001–02 2002–03 2001–02 2000–01 2001–02 2000–01 1999–2000 2000–01 1999–2000 1998–99 1999–2000 1998–99 1997–98 1998–99 1997–98 1996–97 1997–98 1996–97 1995–96

No. of sample Remuneration to Interest to gross Tax provision to companies employees to sales profits profits before tax 3,016

2,214

2,201

2,031

2,024

1,927

1,914

1,848

1,948

7.4 7.3 7.2 7.5 8.0 8.1 7.9 8.0 7.9 8.0 8.0 7.3 7.8 7.2 7.2 8.2 8.2 8.5 8.2 8.4 8.2 8.7 8.3 7.9 8.5 8.0 8.0

16.1 18.6 22.0 21.8 30.7 43.6 30.1 43.1 56.0 47.9 58.3 63.2 59.0 63.2 58.7 60.0 59.3 60.6 58.7 60.7 53.4 61.2 53.3 46.0 54.4 47.4 36.8

24.0 24.6 24.9 25.7 28.1 29.9 27.9 30.5 35.5 31.3 36.7 30.4 35.6 31.1 29.4 32.3 33.2 32.0 31.8 31.4 27.2 31.4 26.4 25.7 28.0 27.1 19.3

Source: RBI (2008): Finances of Public Limited Companies; various issues.

121

S. L. Shetty

V Financial Exclusion

Stimulus for enhanced economic activities with a distributional bias can come from two sources: fiscal and monetary. The fiscal thrust has indeed suffered because of the constraints of fiscal reforms beyond prudent limits giving rise to relatively poor growth in expenditures particularly for the social sectors and unduly low levels of tax burden on the richer segments of society. As explained below, after the reforms began in the 1990s, even the new monetary and credit policy regime has failed to keep up with the distributional goals. Studies have shown that in the 1980s, substantial redistribution of institutional credit in favour of agriculture, Small-scale Industries (SSIs) and other informal sectors as well as the general category of small borrowers, had conferred many an economic and social benefit: reduction in dependence on moneylenders and widening the demand base of the economy leading to acceleration in overall economic growth. Now, under the dispensation of global standards, the formal financial institutions find it difficult to reach the asset less poor. Economic Structure and the Financial Architecture

To begin with, in the whole policy discourse now on the expected role of the financial system in India, what is neglected is the imperative of institution-building which is the fountainhead of the supply-leading approach to credit delivery for agriculture and various other historically neglected sectors adopted following bank nationalization. The spread of banking is neglected on the ground of high operational costs and risks associated with informal sector lending. It is worth remembering that rural branches with banking potentials reach break even points within a period of three years or so and that a good part of the risk management issues can be taken care 122

Growing Inequality

of, if we have a fairly decentralized institutional structure with the spread of branch network in the length and breadth of the country, professionally well-manned, such that ‘lenders have sufficient knowledge about borrowers’ and information asymmetry giving rise to the issues of moral hazard and adverse selection is avoided.3 Be that as it may, the evolving economic structure calls for the strengthening of the financial architecture befitting such an economic structure. The current disjoint is sure to hurt the growth process. The following paragraphs address these issues. Increasing Marginalization of Land Holdings

As consistent National Sample Survey Organisation (NSSO) reports on land (and livestock) holding surveys reveal, the phenomenon of sub-division has resulted in the number of operational holdings steadily rising over the period 1960–61 to 2003, from 51 million to 101 million, but more significantly, the area operated has receded from 133 million hectares to 108 million hectares partly due to the uneconomic nature of tiny holdings.4 As a result, the average size of operational holdings has dwindled from 2.63 hectares in 1960–61 to only 1.06 hectares in 2003 (Table 4.28).

In our perception, the presence of information asymmetry and the issues of moral hazard and adverse selection are exaggerated insofar as the functioning of commercial and cooperative banks in developing economies is concerned. Unlike in advanced market economies where banks operate as wholesale financial intermediaries, banks in developing countries adopt branch banking combined with relationship banking under which bank managers, if they function professionally, have reasonably good knowledge of the regions and clientele they serve. 4 As indicated in Table 4.28 above, the year 2003 was a drought year and hence the decline may have been partly due to that phenomenon. Also, the estimates for 2003 cover only kharif season operations. The NSSO (January 2006, Report No. 493) has emphasized that kharif estimates are lower than the total only about 4 per cent in terms of the number of operational holdings and 1 per cent in terms of area. 3

123

S. L. Shetty Table 4.28:â•… Certain Key Characteristics of Operational Holdings â•¯ â•¯

1960–61 (17th)

1970–71 (26th)

1981–82 (37th)

1991–92 (48th)

2003 a (59th)

1. Number of operational holdings (millions) 1.1 Percentage increase 2. Area operated (million hectares) 3. Average area operated (hectares)

50.77

57.07

71.04

93.45

101.27

–

12.40

24.50

31.50

8.40

133.48

125.68

118.57

125.10

107.65

2.63

2.20

1.67

1.34

1.06

Source: Source of estimates of 17th, 26th, 37th, 48th and 59th rounds: NSS Report Nos 144, 215, 338, 408 and 493. Note: aEstimates for 59th round are based on the holdings reported for the kharif season. Also, 2003 was a drought year.

With the inadequacy of employment opportunities in the nonfarm sector, the work force dependence on agriculture has remained high. And this has happened with the occurrence a continuous decline in the share of agriculture in the country’s GDP. While the share of agriculture in total employment has remained at 52.1 per cent in 2004–05, declining gently from 65.4 per cent in 1983 and 61.0 per cent in 1993–94, the sector’s share in GDP has dwindled to 19.2 per cent in 2004–05 or to 17.8 per cent in 2007–08 from 35.7 per cent in 1980–81 and 28.9 per cent in 1993–94. Within agriculture, there have been many other adverse consequences. The continued dependence of rising population and labour force on limited and non-expanding land has resulted in a continuous decline in the availability of land per agricultural worker. Apart from the sharp decline in the average size of holding, there is the growing marginalization. The increases in the proportions of operational holdings have occurred only under the size class of marginal holdings. In 2003, as per NSSO data, as much as 71 per cent of operational holdings were such marginal holdings of (of below one hectare) as against 39.1 per cent in 1960–61 (Table 4.29). 124

39.1 22.6 19.8 14.0 4.5 100.0

1960–61 (17th)

45.8 22.4 17.7 11.1 3.1 100.0

1970–71 (26th) 56.0 19.3 14.2 8.6 1.9 100.0

1981–82 (37th) 62.8 17.8 12.0 6.1 1.3 100.0

1991–92 (48th) 71.0 16.6 9.2 4.3 0.8 100.0

2003 (59th) 6.9 12.3 20.7 31.2 29.0 100.0

1960–61 (17th)

Source: NSSO, Some Aspects of Operational Land Holdings in India; various rounds.

Marginal Small Semi-medium Medium Large All sizes

Category of holdings

Percentage of operational holdings

9.2 14.8 22.6 30.5 23.0 100.0

1970–71 (26th)

11.5 16.6 23.6 30.1 18.2 100.0

1981–82 (37th)

15.6 18.7 24.1 26.4 15.2 100.0

1991–92 (48th)

Percentage of operated area

Table 4.29:â•… Changes in the Size Distribution of Operational Holdings and Operated Area 1960–61 to 2002–03

22.6 20.9 22.5 22.2 11.8 100.0

2003 (59th)

S. L. Shetty

In other words, 72 million out of 101 million operational holdings belong to such tiny land cultivation. If the small farmer category is also included, as much as near 80 per cent of cultivator households belong to the small and marginal categories and they possess 43.5 per cent of operated area. Farmers have thus been facing multiple challenges with what has been described as the twin crisis—an agrarian crisis and an agricultural crisis.5 Amongst the most dominating reasons for this crisis, a distinct one has been the weakening of the rural credit structure and the inability of the system to strengthen credit delivery arrangements for the farm community, particularly for small and marginal farmers. As per the evidence provided below, a large number of farm households (about 46 million out of 89 million or 51 per cent) are excluded from the availability of any credit arrangement, let alone institutional finance, because of the weaknesses in the credit delivery mechanism. They need credit for improving productivity of farm operations. Above all, they require credit support for supplementary operations in allied activities; some of them need to migrate to non-farm activities for which they need start-up capital even as they report as farmers with tiny holdings. Non-farm Sector Households and Enterprises

As per the NSSO 61st Round 2004–05, the estimated number of total workers in the country was about 457 million, of whom 199â•¯million or 43.4 per cent were in the non-farm sector. A few distinct features of non-farm employment are relevant for the subject of finance. First, as depicted earlier, employment in the organized sector has barely risen and as a result, the additional labour force is primarily getting absorbed in the unorganized/ Prof. V. M. Rao described so at a seminar organized by the Indira Gandhi Institute of Development Research (IGIDR), Mumbai, in the context of subgroup deliberations for crystallizing ideas on Report of the Expert Group on Agricultural Indebtedness, Ministry of Finance, Government of India, July 2007 (Chairman: Prof. R. Radhakrishna). 5

126

Growing Inequality

informal sectors. Second, while employment in the unorganized sector has risen over recent years, it has been generally in the form of low-quality employment constrained by low productivity (NCEUS, 2007). Third, the proportion of self-employment, both amongst urban males and females, has risen, and such employment obviously requires external finance for running micro business activities. As a result of the vast increase in the number of the self-employed, there is a corresponding increase in the number of non-farm enterprises, of which an overwhelming number are of small or micro size. All nation-wide field surveys of informal non-agricultural enterprises, unorganized manufacturing and unorganized service sector enterprises, have revealed that about 98 per cent to 99 per cent of them are having employment size of less than 10 workers each. Concurrently, over 96 per cent of unorganized enterprises have investment in plant and machinery worth less than `1 lakh each. Taking various reports into account, the National Commission for Enterprises in the Unorganized Sector (NCEUS) has estimated that the number of non-farm enterprises might have increased from 44 million in 1999–2000 to 54 million in 2004–05 and further to 58 million in 2006–07. These enterprises are obviously spread over throughout the length and breadth of the country. The limited availability of external sources of funds for these enterprises is explained in the next section. As in the case of agriculture, there is preponderant financial exclusion of non-farm enterprises by the formal financial institutions. Financial Exclusion: Farmer Households

As per the 59th NSS Round (January–December 2003) of the NSSO, of total 148 million rural households, 89.35 million (or 60.4 per cent) were farmer households. Of the 89.35 million farm households, 43.42 million (48.6 per cent) were reported to be indebted. That is, 51.4 per cent or about 46 million did not reveal enjoying any indebtedness (of the value above `300) to any of the credit agencies—institutional or non-institutional. 127

S. L. Shetty

About 68 per cent of the excluded farmer households belong to the three underdeveloped regions, with the central region accounting for 34.5 per cent, the eastern region 27.6 per cent, and the northeastern region 6.1 per cent. On the other hand, the three relatively advanced regions have about 10 per cent each of the excluded farm households. With the easing of directed credit regulations in the early 1990s, there was a decline in the share of institutional agencies in the debt outstanding of cultivator households from 66.3 per cent in 1991 to 61.1 per cent in 2002 and a distinct increase in the dependence of cultivators on moneylenders from 17.5 per cent to 26.8 per cent, thus arresting the earlier trend decline from 70 per cent to 17.5 per cent over decades. What is of further significance is that indebtedness increases with the size of land holdings and more importantly, the share of institutional agencies in total loans tends to rise progressively. In the lowest size groups up to 0.40 hectare (marginal farmers), the shares of institutional agencies ranged from 23 per cent to 43 per cent, whereas in the large size groups of above two hectares, the corresponding shares have been 65 per cent to 69 per cent. In contrast, in the case of marginal farmers, the share of non-institutional agencies in total indebtedness has been in the range of 57 per cent to 77 per cent, whereas such shares for large-size groups have been 31 per cent to 35 per cent. Evidence of ‘financial exclusion’ in the non-farm sector is equally glaring. As per the Third Census of SSI Sector, less than 5 per cent of the small-scale units enjoyed any bank finance; in the case of unregistered units which dominate, it has been just about 3.1 per cent. Based on the above data, NCEUS estimated that only 5.3 per cent out of 58 million units in March 2007 with investment of `25 lakh or less had any institutional credit; about 55 million (about 95 per cent) did not enjoy any such facility. The importance of non-farm informal sector enterprises in the development process is self-evident. If the agricultural sector absorbed 256 million of workers (56.0 per cent), non-agricultural informal enterprises absorbed 139 million or 30 per cent of the total work force. 128

Growing Inequality

On the other hand, organized sector absorbed 63 million (13.8), of whom also 28 million were unorganized contract labour. Key Trends in Credit for the Informal Sectors

The incidence of ‘financial exclusion’ after the beginning of the 1990s, as revealed in the above field surveys, is evident from the credit trends in respect of scheduled commercial banks including Regional Rural Banks (RRBs) (but excluding cooperatives). The expansion of commercial banks credit to agriculture had been impressive in the period after bank nationalization. The share of agriculture credit in total commercial bank lending rose from around 10 per cent in the mid-1970s to a peak of about 18â•¯per cent at the end of the 1980s. But, thereafter, it has steadily declined to a low of around 11 per cent during the period 2004 to 2007 (Figure 4.2). Figure 4.2:â•… Share of Agriculture and Other Small-scale Industries Credit in Total Scheduled Commercial Bank’s Credit

Source: RBI (2007a).

129

S. L. Shetty

The number of agriculture loan accounts, which had reached the peak of 27.74 million in March 1992, steadily fell to 20.35 million in March 2002; there has been some improvement thereafter with the number reaching 33.22 million in March 2007 because of the policy of doubling of agricultural credit. Nevertheless, studies (such as EPWRF, December 2007) indicate that agricultural activities have been relatively neglected by banks and other credit agencies. Table 4.30 presents some data on agricultural credit to output and other ratios. It is found that total direct credit to agricultural GDP ratio was static during the eighth plan period, registered a steady increase during the ninth plan period, and made a dramatic increase during the 10th plan period. Indirect lending increased sharply in the 10th plan period. Interestingly, agricultural inputs and Gross Capital Formation (GCF) show divergent trends in relation to agricultural GDP. While the farm inputs to GDP ratio was almost unchanged in the eighth and ninth plan periods at around 26 per cent to 27 per cent and edged up to around 29 per cent in the 10th plan period, GCF to GDP ratio has made a remarkable recovery in the final three years of the ninth plan (1999–2000 to 2001–02) from around 7 per cent to 12 per cent and further improved to a range of 13 per cent to 14 per cent thereafter. These relationships give an impression of being very complex, since much the larger part of farm credit absorption is not output related. It is rather based on the requirements of individual cultivating farmers, whose number exceeds 100 million even though there are only 33 million loan accounts. There is large exclusion of small and marginal farmers. A similar reduction has occurred in the share of bank credit in favour of SSIs by scheduled commercial banks. In the case of SSIs, the number of loan accounts has persistently declined from the peak of 2.19 million in March 1992 to 0.80 million now. The share of SSIs in total bank credit had reached 12.5 per cent in March 1991; it fell to 5 per cent in March 2003. Thereafter, these proportions have experienced precipitate declines, with the share touching as low as 3.5 per cent by the end of March 2007. 130

16.7 16.8 12.1 16.0 15.2 8.7 20.2 6.1 14.8 6.2 0.7 8.3 –3.0 12.9 0.6 10.9 10.2

4.0 –2.0

6.7 3.3 4.7 –0.7 9.9

–2.6 6.3 2.7 –0.2 6.3

–7.2 10.0 0.0 6.0 2.7

13.4 14.6 19.3 24.5 25.1

8.2 8.3 9.6 10.9 11.1

7.6 7.1 6.7 7.3 7.3

6.2

Direct

1.3 1.7 4.0 5.8 5.9

0.5 0.5 0.8 0.9 1.6

0.1 0.1 0.2 0.4 0.4

0.1

Indirect

14.7 16.3 23.4 30.3 31.0

8.7 8.8 10.4 11.7 12.7

7.7 7.2 7.0 7.7 7.7

6.4

Total

Ratio of bank credit to agricultural GDP (at current prices)

27.3 26.0 26.3 25.7 26.00a

27.0 26.8 26.6 26.2 25.8

27.4 27.4 26.8 27.6 25.4

27.9 28.9

at 1999–2000 prices

28.8 28.2 29.2 28.3 29.00a

26.3 25.7 26.6 27.0 26.8

29.3 27.9 27.9 28.9 25.0

30.2 30.6

at current prices

Share of inputs in GDP of agriculture and allied activities

13.1 11.6 13.2 14.1

7.8 7.4 11.2 10.3 12.4

8.4 7.1 6.6 6.9 7.0

10.5 6.7

GCF as % of agricultural GDP (at current prices)

(in percentage)

Sources: Data on GDP, inputs and gross capital formation (GCF) are from CSO’s National Accounts Statistics (various issues), and for bank credit data, see EPWRF (2007); these bank credit data cover scheduled commercial banks as well as cooperatives. â•¯ Notes: aAssumed. â•¯ GDPAU: Gross domestic product from agriculture and allied activities at current prices.

1990–91 1991–92 Eighth Plan 1992–93 1993–94 1994–95 1995–96 1996–97 Ninth Plan 1997–98 1998–99 1999–2000 2000–01 2001–02 Tenth Plan 2002–03 2003–04 2004–05 2005–06 2006–07

Year

at 1999–2000 at current prices prices

Annual growth rate in agricultural GDP

Table 4.30:â•… Select Ratios and Growth Rates of Agriculture and Allied Activities Sector

S. L. Shetty

Small borrowal accounts (with credit limits of `25,000) have been the worst affected. Table 4.31 shows that after bank nationalization, there was an upsurge in small borrowal accounts, because the principle of ‘financial inclusion’ had been accepted as part of public policy. The number of such small borrowal accounts reached a peak at 62.55 million in March 1992, and steadily dwindled thereafter to 37.22 million in March 2002. The share of such accounts in total bank credit slipped from about 25 per cent to as low a figure as about 6 per cent during the same period, and the share of such accounts in total credit extended fell from 12.5 per cent in March 1998 to as low as 2.4 per cent in March 2007. A number of policy devices were responsible for such neglect of small borrowers. 1. Distorted Policy of ‘Priority Sector’ Lendings

Being unable to dispense with the 40 per cent target because of socio-political pressures, the authorities have so distorted the definition of ‘Priority Sector’ that there has been a distinct shift of focus in favour of housing loans and loans to professionals and other new categories, as distinguished from agricultural and small-scale sector loans, for which the directed credit programme was intended. As a result, out of 28 public sectors, only eight banks have achieved the 18â•¯per cent agricultural lending target. In the case of lending to weaker sections, only seven public sector banks have achieved their 10 per cent sub-target (RBI, 2007b: 72). On the other hand, 42 per cent to 48 per cent of ‘priority sector’ lending has gone in favour of ‘other’ categories comprising loans for housing, education and professional activities (Tableâ•¯4.32), even though these are by their very nature ‘bankable’ activities which do not deserve the benefits of the ‘directed’ credit arrangement. Such laxity in policy has distracted the attention of bankers away from the real sectors like agriculture, SSIs and small borrowers. 132

Mar ’07 Mar ’06 Mar ’05 Mar ’04 Mar ’03 Mar ’02 Mar ’01 Mar ’00 Mar ’99 Mar ’98 Mar ’97 Mar ’96 Mar ’95 Mar ’94 Mar ’93 Mar ’92 Mar ’91 Mar ’90

Year

94,442,027 85,435,381 77,150,794 66,390,290 59,491,187 56,388,379 52,364,395 54,370,397 52,305,456 53,583,956 55,617,917 56,672,429 58,097,104 59,650,805 62,116,396 65,860,730 61,946,755 53,850,686

No. of accounts

2,773,409 2,118,527 1,646,266 1,176,959 995,134 855,428 686,951 569,096 475,451 397,330 350,617 308,579 257,782 217,330 198,765 160,643 146,547 121,654

Credit limit

All loan accounts

1,947,100 1,513,842 1,152,468 880,312 755,969 655,994 538,434 460,081 382,425 329,944 284,373 254,692 210,939 175,891 162,467 136,706 124,203 104,312

Amount outstanding 38,612,331 38,419,104 38,732,564 36,766,092 36,872,666 37,322,523 37,252,319 39,275,614 42,747,346 46,828,393 50,094,017 51,904,658 53,914,923 55,810,055 58,520,533 62,547,660 58,784,192 51,179,961

No. of accounts (40.9) (45.0) (50.2) (55.4) (62.0) (66.2) (71.1) (72.2) (81.7) (87.4) (90.1) (91.6) (92.8) (93.6) (94.2) (95.0) (94.9) (95.0)

58,781 56,430 54,877 49,745 47,531 45,639 42,942 41,514 43,740 44,079 41,732 40,138 37,350 35,418 35,801 34,898 31,462 26,111

Credit limit

(2.1) 45,903 (2.4) (2.7) 45,217 (3.0) (3.3) 42,992 (3.7) (4.2) 38,555 (4.4) (4.8) 41,038 (5.4) (5.3) 38,501 (5.9) (6.3) 37,816 (7.0) (7.3) 36,409 (7.9) (9.2) 38,285 (10.0) (11.1) 41,095 (12.5) (11.9) 37,446 (13.2) (13.0) 36,253 (14.2) (14.5) 34,060 (16.1) (16.3) 32,188 (18.3) (18.0) 32,091 (19.8) (21.7) 29,945 (21.9) (21.5) 27,323 (22.0) (21.5) 24,147 (23.1) (Table 4.31: continued )

Amount outstanding

Loan accounts with ` 25,000 and less

Table 4.31:â•…Outstanding Credit of Scheduled Commercial Banks According to Size of Credit Limit (Amount in ` Crore)

52,113,457 51,138,122 47,980,806 46,214,365 43,435,976 41,635,326 38,789,013 36,411,734 33,610,827 31,581,587 29,536,919 27,747,255

No. of accounts 106,720 97,797 88,552 84,288 79,305 74,072 72,280 66,164 66,156 59,236 56,504 51,906

Credit limit

All loan accounts

Source: RBI (2007a). Note: Figures in brackets are percentage to total.

June ’89 Dec ’88 June ’88 Dec ’87 June ’87 Dec ’86 June ’86 Dec ’85 June ’85 Dec ’84 June ’84 Dec ’83

Year

(Table 4.31: continued )

88,027 79,782 71,285 68,278 63,727 60,216 56,182 52,228 49,995 46,075 43,326 38,922

Amount outstanding 49,716,838 48,915,942 45,886,313 44,236,197 41,620,163 39,924,897 37,142,794 34,863,109 32,137,451 30,240,469 28,211,113 26,521,062

No. of accounts (95.4) (95.7) (95.6) (95.7) (95.8) (95.9) (95.8) (95.7) (95.6) (95.8) (95.5) (95.6)

23,891 22,784 20,378 19,187 17,505 16,187 14,887 13,113 11,795 10,678 9,819 8,923

Credit limit (22.4) (23.3) (23.0) (22.8) (22.1) (21.9) (20.6) (19.8) (17.8) (18.0) (17.4) (17.2)

22,330 20,258 17,954 16,820 15,444 13,929 12,615 11,236 10,028 9,202 8,897 7,624

Amount outstanding

Loan accounts with ` 25,000 and less

(25.4) (25.4) (25.2) (24.6) (24.2) (23.1) (22.5) (21.5) (20.1) (20.0) (20.5) (19.6)

17,181 52,814 56,002 57,199 60,394 65,855 74,588 91,212 117,880 155,804

(40.0) (40.1) (36.3) (32.6) (28.5) (25.0) (19.6) (17.9) (18.6) (21.1)

15.1 14.1 13.0 11.8 9.7 9.0 7.5 6.5 6.5 7.1

SSI (percentage to column 6) 3 8,984 34,632 46,490 57,299 77,697 107,438 181,638 245,554 285,864 309,224

(20.9) (26.3) (30.1) (32.7) (36.7) (40.7) (47.6) (48.1) (45.1) (41.9)

7.9 9.2 10.8 11.9 12.5 14.7 18.2 17.5 15.9 14.0

Others (percentage to column 6) 4 42,915 131,827 154,414 175,259 211,609 263,834 381,476 510,738 634,142 738,686

37.8 35.1 36.0 36.3 34.1 36.2 38.2 36.4 35.2 33.5

113,513 375,127 429,162 482,749 620,055 728,422 999,788 1,404,840 1,801,239 2,203,038

Total priority sector lending Non-food (percentage to gross bank column 6) credit 5 6

Source: RBI (2008). Notes: 1. Data are provisional and relate to select banks (47 banks for 2003–04 and 52 banks from 2004–05 onwards) which account for 90 per cent of bank credit of all scheduled commercial banks. 2. Non-food gross bank credit data include bills rediscounted with RBI, IDBI, EXIM Bank, other approved financial institutions and inter-bank participations. 3. Figures within brackets are percentages to total “priority sector advances”.

14.8 11.8 12.1 12.6 11.9 12.4 12.5 12.4 12.8 12.4

16,750 44,381 51,922 60,761 73,518 90,541 125,250 173,972 230,398 273,658

1990–91 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08

(39.0) (33.7) (33.6) (34.7) (34.7) (34.3) (32.8) (34.1) (36.3) (37.0)

Agriculture (percentage to column 6) 2

Year 1

Table 4.32:â•… Priority Sector Advances (`, Crore)

S. L. Shetty

2. Narrowing of Rural Branch Network

As the Reserve Bank of India (RBI) gave up the branch licensing policy in 1995 and allowed the banks to consolidate their rural presence by even closing branches of rural centres served by two commercial banks or relocate their lossmaking branches at new places even outside the rural areas, the number of rural branches of scheduled commercial banks declined from 33,017 at the end of March 1995 to 31,967 at the end of March 2005. This was a loss of 1,056 branches, followed by a likely further loss of 2,500 rural and semi-urban branches in the next two years on a comparable 1991 census classification basis (Table 4.33). In the normal course of branch banking, in order to serve the under banked amongst six lakh villages, at least another 5,000 to 6,000 rural branches should have been added. More significantly, the number of bank employees posted to rural and semi-urban branches declined by 11 per cent, or a reduction of 46,060 employees between March 1996 and March 2005, with a further reduction of about 15,000 in the subsequent two years (Table 4.34). 3. Lending to Sensitive Sector

In such a policy environment, the propagation of ‘financial inclusion’ appears to be hollow. To cite an example, in the years 2005–06 and 2006–07 when the RBI went to town with the declaration that ‘as banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of the public policy (Leeladhar, 2006)’, the banks hardly observed any of the credit guidelines for the real and neglected sectors including those for opening general credit lines for the weaker sections or the need for expanding branch network in rural areas. Instead they extended unprecedented levels of bank credit for real estate, capital market and commodity market operators (Table 4.35). Outstanding loans of public sector banks against real estate (including housing loans) at the 136

Rural

Net increase

Net increase

–148 881

(21.2) 1,461 (21.3) 229 (21.4) 200 (21.5) 243 (21.5) 174 (21.7) 232 (21.8) 120 (22.0) 210 (22.1) 132 (22.2) 210 (22.3) 367

15,471 (21.9) 16,352 (22.3)

13,502 13,731 13,931 14,174 14,348 14,580 14,700 14,910 15,042 15,252 15,619

Semiurban

Source: RBI (2007a). Note: Figures in brackets are percentages to all India.

Classification based on 1991 Census Mar ’95 33,017 (51.7) –2,379 Mar ’96 32,981 (51.2) –36 Mar ’97 32,909 (50.5) –72 Mar ’98 32,854 (49.9) –55 Mar ’99 32,840 (49.3) –14 Mar 2000 32,673 (48.7) –167 Mar ’01 32,640 (48.3) –33 Mar ’02 32,443 (47.8) –197 Mar ’03 32,283 (47.4) –160 Mar ’04 32,107 (46.8) –176 Mar ’05 31,967 (45.7) –140 Classification based on 2001 Census Mar ’06 30,610 (43.2) –1,357 Mar ’07 30,393 (41.5) –217

Year

Number of Offices

(15.0) (15.2) (15.5) (15.7) (16.1) (16.2) (16.3) (16.6) (16.8) (17.0) (17.6)

46 223 263 280 365 145 175 226 171 280 601

Net increase

12,697 (17.9) 393 13,699 (18.7) 1,002

9,575 9,798 10,061 10,341 10,706 10,851 11,026 11,252 11,423 11,703 12,304

Urban

11,998 12,755

7,723 7,946 8,210 8,459 8,783 8,957 9,159 9,292 9,330 9,583 10,079

Metropolitan

(17.0) 1,919 (17.4) 757

(12.1) 1,331 (12.3) 223 (12.6) 264 (12.9) 249 (13.2) 324 (13.4) 174 (13.6) 202 (13.7) 133 (13.7) 38 (14.0) 253 (14.4) 496

Net increase

Table 4.33:â•… Number of Offices of Scheduled Commercial Banks According to Population Group

459 639 655 717 849 384 464 372 181 567 1324

Net increase

70,776 807 73,199 2,423

63,817 64,456 65,111 65,828 66,677 67,061 67,525 67,897 68,078 68,645 69,969

All India

196,031 197,551 197,531 195,312 194,385 186,471 183,027 182,686 180,869 179,423 169,088 162,870

Rural 19.2 19.3 19.3 19.2 19.3 20.1 20.3 20.3 20.5 19.9 18.8 18.1

Percentage to total 227,039 227,512 224,635 223,360 223,380 208,392 202,833 203,013 197,950 197,587 176,104 175,066

Semi-urban 22.3 22.3 21.9 22.0 22.2 22.5 22.5 22.5 22.5 21.9 19.6 19.5

Percentage to total 595,955 595,960 601,805 598,818 588,866 531,655 515,428 515,450 502,903 523,423 554,932 561,471

Urban + Metropolitan 58.5 58.4 58.8 58.9 58.5 57.4 57.2 57.2 57.0 58.1 61.7 62.4

Percentage to total

Total 1,019,025 1,021,023 1,023,971 1,017,490 1,006,631 926,518 901,288 901,149 881,722 900,433 900,124 899,407

Source: RBI, Banking Statistics: Basic Statistical Returns of Scheduled Commercial Banks in India, March 2007, Vol. 36 and earlier issues. Note: Classification of population groups for the period March 1996 to March 2005 is based on 1991 Census. From March 2006 onwards the population groups of centres have been revised based on the 2001 Census.

Mar ’96 Mar ’97 Mar ’98 Mar ’99 Mar 2000 Mar ’01 Mar ’02 Mar ’03 Mar ’04 Mar ’05 Mar ’06 Mar ’07

Year

Table 4.34:â•… Population Group-wise Distribution of Employees of Scheduled Commercial Banks in India

19,093 (1.3) 217,979 (15.1) 1,695 (0.1) 238,767 (16.6)

13,470 (1.2) 158,033 (14.3) 1,227 (0.1) 172,731 (15.6)

Capital marketa

38.2

38.1

37.9

41.7

Percentage variation 22,303 (1.5) 262,054 (17.3) 1,414 (0.1) 285,771 (18.8)

2005–06

30,637 (1.6) 370,690 (18.7) 2,207 (0.1) 403,534 (20.4)

2006–07

41.2

56.1

41.5

37.4

Percentage variation

All scheduled commercial banks

Source: RBI, Report on Trend and Progress of Banking in India, 2006–07 (p. 302). Notes: a Exposure to capital market is inclusive of both investments and advances. b Exposure to real estate sector is inclusive of both direct and indirect lending. Figures in brackets are percentages to total loans and advances of the concerned bank-group.

Total advances to sensitive sectors

Commodities

Real Estateb

2006–07

2005–06

Advances to

Public sector banks

Table 4.35:â•…Bank Group-wise Lending to Real Estate and Other Sensitive Sectors

S. L. Shetty

end of March 2007 (at `217,979 crore) far exceeded their loans against agriculture, both direct and indirect together (Rs 205,091 crore).

VI Financial Markets: Encouragement to Speculative and Unearned Incomes Unmitigated Secondary Market Operations: A Source of Unearned Incomes and Financial Stress

While studying the growth of the Indian financial system, what stands out is the mindboggling size of turnover in secondary markets in every segment of the system. History has shown that entrepreneurship in this country has strong trading proclivities. Every opportunity is taken for arbitrage and speculation far beyond the genuine requirements of hedging and far beyond the practices prevalent in the advanced healthy markets (Table 4.36). Such activities in this country are stimulated by the policies pursued by public authorities, which effectively promote the generation of unearned and speculative incomes which in turn become a major source of inequality. First, in the commodities markets, futures trading may be helpful in some instances, but there are problems in the way the authorities have permitted futures trading in about 100 commodities, mostly from the agricultural sector, with hardly any distinction in margins for hedging and speculation. Because of the dominance of the speculator-financial interests in futures markets, genuine price discovery for the farmer is found to be very difficult. Anybody familiar with the current agrarian structure would vouch that not even a miniscule fraction of farmers can participate in the futures market and enjoy the benefits of hedging and risk management. Because of the limited amounts of physical deliveries including the presence of enabling warehouses, effective risk management is almost impossible to achieve. 140

2,639,244 (95.8) 2,318,531 (84.2) 3,744,841 (135.9) 2,130,612 1,099,535 3,230,147 (117.3) 12,074 502,620 514,694 (18.7) 129,400 (4.7) 2,754,621 7,188

2,194

2003–04

1,941,673 (79.1) 658,035 (26.8) 1,374,403 (56.0) 439,863 617,989 1,057,852 (43.1) 2,478 314,073 316,551 (12.9) 66,500 (2.7) 2,454,561

2002–03

21,052

2,692,129 (85.5) 4,042,435 (128.4) 4,221,952 (134.1) 2,547,053 1,140,072 3,687,125 (117.1) 16,112 518,715 534,827 (17.0) 571,759 (18.2) 3,149,407

2004–05

38,470

2,559,260 (71.4) 5,239,674 (146.1) 7,209,892 (201.0) 4,824,251 1,569,558 6,393,809 (178.3) 9 816,074 816,083 (22.8) 2,134,000 (59.5) 3,586,743

2005–06

38,670

3,578,037 (86.7) 8,023,078 (194.3) 10,316,750 (249.9) 7,356,271 1,945,287 9,301,558 (225.3) 59,007 956,185 1,015,192 (24.6) 4,644,494 (112.5) 4,129,173

2006–07

48,900

5,602,602 (118.6) 12,726,832 (269.4) 18,462,681 (390.9) 13,090,478 3,551,038 16,641,516 (352.3) 242,308 1,578,856 1,821,165 (38.6) 4,065,989 (86.1) 4,723,400

2007–08

Source: Compiled by the author (based on the data given in Handbook of Statistics on Indian Economy, various issues, RBI).

GDP at market prices Memo Item: Open Interest at the end for derivative contracts traded on NSE (` crore)

4 Commodities market

II Capital Derivatives market (BSE) Cash Total

3 Total stock market turnover (I + II) I Capital Derivatives market (NSE) Cash Total

2 Forex market

1 Government securities market

Market segments/year 4,544,906

2007–08

60,072

3,161,093

39,690

4,160,261

12,257 975,954 988,212

9,258,181 2,399,367 11,657,548

11,370,047 3,017,849 14,387,896 201,165 1,345,890 1,547,055

12,645,760

14,429,796

4,931,541

2008–09

15,934,951

10,025,361

Table 4.36:â•… Secondary Market Turnover in Financial and Commodities Markets (Amount in ` Crore)

S. L. Shetty

Second, though on the face of it, it appears that the stock market operations in India are more modern and sophisticated, underneath their operations are inherent destabilizing elements which are officially permitted. Some key lacunae in the derivative segments of the Indian stock market have been noted by experts like R. H. Patil (former head of the National Stock Exchange) and Deena Mehta (former head of the Bombay Stock Exchange), who have questioned the wisdom of permitting futures trading in individual stocks. Emphasizing that equity futures are essentially intended to serve as hedges against unanticipated risks, Patil (2006) argues that: [T]he world over the stock futures are not favoured in view of the risks they pose to the investors as also to the markets… Most of the countries that have introduced equity futures have preferred to introduce index futures, and options in index and individual stocks… All the major exchanges of the world (in the US or Europe in particular) consider that individual stock futures are not only highly unsafe but also that they do not serve any justifiable purpose.

Despite such weighty opinion against stock futures, the same have been permitted in Indian stock exchanges and they now constitute over 53 per cent of the total futures and options market on the National Stock Exchange (NSE), as shown in Table 4.37. In addition, Deena Mehta (2005) has pointedly brought out how in equity derivatives, trades are allowed to be cash settled and not delivery settled: In the absence of physical delivery, the system simply flushes out all trades at the end of the month when the contract expires. There is no logical conclusion to the futures trade. On the last day, cash is exchanged and the one-way traffic of buy does not have any speedbreaker of sale transactions. The continuous balancing of buy and sell does not happen and the populist view gets further propagated as the buyer does not have any obligation to take delivery.

She concludes by asserting thus: The country takes great pride in following international best practices. In all developed countries, derivative trades are delivery settled. The danger 142

9,247 (2.1) 52,823 (2.5) 121,954 (4.8) 338,469 (7.0) 791,906 (10.8) 1,362,111 (10.4)

100,134 (22.8) 217,212 (10.2) 168,858 (6.6) 180,270 (3.7) 193,795 (2.6) 359,137 (2.5)

109,381 (24.9) 270,035 (12.7) 290,812 (11.4) 518,739 (10.8) 985,701 (13.4) 1,721,247 (13.2)

Source: Compiled from the data given in www.nseindia.com (accessed on 9 December 2008). Note: Figures in bracket are per cent to total.

2007–08

2006–07

2005–06

2004–05

2003–04

330,483 (75.1) 1,860,411 (87.3) 2,256,241 (88.6) 4,305,512 (89.2) 6,370,541 (86.6) 11,369,231 (86.9)

286,532 (65.1) 1,305,949 (61.3) 1,484,067 (58.3) 2,791,721 (57.9) 3,830,967 (52.1) 7,548,563 (57.7)

2002–03

43,951 (10.0) 554,462 (26.0) 772,174 (30.3) 1,513,791 (31.4) 2,539,574 (34.5) 3,820,667 (29.2)

Total futures trading (` in cr)

Index futures Stock futures turnover turnover Month/year (` in cr) (` in cr)

13,090,478

7,356,242

4,824,251

2,547,053

2,130,446

439,864

30,814

29,543

19,220

10,107

8,388

1,752

3.69

3.78

3.07

2.23

1.94

0.71

Ratio of derivatives Index options Stock options Total options Grand total Average daily turnover to equity turnover turnover trading turnover turnover (` in cr) (` in cr) (` in cr) (` in cr) (` in cr) (percentage)

Table 4.37:â•…Business Growth of Futures and Options Segment of NSE

S. L. Shetty

of a cash-settled system is highlighted above. After the experience of five years in the derivatives market, the regulator must look at the issue on hand objectively. The size of derivatives market being bigger than the cash market, we cannot afford a structurally weak system. Exotic Derivative Contracts in the Forex Market

Operators in the foreign exchange market also enjoy the benefits of officially aided speculation that increase the possibilities of generating unearned incomes. As explained in EPWRF (2008), the genesis of the problem should be traced to two policy developments relevant to the operations of the domestic foreign exchange market. First, the authorities resorted to a major turnabout in their exchange rate policy as a measure of fighting inflation; they allowed the rupee to appreciate from about `44 per dollar in March 2007 to `40 per dollar in May 2007. Just at the time when the market expectations of the prospects of further appreciation were thus reinforced, there occurred the second event. The RBI, in its 24 April 2007 annual policy statement for 2007–08, sought to expand hedging facilities in the foreign exchange market. It said that a range of hedging instruments had been already permitted to market participants including foreign exchange forwards, swaps and options, but these were permitted ‘mainly against crystallized foreign currency exposures’. That is, hedging had to be against the underlying exposures based on actuals or past records. But the April 2007 policy expanded the scope of hedging considerably thus: ‘It is now proposed to expand the range of hedging tools available to the market participants as also facilitate dynamic hedging by the residents’. Importers and exporters of goods and services were permitted to book contracts on the basis of declaration of an exposure actually in sight or based on past performance, but earlier forward contracts booked in excess of 50 per cent of the eligible limits had to be on deliverable basis; in the April 2007 statement, this limit was raised to 75 per cent and the contracts could be cancelled and rebooked. But, the most damaging aspect of the newly introduced expansion of hedging facilities, as revealed by the recent corporate turmoil, relates to the 144

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small and medium enterprises. Page 56 in the April 2007 policy statement said: In order to enable small and medium enterprises (SMEs) to hedge their foreign exchange exposures, it is proposed to permit them to book forward contracts without underlying exposures or past records of exports and imports. Such contracts may be booked through authorised dealers with whom the SMEs have credit facilities. The SMEs are also permitted to freely cancel and rebook the contracts.

In such a free-for-all policy environment, banks and the corporates have indulged in huge amounts of hedging. The banks appear to have sold contracts to corporates, particularly the SMEs, hardly based on underlying exposures. As evident from the huge forex losses that have been estimated over the period 2007–08, such liberalization measures without proper checks and balance have an inherent tendency to create stress in the financial markets. What is more, such speculative activities do not help us to achieve the primary goals of better liquidity and stability in the respective market segments. References Annan, Kofi. 2007. ‘Reforms in Governance and Administration: An approach paper of the Second Administrative Reforms Commission’. Available on-line at, http://www.arc.gov.in/reforms.htm(accessed on a December 2008). Bagchi, Amaresh. 2007. ‘Rethinking Tax Treatment of Capital Gains from Securities’ Economic and Political Weekly, 2742 (4): 287–90. Banerjee, Abhijit and Thomas Piketty. 2003. ‘Top Indian Incomes, 1956–2000’, Bureau for Research in Economic Analysis of Development (BREAD) Working Paper No. 046, September, (BREAD = Bureau for Research in Economic Analysis of Development, MIT). Banerjee, Sumanta. 2008. ‘On the Naxalite Movement: A Report with a Difference’, Economic and Political Weekly, 43 (21), 24 May: 10–12. Chen, Shaohua and Martin Ravallion. 2008. ‘The Developing World is Poorer than We Thought, But No Less Successful in the Fight against Poverty’, Policy Research Working Paper 4703, Development Research Group, The World Bank, August, Washington DC.

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Editorial, EPW. 2008. ‘Widening Debate on the Naxalite Movement: Who will heed a government committee that has discarded the “security-centric” view of Naxalism?’, Economic and Political Weekly, 1043 (19): 5–6, May 2008. EPWRF. 2003. Domestic Product of States of India: Vol. I: 1960–61 to 2000–01, EPW Research Foundation, Mumbai. EPWRF. 2007. Agricultural Credit in India: Changing Profile and Regional Imbalances December 2007. EPW Research Foundation, Mumbai. EPWRF. 2008. ‘Exotic Derivative Contracts’, Money Market Review, Economic and Political Weekly, 2643 (17): April, 22–28. Government of India (GoI). 2008. ‘Budget documents of Centre and State Governments/RBI’, Economic Survey 2007–08, p. 242. Guha, Ramachandra. 2007. ‘Adivasis, Naxalites and Indian Democracy’, Economic and Political Weekly, 42 (32), August 11: 3305–12. Guruswamy, Mohan and Ronald Joseph Abraham. 2006. ‘Redefining Poverty: A New Poverty Line for a New India’, Economic and Political Weekly, 41 (No. 25), June, 242534–41, http://www.arc.gov.in/reforms.htm (accessed on 9 December 2008). Krishna, Anirudh, Mahesh Kapila, Sharad Pathak, Mahendra Porwal, Kiranpal Singh, and Virpal Singh. 2004. ‘Falling into Poverty in Villages of Andhra Pradesh: Why Poverty Avoidance Policies are Needed’, Economic and Political Weekly, 39 (29), July 17–23, 3249–56. Krishna, Anirudh. 2003. ‘Falling into Poverty: Other Side of Poverty Reduc-tion’, Economic and Political Weekly, 38 (6), February 8–14, 533–42. Leeladhar, V. 2006. ‘Taking Banking Services to the Common Man—Financial Inclusion’, RBI Bulletin, January, LX: 73–77. Mehta, Deena. 2005. ‘Is the Derivatives Market Model a Weak Link?’, The Hindu Business Line, 3 August, Mumbai. Mukherjee, Doel. 2003. Police Reform Initiatives in India: Commonwealth Human Rights Initiative. Police, Prison and Human Rights (PPHR) programme, 2 July. Available online at http://www.humanrightsinitiative. org/publications/police/police_reform_initiative_india.pdf (accessed on 9 December 2008). NCAER and EPWRF. 2003. Household Savings and Investment Behaviour in India, September, EPW Research Foundation and National Council of Applied Economic Research, Mumbai. NCEUS. 2007. Reports on Financing of Enterprises in the Unorganised Sector and Creation of a National Fund for the Unorganised Sector (NAFUS), (Chairman: Arjun K. Sengupta). Report, submitted to GoI, November 5. Patil, R. H. 2006. ‘Current State of the Indian Capital Market’, Economic and Political Weekly, 41 (11): 1001–10. Planning Commission. 2005. Mid-Term Appraisal of 10th Five Year Plan (2002–2007), June. New Delhi: Planning Commission, Government of India.

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Planning Commission. 2008a. Eleventh Five Year Plan 2007–2012, Vol. I: Inclusive Growth. New Delhi: Planning Commission, Government of India. Planning Commission. 2008b. Eleventh Five Year Plan 2007–2012, Vol. II: Social Sector. New Delhi: Planning Commission, Government of India. Planning Commission. 2008c. Eleventh Five Year Plan 2007–12, Vol. III: Agriculture, Rural Development, Industry, Services, and Physical Infrastructure, 100–12. New Delhi: Planning Commission, Government of India. Rao, V. M. 2008. ‘The Emerging Poverty Scenario—Alternative Development Paradigm for Poverty Elimination’, a paper submitted at the Seminar on ‘Development through Planning, Market, or Decentralization?’, held at the Indian Institute of Technology (IIT), Mumbai, 21–23 January. Ray, R. and G. Lancaster. 2005. ‘On Setting the Poverty Line Based on Estimated Nutrient Prices: Condition of Socially Disadvantaged Groups During the Reform Period’, Economic and Political Weekly, Vol. XL, No. (1), 1–7 January: 46–56. RBI. 2007a. Banking Statistics: Basic Statistical Returns of Scheduled Commercial Banks in India, 36 (March) and earlier issues. RBI. 2007b. Report on Trend and Progress of Banking in India 2006–07. Supplement to RBI Bulletin, December, Mumbai. RBI. 2008. Handbook of Statistics on the Indian Economy 2007–08. Mumbai: Reserve Bank of India. Sen, Amartya. 1994. ‘Growth Isn’t Everything’, Interview with of Prof. Amartya Sen, in Business Today, 22 August–6 September. Shetty, S. L. 2003. ‘Growth of SDP and Structural Changes in State Economies: Interstate Comparisons’, Economic and Political Weekly (EPW), 38 (49): 6 December, 5189–200. Sundaram, K. and Suresh, D. Tendulkar. 2003. ‘Poverty among Social and Economic Groups in India in 1990s’, Economic and Political Weekly, 38 (50): 13 December, 5263–76.

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5 Assessing Tax Policy and Tax Compliance in the Reform Era Saumen Chattopadhyay

Introduction

Tax reform has been an integral part of fiscal reform since the new economic policy was introduced in 1991. The primary aim of fiscal reform as a part of the stabilization package was to bring down the level of fiscal deficit of the Centre as a percentage of Gross Domestic Product (GDP). However, the burden of fiscal adjustment was mainly borne by reining in expenditure, expenditure on capital formation in particular, during the 1990s as tax to GDP ratio remained nearly stagnant during the period. However, tax collection (gross) of the Centre had witnessed an unprecedented growth during 2002–03 to 2007–08 driven mainly by an acceleration in direct tax collection. Tax revenue (gross) for the Centre grew at an average rate of 21.2 per cent during 2002–03 to 2007–08 as compared to nearly 11.8 per cent during 1991–92 to 2001–02.1 It is claimed that However, during 2008–09 as per the revised estimate, gross tax revenue grew by a little less than 6 per cent largely because of the adverse impact of global recession on the Indian economy. During 2009–10, as per the budgetary estimate, gross tax revenue is expected to rise by nearly 7 per cent. 1

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Assessing Tax Policy and Tax Compliance in the Reform Era

this surge in tax collection during the second phase of economic reform can be attributed to tax reform measures implemented, justifying thereby the basic philosophy of tax reform which entailed lowering of tax rate, widening of tax base, gradual withdrawal of tax concessions and strengthening tax administration inter alia primarily to foster tax compliance on the part of the tax payers. But, in order to understand this high growth in tax collection in the recent years, one has to delve deeper and probe the very character of the growth process achieved in India. Obsession with growth rate has generated a growth process under the dominant influence of the neoliberal agenda which has relegated concern for equity from the policy maker’s framework. The emerging policy stance seems to be oblivious of the growing disparities in income and dismal levels of human development. On the face of it, fiscal policy has been largely successful as the fiscal imbalances both at the Centre as well as at the level of state governments could be reined in before the onset of recession resulting in derailment of fiscal consolidation during 2008–09. However, the apparent success with fiscal reform does not leave much space for us to be complacent; rather, it commands courage and commitment to confront the challenge of achieving equitable growth in globalizing India. It is in this context that tax policy has to complement the public expenditure policy which has a larger role to play in designing a progressive fiscal policy. This chapter seeks to review the claim that it is primarily an improvement in tax compliance which has been instrumental in the high growth of tax revenue in the last six to seven years. The chapter also explores the nature and character of tax reform (essentially confined to the major central taxes) and its relationship with economic growth. The paper concludes with some suggestions for possible areas of tax reform for equitable growth. First, the broad contour of tax reform measures since 1991 is briefly discussed. Then, the impact of tax reform on compliance is reviewed and assessed. Conclusively, possible areas of reform are suggested.

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Tax Reform The Basic Approach

Tax reform in India during the reform era has been primarily guided by the conventional approach to tax reform largely based on international experiences, and in particular, the very process of integration with the global economy, institutional changes and the Information and Communication Technology (ICT) revolution. However, tax reform has been a concern for the government ever since the beginning of plan period as exemplified by the constitution of some important tax reforms committees.2 The federal system and the polity along with the emergence of power groups often made the process of reform tardy, complex and difficult. In practice, tax policy has been mainly informed by practical aspects of tax administration, with the objective of minimizing tax distortions and raising the revenue productivity of the tax system in an equitable fashion. As mentioned above, widening tax base, lowering tax rates coupled with the reduction in the differentiation of tax rate structure, gradual phasing out of tax concessions and an effective tax administration have been the major pillars of tax reform. Ensuring both horizontal as well as vertical equity have been the underlying concerns. It is argued that reduced tax rates imposed on a wider base facilitated by effective tax administration would encourage voluntary tax compliance and in the process; it would mitigate tax inefficiencies, generate lower costs of tax compliance and curb tax avoidance and tax evasion. Although optimal tax theory is largely ignored in guiding tax reform, one important aspect of the theory deserves attention here. In the second-best situation,3 there exists a trade-off between efficiency and equity and how much importance equity gets depends on the discretion of the policy makers. For Personal Income Tax (PIT), It started with submission of the Taxation Enquiry Commission in 1953. In the second-best situation, at least one of the assumptions of a perfectly competitive market and other assumptions required to reach the ‘Bliss Point’ are not satisfied. 2 3

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the attempt has been to moderate the progressivity of the tax structure by lowering the tax rates, widening the tax base mainly through phasing out of tax concessions and expansion of the tax information network. The tax rate for Corporate Income Tax (CIT) had to be brought down to be at par with not only PIT but also the international standard. In a globalizing world with near-free mobility of capital there are compulsions to ensure that the tax burden on the corporate sector is comparable across the borders. For customs, the tax rates have been gradually reduced and constraints removed so as to facilitate the process of embracing the global economy through the opening up of the border. For excise, the objective has been to rationalize tax rates and to gradually move towards a comprehensive consumption based tax ideally encompassing both the Centre and the state and manufacturing as well as services. After all, tax policy is what tax administration does particularly for a developing economy. Therefore, the focus on tax administration could not be less while designing tax policy. What does this mean? Direct Taxes

We present below a broad contour of major tax reforms before we undertake an analysis of tax performance and, in particular, tax compliance. To begin with, with regard to PIT, the tax rates were simplified in a major way to have three rates beginning with 20 per cent, 30 per cent and 40 per cent in 1992–93. For computation of wealth tax, financial assets were kept outside of its purview. In 1997–98, the rates were further revised downward to 10 per cent to 20 per cent to 30 per cent. To allocate more resources towards primary education, a 2 per cent cess was levied on all taxes in 2004–05 and this was followed up with levying a 2 per cent cess for higher education in 2006–07. Though the rates have been maintained since then, there have been changes in the income brackets and exemption limits. The surcharge tax of 5 per cent was imposed on tax payable in the wake of the Kargil War in 2002–03, but it was withdrawn in the next financial year. However, a separate surcharge 151

Saumen Chattopadhyay

was introduced at the rate of 10 per cent on all the tax payers with taxable income exceeding `0.85 million which was revised up to `one million in the next year, 2005–06. It took rather long to revise the exemption limit keeping in mind the extent to which inflation had reduced real income over the preceding years. The exemption limit was kept at `50,000 since 1998–99. Instead of pushing the exemption limit up in the Budget for 2005–06, it was decided that those with income below `100,000 need not pay taxes. But this created an anomaly in the post-tax burden as those with income just exceeding `100,000 paid more taxes and therefore had lower post tax income than those with income below `100,000. This anomaly was removed and the exemption limit was raised to `100,000 and standard deduction was abolished. However, the exemption limit was pegged at higher levels for women tax payers and senior citizens. To identify potential income taxpayers, a ‘one by six’ presumptive criterion was introduced. In 1997, it was modified to ‘two by four’ criterion to reflect changing income and consumption patterns. This led to a sharp increase in the number of individuals filing tax returns.4 For CIT, the basic rate was reduced to 50 per cent and for closely held companies, the rate was unified at 55 per cent. Based on the recommendations of the Tax Reforms Committee (1991), the distinction between closely held and widely held companies was abolished and the tax rate was pegged at 40 per cent in 1993–94. In 1997–98 at the time of reducing tax rate for PIT, this highest rate was brought down to 35 per cent and the dividend tax of 10â•¯per cent was moved from individuals to the companies. There was very little evidence of some direction and confidence with regard to the dividend tax. It was raised to 20 per cent in 2000–01, again reduced to 10 per cent in 2001–02 in the hands of the shareholders. In 2003–04, it was again shifted to the company. Tax incentives and 4 An increase of 120 per cent over 1997–2000. The criteria were home ownership, visit to a foreign country, ownership of a telephone and ownership of a motor vehicle. Despite this, it could be argued that a rough estimate of 50 per cent of potential taxpayers who remained the outside the tax net.

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concessions distorted the post-tax return on assets and eroded the tax base. For CIT, major tax preferences were investment allowance and depreciation allowance. Further, there were allowances for backward areas. To counter rising cases of tax avoidance, Minimum Alternate Tax (MAT) was introduced in 1996–97 for ‘Zero Tax Companies’. The companies were required to pay a tax on 30 per cent of their book profits as they availed off tax concessions and brought their tax liabilities to virtually nil. There were some innovative tax measures, as the need was increasingly being felt to mop up more tax revenue and plug tax leakages. Securities transaction tax was introduced in 2004 and a cash withdrawal tax at the rate of 0.1 per cent was imposed on all cash withdrawals exceeding `25,000. In 2005 Union Budget, a new tax with the name ‘Fringe Benefits Tax (FBT)’ was introduced, as a tax that the employer pays on perquisites and benefits which accrue to the employees. Though this has been opposed by the corporate sector, the trade associations, the government has justified this on the grounds of equity and efficiency. It is argued that ‘fringe benefits’ provided by the employer are part of employees’ overall remuneration package and hence should be taxed irrespective of the mix (cash, kind or facilities) (Kishore, 2009). Another justification in favour of FBT is to rein in the erosion of tax base.5 In tax administration, two important changes have been to extend the coverage of Tax Deduction at Source (TDS) and making use of Permanent Account Number (PAN) mandatory in the majority of cases. Indirect Taxes

The Indirect Tax Enquiry Report (1977) came up with a rigorous analysis of the Union Excise duties in terms of its allocative and 5 The Income Tax Act provides for a comprehensive and specific list of such expenses/categories. Through deeming provisions, a certain percentage (which varies from 5 per cent to 100 per cent) is considered to be values of fringe benefits. A flat rate of 30 per cent is imposed with applicable surcharge and cess. At present 20 such heads of expenses are allowed for.

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distributional consequences. But the implementation began only in 1986–87. The attempt was to convert specific duties into ad valorem rates, unification of rates and gradual introduction of input tax credit to mitigate the impact of cascading effect to move towards manufacturing stage value added tax (MANVAT). But overall, the process of implementation remained one of experimentation and in an ad hoc manner (Rao and Rao, 2005). In 1996–97, an attempt was made to bring under the net a majority of the commodities in the excise tariff and to make input credit comprehensive. In 1999–2000, almost 11 rates were merged into three and a few luxury items were subject to two non-vatable additional rates of 6 per cent and 16â•¯per cent. In 2000–01, rates were further merged and CenVAT was introduced along with three special non-vatable excises (8, 16 and 24â•¯per cent). Some exemptions were replaced with an 8 per cent rate and tax on small-scale sector was simplified. Restructuring of customs duties constituted a major reform, which in a big way facilitated the process of trade reform. The rates above 150 per cent were brought down to what was called the peak rate. This rate was reduced successively to 50 per cent in 1995–96, and further to 40 per cent in 1997–98, to 30 per cent in 2002–03, to 25â•¯per cent in 2003–04 and to 15 per cent in 2005–06 for nonagricultural goods. Quantitative restrictions were phased out. There was also an attempt to reduce the major duty rates from 22 in 1990–91 to 4 in 2003–04. Some items were kept under the purview of four rates. A special additional duty was imposed on inter-state sales at the rate of 4 per cent in January 2004 to be withdrawn and reintroduced again in 2005–06 under the garb of Countervailing Duty (CVD). Notwithstanding this rate rationalization, studies indicate that high effective rates of protection (ERP) continue. In our federal system, only a few services were under the purview of the states, such as entertainment tax, passengers and goods tax and electricity duty. The Centre decided to bring the remaining services under its net to mobilize more resources from the growing services sector. Further, this attempt made the consumption base wider and rendered the tax structure more progressive (Rao and Rao, 2005). Ultimately, the objective is that the Centre has to move 154

Assessing Tax Policy and Tax Compliance in the Reform Era

towards a consumption-based tax system keeping in mind interconnections in the sphere of production of goods and services. In 1994–95, three services were introduced. They were non-life insurance, stock brokerage and telecommunications. The list has been expanded in successive years to raise the number of services included to 80+. The rate has been raised as well. It was 5 per cent at the time of introduction. Subsequently, the rate was raised to 8â•¯per cent in 2003–04 and further to 10 per cent in 2004–05. With the ultimate objective of integrating this with CenVAT, the Expert Group on Taxation of Services (2001) recommended inclusion of all taxes along with the provision of input tax credit. However, there were provisions of two lists of exempt services and a negative list of services. The practice at present is to impose service tax on selective services. Input tax credit for services entering into goods production and vice versa has been implemented. Tax Collection

One most important way of assessing the tax system and tax policy is to look at the tax collection as it has grown over the years. After all, as per the mandate of the tax reform, tax collection should go up, inflicting in the process, the least possible burden6 on the economy, the tax payers and the tax administration in particular. So the share of direct taxes rose by nearly 4.7 percentage points while the share of indirect taxes fell by 3.1 percentage points during 1990–01 to 2007–08. Adding the share of services sector of 1.1 percentage point, the tax to GDP ratio rose by nearly 2.7 percentage points during the period 1990–91 to 2007–98. However, during the 1990s the overall impact of tax reform on tax collection in terms of GDP was rather depressing. In fact, the share was 10 per cent in 1991–92 and after experiencing a fluctuating fortune it had Burden imposed on the tax system in the process of transfer of tax from the taxpayers to the exchequer are inefficiency cost or deadweight loss, cost of equity and tax compliance costs. 6

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fallen to 8.2 in 2001–02. The trend has seen a reversal since then. So the second phase has been one of a steady rise, at least, that is what happened till 2007–08. Barring excise, the shares of all other taxes have gone up. In the following sections, we review how tax collection has risen over the years and how the tax composition has been changing. Direct Taxes

The gross tax revenue of the Centre for the year 2007–08 registered a 25.3 per cent growth over the previous year, well over the envisaged budgeted rise of 15.8 per cent. This sustained the tempo achieved in the preceding five years. What is striking is that this growth attained mainly with reference to the direct taxes surpassed budgetary estimates many times over, as tax collection continued to soar, defying expectations. In fact, this marks a break from the earlier practice of over-estimating tax revenue growth. Barring excise duty, the growth in all other major taxes, such as income tax, corporation tax and customs duty exceeded the growth envisaged in the budgetary estimate for 2007–08. In fact, the actual collection of excise duty fell short of the budgetary expectations for several consecutive years. As observed by the Comptroller and Auditor General (CAG) (2007), ‘the actual collections fell short of the budget estimates as well as the government continued to make optimistic projections during presentation of the annual budget.’ The share of major central taxes (gross) in GDP rose by nearly 4.5 percentage points from 8 per cent in 1990–91 to 12.6 per cent in 2007–08. The significant contributor to such a rise has been the CIT which has gained nearly by 4 percentage points during the same period. The share of PIT has risen by 2.5 percentage points. In the beginning of the reform era, the share of CIT and PIT in GDP were almost equal at 1 per cent of GDP but as the economy grew, acceleration in collection of CIT outpaced the growth in PIT over time. While the share of excise has remained the same, customs’ contribution has seen a steady decline. In a way, composition of tax collection has moved in favour of direct taxes (Table 5A.1). The 156

Assessing Tax Policy and Tax Compliance in the Reform Era

collection from services tax started growing at a faster rate since 2002–03 after it was introduced in the Union Budget for 1995–96 (Table 5.1). Table 5.1:â•… Share of Central Taxes in GDP in the Reform Era Year

CIT

PIT

Customs

Excise

Services

Tax total

1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 RE 2009–10 BE

0.9 1.2 1.2 1.2 1.4 1.4 1.4 1.3 1.4 1.6 1.7 1.6 1.9 2.3 2.6 2.8 3.5 4.1 4.1 4.1

0.9 1.0 1.1 1.1 1.2 1.3 1.3 1.1 1.2 1.3 1.5 1.4 1.5 1.5 1.6 1.6 1.8 2.2 2.3 2.2

3.6 3.4 3.2 2.6 2.6 3.0 3.1 2.6 2.3 2.5 2.3 1.8 1.8 1.8 1.8 1.8 2.1 2.2 2.0 1.8

4.3 4.3 4.1 3.7 3.7 3.4 3.3 3.2 3.1 3.2 3.3 3.2 3.3 3.3 3.1 3.1 2.8 2.6 2.0 1.8

0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.3 0.5 0.6 0.9 1.1 1.2 1.1

9.9 10.0 9.7 8.6 9.0 9.3 9.3 9.1 8.3 8.9 9.0 8.2 8.8 9.2 9.7 10.2 11.4 12.64 11.57 11.15

Sources: Receipts Budget, Union Budget 2009–10 and previous issues. National Accounts Statistics 2007 and previous issues. Notes: The five taxes as shown are the major taxes. The sum is not equal to total tax collection. GDP for 2009–10 is obtained from the Union Budget 2009–10. RE: Revised Estimate. BE: Budget Estimate.

The same saga unfolds rather sharply if we look at the composition of these major central taxes since 1990–91. The government is now, as per the actual of 2007–08 close to collection of nearly one-third of its gross tax from CIT. The contribution of CIT and PIT were almost equal at a little less than 12 per cent in the beginning of the reform period. The share of PIT was a little more than 17 per cent in 2007–08. The share of excise has fallen from 31 per cent to 21 per cent while the fall in case of customs has been the 157

Saumen Chattopadhyay

sharpest, from 45 per cent to 17 per cent. Services tax will soon be contributing around 10 per cent to the exchequer. Who Has Been Paying Taxes and at What Rate

The number of income tax payers in the highest income category of `10 lakh and above grew very rapidly recording an annual growth rate of 63.3 per cent followed by 21.4 per cent for income in the range of `5 to Rs 10 lakh during just four years, 2001–02 to 2005–06. With lowest growth achieved for those with income below `2 lakh, it is obvious that the sheer growth in the number of those high income tax payers who effectively pay taxes pushed up the tax collection to attain higher growth in the income tax collection. Because of tax concessions on savings and pension schemes, tax payers with income below `2 lakh pay minimal amount of taxes. So, the buoyancy was actually being maintained by only around 15 per cent of the taxpayers whose numbers continued to surge ahead. The scenario did not undergo much of a change with the corporate assesses. The highest growth rate was achieved by the corporate in the highest income category of income of `10 lakh and above. The flat rate and varying amount of tax concessions being availed off by the corporate assessees across the income groups and industry groups notwithstanding, it can be argued that swelling numbers of corporate assesses with soaring profits have led to a high growth in corporate tax collection (Table 5.2). There have been many initiatives to enforce better tax administration such as increased use of computerization and information technology to gather information about tax payers’ true income. It is, however, difficult to argue that voluntary compliance has improved. As recently noted by the Finance Minister, there were 13â•¯lakh duplicate PAN card holders out of roughly four crore card holders.7 This is possibly a reflection of the still prevalent dominant Though necessary steps have been initiated to weed out the duplicate numbers. 7

158

Assessing Tax Policy and Tax Compliance in the Reform Era Table 5.2:â•… Increase in Non-corporate and Corporate Assesses Compound annual growth rate

Percent share in total assesses

Noncorporate Corporate Income level A B Lower B Higher C D Total No. of assesses (in lakh)

2001–02 2005–06 1.55 16.73 21.43 63.32 59.39 3.24

1.03 5.48 –6.03 18.92 0.00 3.01

Non-corporate

Corporate

2001–02 2005–06 2001–02 2005–06 94.09 4.32 1.15 0.31 0.13 100.00 258.77

88.10 7.06 2.20 1.91 0.73 100.00 293.95

54.73 18.05 16.91 9.74 0.57 100.00 3.49

50.64 19.85 11.70 17.30 0.51 100.00 3.93

Sources: Report No. 8 of 2007 (Direct Taxes), CAG, GoI. Notes: For non-corporate assesses: A: Assessments with income/loss below `two lakh. B Lower: Assessments with income/loss between ` two lakh and `five lakh. B Higher: Between `five lakh and `10 lakh. C: `10 lakh and above. For corporate assesses: A: Assessments with income/loss below `50,000. B Lower: Assessments with income/loss `50,000 above but below `five lakh. B Higher: `five lakh and above but below `10 lakh. C: `10 lakh and above. D: Search and seizure.

inclination to evade taxes. With ingenuity, even the best of the technology can be subverted by the dishonest (Kumar, 2000). Personal Income Tax

For personal income tax, there has been a distinct rise in the effective tax rate (ETR) as shown in Table 5.3. The fall in the tax burden as indicated by the drop in ETR has been more for the lower tax brackets. It may be because of the fact that the threshold limit has been raised resulting in lowering of burden and reduction of the 159

Saumen Chattopadhyay Table 5.3:â•… Personal Income Tax: Income Per Return and ETR Income bracket TL–20K 20–50K 50–100K 100–200K 200–300K 300–400K 400–500K 500–1,000K over 1,000K

Income per return (` lakh)

Effective tax rate

1991–92 1995–96 1999–2000 1991–92 1995–96 1999–2000 0.18 0.36 0.73 1.55 2.68 3.90 4.71 7.31 18.12

0.34 0.44 0.71 1.33 2.41 3.44 4.48 6.95 30.68

0.16 â•¯ 0.61 1.34 â•¯ 2.60 â•¯ 6.55 14.63

17.65 13.00 11.75 41.00 40.00 41.00 38.00 43.00 45.00

3.30 5.14 12.08 20.75 27.57 29.12 28.24 30.53 28.00

3.53 â•¯ 2.54 8.66 â•¯ 18.07 â•¯ 20.68 21.37

Source: All India Income Tax Statistics (AIITS, sample data) reported in the Indian Public Finance Statistics (2001–02 and 2002–03), Ministry of Finance, Department of Economic Affairs (DEA), GoI. Notes: Effective tax rate is defined as tax paid divided by income per return.

tax rates. But it is difficult to reject the claim that the ETR has declined across the board. Corporate Income Tax

The tax burden is not being borne equally among the corporate assessees, even though there is no apparent reason for this. The effective tax rate on companies was 20.6 per cent for the year 2007–08 (Table 5.4). While this showed a marginal rise compared to the previous year, it continues to be much lower than the applicable tax rate of 33.66â•¯per cent (Receipts Budget, 2008–09). The companies with PBT (profit before tax) lying between `zero to one crore had the highest effective tax rate of 25.4 per cent. The effective tax rate fell to 19.1 per cent for companies making profits in the higher range of `50–100 crore. ETR rose again to 20.3â•¯per cent for companies with PBT greater than `500 crore. The public sector companies paid tax at a rate of 23.35 per cent which is higher than the rate paid by the private sector companies (19.5 per cent). Compared to ETR for 2005–06, the profile for 2006–07 seemed to have shifted up, albeit marginally. It is not surprising that the 160

33.60 6.60 54.50 4.20 0.80 0.10 0.10 0.00 100.0 301,736

Less than zero Zero `0–1 crore `1–10 crore `10–50 crore `50–100 crore `100–500 crore Greater than `500 crore All sample companies Memo: Number of companies

0.28 3.79 4.87 8.94 11.10 6.22 15.33 49.46 100.00

Share in CIT payable

Source: Receipts Budget, Union Budget 2008–09, GoI and previous issues.

Percentage share of companies

Profit before taxes

2005–06

– – 24.29 18.49 17.17 16.33 17.21 19.10 19.26

ETR 31.60 9.40 53.30 4.50 0.90 0.10 0.10 0.00 100.00 328,061

Percentage share of companies

Table 5.4:â•… Profit-wise Distribution of Companies and Effective Tax Rate

0.25 1.75 4.08 8.12 10.02 5.74 15.89 54.15 100.00

Share in CIT payable

2006–07

– – 25.40 20.80 19.40 19.10 19.20 20.30 20.60

ETR

Saumen Chattopadhyay

growth in the number of companies went up by 37 per cent and 33 per cent for the highest profit bracket, `100 to 500 crore and `500 crore and above respectively. The service sector pays tax at a lower rate (19.01 per cent) than the manufacturing sector (21.91 per cent). But the lowest effective tax rate is paid by the IT-enabled service providers and BPO service providers (7.36 per cent) and software development agencies (6.38 per cent) (Receipts Budget, 2008–09). Issues in Tax Compliance

A proper assessment of the tax policy entails an analysis of tax compliance as one of the major objectives of tax policy is to encourage voluntary tax compliance. The pertinent question to ask is whether the rise in tax collection, particularly since 2001–02 can be said to be a mere outcome of an improvement in voluntary tax compliance as the government often claims or is it the character of the growth process which has led to a higher profile of tax collection as discussed above. Das-Gupta (2005) has argued that tax compliance showed signs of an improvement as tax gap8 narrowed down after reform era began. Das-Gupta argues that there are indications that income tax compliance has improved in the recent years, and, therefore, its impact on revenue seems to be positive, although the extent of this may remain moderate. The ratio remained below one in the late 1990s and crossed one in 2002–03 and since then, it has remained above one.9 It may be argued that a fall in the ratio below one indicates a decline in tax compliance since the growth in income tax per assessee is not commensurate with the growth in 8 Tax gap for any year is estimated as 100[1 – (i/P)], where i = actual noncorporate income tax revenue and P = estimated potential income tax revenue. The trick in obtaining the potential revenue lies in applying the maximum compliance index observed between 1965–66 to 2004–05 to the product of average tax rate (weighted) and non-agricultural GDP. For details, see Das-Gupta (2005). 9 The ratio has been normalized and put within the limit of zero and one.

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Assessing Tax Policy and Tax Compliance in the Reform Era

income per capita. Rao and Rao (2005) seem to concur that the compliance level has indeed improved. Further, it is often the negative correlation between effective tax rate and ratio of income tax collections to GDP which validates the Laffer curve hypothesis. Tax gap as used by Das-Gupta (2005) does not take into consideration that both tax paid per assessee and per capita income as measured by Net National Product (NNP) at factor cost are not really reliable as both the indicators ignore tax evasion or the generation of the black income. Tax collection can also go up when the size of the tax base expands in the process of economic growth relative to the size of the overall growth. The share of non-agricultural GDP or, even better, the share of nonagricultural organized sector Net Domestic Product (NDP) would rise as an economy develops (Kumar et al., 2006). This is what happened in case of India. When we assess tax collection with respect to these two bases, the buoyancy estimates turned out to be lower. Tax collection can also go up if there is a higher growth of high income tax payers implying increasing income disparities among the income tax payers. In practice, therefore, tax collection reflects not only an improvement tax compliance but also structural and policy changes in an economy, as reflected in an enlargement of tax base and the changing distribution of tax burden across different category of tax payers. Tax Buoyancy

In order to understand to what extent the growth in tax revenue could be made attributable to the intrinsic growth of the economy, we examine the buoyancy of all the taxes during the reform era. The performance in tax collection achieved during the last five to six years (or, since 2001–02) should be distinguished from that of the 1990s (Table 5.5). The growth in tax collection to an extent has been intrinsic to the very growth process that we could achieve over the last couple of years when we find that the relevant tax base expanded at a faster rate than the GDP (Kumar et al., 2005). 163

0.87 0.79 0.57

GDP factor cost Non-agr GDP Non-agr org NDP

0.86 0.76 0.29

1.27 1.12 0.90

2001–02 to 2006–07

1.20 1.08 1.15

1.80 1.66 1.50

1990–91 to 2006–07

1.56 1.47 1.39 Tax revenue (gross) 1.18 1.08 1.11

CIT

1990–91 to 2000–01

1.36 1.20 1.23

2.22 1.97 1.70

2001–02 to 2006–07

Source: NAS and Receipts Budget, Union Budget, various issues. Notes: Buoyancy estimates are obtained by simply taking the ration of rates of growth of tax with its base. Buoyancy estimates for customs and services are not provided as for both these taxes there has been a change.

PIT 1.47 1.35 1.34 Excise 0.83 0.76 0.71

1.39 1.27 1.19

GDP factor cost Non-agr. GDP Non-agr. org. NDP

1990–91 to 2000–01

Key indicators

1990–91 to 2006–07

Table 5.5:â•… Buoyancy Estimates of Central Taxes in the Reform Era

Assessing Tax Policy and Tax Compliance in the Reform Era

We estimate buoyancy with regard to non-agricultural GDP at factor cost rather than GDP at factor cost. In fact, unorganized sector GDP is largely untaxed. Even if it is, it is largely the growth of the organized sector which contributes to tax collection. The third base we consider therefore is non-agricultural organized sector NDP. We find from the above table, that buoyancy for PIT falls below one with respect to the non agricultural NDP during the second period of reform. Similarly, there is also a fall in the buoyancy estimates for CIT and excise as we converge towards a more appropriate tax base. The rise in PIT collection can therefore be explained by a growth in the relevant tax base. However, the buoyancy estimates for CIT turn out to be close to two. While widening of tax base is desirable and very much part of the growth process, a part of higher tax collection can also be due to the change in the distribution of income. A steady rise in the share of TDS in, say, PIT has also contributed to higher tax collection (Rao and Rao, 2005). An increase in the coverage of TDS is a part of an institutional change which would actually lessen the scope for voluntary compliance.10 The other factor which would contest the argument that voluntary compliance has gone up is the steady rise in taxes paid by the Public Sector Enterprises (PSEs) for CIT (Rao and Rao, 2005). PSEs contributed only 23 per cent to total CIT which increased to 37.75 per cent by 2002–03. Tax Expenditures

Tax concessions extended to the tax payers indicate government’s specific policy towards different categories of tax payers and taxes themselves. The government has been arguing for phasing out tax 10 The proportion of tax deducted to total revenue collections fell from 42â•¯per cent in 1990–91 to 22 per cent in 1994–95 to rise again to 50 per cent in 1996–97 as an outcome of policy measure to expand the scope of TDS. It rose to 64 per cent in 2003–04 (Rao and Rao, 2005).

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concessions to move towards a lower tax regime to ensure transparency. An analysis of tax expenditures will help us to identify whether the actual beneficiaries are the intended beneficiaries (Kumar et al., 2008). Tax incentives or tax ‘breaks’ have been found in general to be inefficient and rather expensive instrument of tax policy (Bagchi et al., 2005). Tax expenditure roughly quantifies revenue foregone, or, what the government could have mobilized had there been no tax concessions under certain restrictive assumptions such as unchanged tax base despite withdrawal of the tax concessions and each tax concession does not interact with other tax incentives. Commensurate with the rise in tax collection, revenue foregone has also gone up in absolute terms. However, as a percent of the total tax collections, it has come down. Revenue foregone as a percent of aggregate tax collection in 2007–08 was 58 per cent, down from 67 per cent in 2005–06 (Table 5.6). If we look at tax expenditure as a percentage of its own tax revenue, we find that tax concessions availed off for PIT and excise has gone up compared to 2005–06. Tax concessions extended for the promotion of the Special Economic Zones (SEZs) are known to be substantial. The amount of tax concessions have increased by around of 35 per cent over the previous year, from ` 2,402 crore to `3,243 crore, a major share of it is appropriated by the exporters (` 2,962 crore). Table 5.6:â•… Tax Expenditures: Revenue Foregone 2005–06 Major heads of taxes CIT PIT Excise Customs Total Less export credit related Grand Total

2007–08

In ` crore

% of total tax

% of own tax

In ` crore

% of % of total tax own tax

34,618 13,550 66,760 127,730 244,290 37,590

9.45 3.70 18.23 34.88 66.72 10.27

34.18 21.30 60.02 196.31 –

58,655 42,161 87,992 148,252 337,060 58,416

10.02 7.20 15.03 25.32 57.58 9.98

206,700

56.45

278,644

47.60

31.51 35.63 68.77 147.13

Source: Receipts Budget 2008–09, Table 11, p. 58, Union Budget 2008–09, GoI.

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Assessing Tax Policy and Tax Compliance in the Reform Era

In brief, there is enough ground to believe that tax concessions are still appropriated by the privileged, which renders the tax system inequitable and leaves substantial scope for achieving higher tax revenue growth. Tax Administration

Tax administration is crucial to successful implementation of tax policy and it is more so in a developing country like India. Tax compliance, in a way, measures the efficacy of tax administration. Kumar, Nagar and Samanta (2007) distinguish between voluntary tax compliance and tax compliance due to enforcement. Effective tax administration implies voluntary compliance on the part of the tax payers through building up of a system where there are carrots for those who voluntarily pay and sticks for those who do not. Kumar et al. (2007) argue that there has not been much of a change in tax administration in the reform era and tax evasion continues. They estimated that delinquent taxes have risen at a compounded annual growth rate of 30 per cent during 1995–96 to 2005–06. The percentage collection of arrear demands has also remained static at 8 per cent to 9 per cent. Further, they argue that the extent of voluntary compliance is not more than 50 per cent of PIT or CIT. The factors such as ‘…complexity of tax laws, lack of fairness of the penalty system, weak taxpayer education programme’ hinder taxpayers’ voluntary compliance through a rise in costs of tax compliance. Das-Gupta (2002) questions the efficiency of the tax administration setup. He argues for the 1990s that ‘[o]verall, for central taxes administrative effectiveness is unlikely to have increased in recent years. This impression is reinforced by findings of annual systems appraisals undertaken by the CAG which document the inability of the tax departments to effectively administer taxes.’ Unprofessional attitude of the tax officials (Chattopadhyay and Das-Gupta, 2002) add to the woes of the taxpayers. Tax administration can be bypassed more easily by the corporates and the tax accountants continue to maintain 167

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contact with the tax officials. But the problem of tax evasion cannot be explained solely by weak tax administration. The nexus among the bureaucrats, businessmen and the politicians fosters the growth of the black economy (Kumar, 2000). Weak administration would also invalidate the Laffer curve hypothesis as the taxpayers perceive costs and benefits of tax evasion in the context of (in)effective tax administration. Possible Reform Measures

As argued earlier, the objective of tax policy should not remain confined merely to raising revenue productivity inflicting minimum burden on the tax system. In fact, the issue goes beyond one of ensuring equitable distribution of tax burden. Tax policy is considered to be one major instrument for attaining equitable growth. Since we are always in a second-best situation, and particularly for a country like India, equity should get priority over efficiency while designing tax policies. From the discussion above, it may be argued that there may not be such a strong case as it is made out to be for attributing higher tax collection to improved tax compliance. We observed that while we have collected more from the high income tax payers, both individuals and corporates, they have paid less in the reform era as low ETRs would indicate. Not only have individual tax payers paid less compared to their incomes, but the companies at the higher end of the profit spectrum have paid at a lower ETR (Kumar et al., 2006). Corruption in the tax machinery as well as among the taxpayers shows only very weak signs of waning. There has been no decline in the scams and frauds as reported in the media. It may be noted that lowering the tax rate to encourage voluntary compliance works under certain assumptions. If the tax laws can be subverted, the tax payer is not necessarily faced with a rising marginal cost of evasion, and tax evasion would continue. Further, the argument behind the Laffer curve hypothesis may not be tenable for profit earners but tax is evaded mainly on profit 168

Assessing Tax Policy and Tax Compliance in the Reform Era

incomes (Kumar, 2000).11 The nexus between tax practitioners and the tax officials (Chattopadhyay and Das-Gupta, 2000) still exists despite major changes in tax administration. The efficacy of the tax administration has, therefore, been sub-optimal (Kumar et al., 2007). Given low ETR and the need for resources for social and physical infrastructure expansion, the government has to take steps to augment tax collection from direct taxes through gradual phasing out tax concessions and to put in place an effective and corruption free tax administration. One has to see how progressive the ETR is in presence of ‘tax expenditures’. As shown above, tax expenditure still constitutes nearly 50 per cent of tax collection. The obsession with distortion or inefficiency as the most important concern for the policy makers should be replaced with concern for equity. Of course, this does not imply gross violation of tax efficiency. The obsession with efficiency is evident as it is often argued that we should ideally move towards a two-rate structure.12 Tax concessions for both PIT and CIT are to be revisited case by case and be phased out as per the merit of the case. There are enough examples where tax concessions have been abused (Rao and Rao, 2005; Bagchi et al., 2005).13 The case for wealth tax and dividend case should be revisited. The Government of India has entered into many Memoranda of Understandings (MoUs) with countries known for tax havens. International treaties with countries for being used as tax shelters should be reexamined. Globalization of 11 Because generation of profit incomes and wage incomes are different. The logic behind the Laffer curve hypothesis is tenable mainly for wage income. 12 Rao and Rao (2005: 55) argue, ‘However, moving towards a single rate of tax may not be politically feasible at this juncture, but it be possible to reduce the number of tax rates to two, with a small reduction in the marginal tax rate (say, 25%).’ 13 Bagchi et al. (2005: 8) examined tax holidays in both income tax and excise, for exports and new industries, exemption from income tax of charitable institutions and deductions allowed for income for gifts to ‘charity’, selected exemptions in central excise and customs, such as SSI.

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capital and development in the electronic media has rendered international tax competitive and there would be a tendency to rely more on resource-based taxation (Lodin, 2002). Though there has been a major overhaul in direct tax administration and results partly reflect the increasing use of ICT, the indirect tax administration has not seen appreciable change. One has to be cautious in our increasing reliance on computerization. How technology can be abused, the duplicate PAN numbers indicate. The ingenuity of tax payers will continue to pose major challenge for the tax administration. Costs of complying with the tax system should be further brought down. Though there have been major innovative changes to make tax paying smooth and less painful, there is a case for it reducing it further (Chattopadhyay and Das-Gupta, 2000) as high costs of tax compliance deter voluntary tax compliance. Reduction in costs of tax compliance in view of widespread tax evasion is rather delicate. Costs of tax compliance often increase in an attempt by the tax administration to deter or curb tax evasion. This is often a tightrope walking by the policy makers. The basic approach of indirect tax reform through moving towards a comprehensive tax base and integration of industry and services should be the goal of the government. Consumptionbased tax would tend to be regressive and a greater reliance on it would entail the revenue neutral rate to be higher (Cnossen, 2002), which is not desirable. The goal of the government should continue to be to focus on collection of direct taxes through better tax administration and lesser tax concessions; the reform of indirect tax should continue. Concluding Remarks

In this paper, we made an attempt to present a broad overview of the tax policy and tax collection during the reform era. Though tax reform had been a major area of policy concern for the government particularly to curb tax evasion, the changes in tax policy effected since 1991 reflect pressure on India to embrace the global economy, 170

Assessing Tax Policy and Tax Compliance in the Reform Era

stress on measures to foster voluntary compliance and building up of an effective and strong tax administration. Tax evasion continues to pose formidable challenge for the government even decades after tax reform. The reform of indirect tax poses challenge for the government in the Indian federal structure. What we observed raises questions about the claim that tax compliance has improved. The burden on the well off has been less as low ETR signifies. The nature of the recent growth with widening tax base with worsening income distribution is possibly one reason behind higher direct tax collection. In this regime of corporate sector driven growth, profits have been given special treatment and profit level has witnessed unprecedented high growth. What is needed therefore is to focus more on direct tax collection through combating tax evasion and on elimination of tax expenditures through removal of tax concessions. It is time that we stop worrying and complaining about scarcity of resources. It is understandable that withdrawal of tax concessions both from the individual tax payers and corporate sector might hamper growth. As higher tax collection is ploughed back as increased public expenditure and less privileged section of the people gains and feel empowered to live with dignity, there is a strong case for a progressive tax policy even if it is at the expense of growth rate. After all, what is the point of 9 per cent GDP growth rates if three-fourths of our population remains ‘poor and vulnerable’. Appendix Table 5A.1:â•… Percentage Composition of Major Central Taxes Year

CIT

PIT

Customs

1990–91 1991–92 1992–93 1993–94 1994–95 1995–96

9.5 12.0 12.3 13.6 15.1 15.0

9.6 10.3 10.9 12.3 13.2 14.2

36.8 33.9 32.8 30.0 29.3 32.5

Excise duties Service tax 43.7 42.9 42.5 42.9 40.9 36.5

0.4 0.8

(Table 5A.1: continued )

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Saumen Chattopadhyay (Table 5A.1: continued ) Year 1996–97 1997–98 1998–99 1999–00 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 RE Memo: 2009–10 BE

CIT 14.6 14.4 17.1 17.9 18.9 19.6 21.3 25.0 27.1 27.7 30.5 32.5 35.4 36.4

PIT 14.3 12.3 14.1 14.9 16.8 17.1 17.0 16.3 16.2 15.3 15.9 17.3 19.5 20.2

Customs 33.6 28.9 28.3 28.2 25.2 21.5 20.7 19.1 18.9 17.8 18.2 17.6 17.2 16.4

Excise duties Service tax 35.3 0.8 34.5 1.1 37.0 1.4 36.0 1.2 36.3 1.4 38.8 1.8 38.1 1.9 35.7 3.1 32.5 4.7 30.4 6.3 24.8 7.9 20.8 8.6 17.3 10.4 16.5 10.3

Source: NAS and Receipts Budget, Union Budget; various issues. Figure 5A.1:â•… Share of Major Central Taxes in GDP in the Reform Era

Sources: Receipts Budget, Union Budget 2009–10 and previous issues. National Accounts Statistics 2007 and previous issues.

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Assessing Tax Policy and Tax Compliance in the Reform Era

References Bagchi, A., K. Rao, and B. Sen. 2005. ‘Raising the Tax Ratio by Reining in the “TaxBreaks” an Agenda for Action’, Working Paper 2, NIPFP, New Delhi. Cnossen, Sijbren. 2002. ‘Taxing Consumption: Some Reflections on the US Debate’, in M. G. Rao (ed.), Development, Poverty, and Fiscal Policy: Decentralization of Instituions, New Delhi: Oxford University Press, pp. 118–27. Chattopadhyay, S. and A. Das-Gupta. 2002. The Personal Income Tax in India: Compliance Costs and Compliance Behaviour of Taxpayers, National Institute of Public Finance and Policy, New Delhi (NIPFP). Report submitted in December to the Planning Commission, Government of India, New Delhi. Das-Gupta, A. 2002. ‘Central Tax and Administration Reform in the 1990s: An Assessment’, in M. G. Rao (ed.), Development, Poverty, and Fiscal Policy: Decentralization of Instituions, New Delhi: Oxford University Press, pp. 139–73. Das-Gupta, A. 2005. ‘Recent Individual Income Tax Reform’, Economic and Political Weekly, 40 (14) 2 April: 1397–1405. Kishore, P. 2009. ‘Fringe Benefits Tax in India: An Empirical Study of Collection and Compliance from Corporate Sector’, paper presented at the National Conference on ‘Corporate Sector, Industrialisation, and Economic Development in India’, ISID, New Delhi, March 27–28. Kumar, A. 2000. The Black Economy in India. Delhi: Penguin. Kumar, A., S. Chattopadhyay, and A. Sunil Dharan. 2005. ‘Fiscal Policy’, Alternative Economic Survey 2004–05. New Delhi: Daanish Books. Kumar, A., S. Chattopadhyay, and A. Sunil Dharan. 2006. ‘Fiscal Policy’, Alternative Economic Survey 2005–06. New Delhi: Daanish Books. Kumar, A., S. Chattopadhyay, and A. Sunil Dharan. 2007. ‘Fiscal Policy’ in Alternate Survey Group (eds), Disempowering Masses, Alternative Economic Survey, 2006–07. New Delhi: Daanish Books. Kumar, A., A. Sunil Dharan and S. Chattopadhyay. 2008. ‘Fiscal Policy: Missing the Opportunity to do More’, in Alternate Survey Group (eds), Alternative Economic Survey 2007–08: Decline of the Developmental State. New Delhi: Daanish Books. Kumar, S., A. L. Nagar and S. Samanta. 2007. ‘Indexing the Effectiveness of Tax Administration’, Economic and Political Weekly, 42 (50) December 15: 104–10. Lodin, Sven-Olof. 2002. ‘What Ought to be Taxed and What can be Taxed: A New International Dilemma’, in M. G. Rao (ed.), Development, Poverty, and Fiscal Policy: Decentralization of Instituions, 85–101. New Delhi: Oxford University Press. Rao, M. G. and Kavita R. Rao. 2005. ‘Trends and Issues in Tax Policy and Reform in India’, Working paper 1, NIPFP, New Delhi.

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II

Pressing Concerns Relating to Fiscal Federalism in India

176

6 Challenges to Fiscal Policy in India in the Era of Reforms T. M. Thomas Isaac and R. Ramakumar*

I Introduction

With the spectre of the financial crisis looming large over the world economy, there is much discussion on solutions and packages. There is consensus that developed and developing countries require a large fiscal stimulus. Estimates of the International Monetary Fund (IMF) show that in the G-20 countries, the increase in the average overall fiscal deficit over the PPP-weighted GDP would be around 1.3 per cent in 2008, 5.5 per cent in 2009 and 5.4 per cent in 2010 (with 2007 as the base). In Japan, the stimulus package is estimated to form 2.4 per cent of the GDP in 2009, while in South Korea, the corresponding figure is estimated to be 3.9 per cent. In November 2008, China decided on a remarkable fiscal stimulus package of nearly $586 billion (` 26.1 lakh crore) for two years. The Chinese package is quite different from the *For helpful comments and discussions on an earlier draft, we thank Amiya Kumar Bagchi, Prabhat Patnaik, S. L. Shetty, C. Rammanohar Reddy, Pallavi Chavan and Jose Cyriac. 177

T. M. Thomas Isaac and R. Ramakumar

American package, which is primarily intended to save the banks from collapse. In China, the intention is to expand the home market through higher public investment; it is an ‘economic stimulus package’, and not a ‘bailout package’. Will the Chinese stimulus package be a good enough stimulus for the Indian government to take a similar road? The response in India has been primarily on the monetary policy front to raise levels of liquidity. The hesitation in spending even during the crisis originates from a dogmatic ideology. This ideology is embedded in a specific approach to fiscal policy that India has sought to adopt, particularly after 1991. What are these constraints that limit the ability of the state to adopt counter-cyclical fiscal stances, even during crises? It would be useful to examine this question in the context of the need for a fiscal stimulus in India today. In this paper, the focus is on the fiscal policies of state governments in India. About 55 per cent of the total public expenditure in India is undertaken by the states. About 85 per cent of the social sector expenditure in India comes under the purview of the states. In much of spending in the infrastructural sector, states contribute a share to the total spending by the Centre. Thus, the nature of fiscal policy of the states is paramount in determining the strength of any counter-cyclical fiscal policy of the central government. An interesting aspect of the fiscal policy of states in the contemporary period is that they are officially alleged to be ‘cash rich’, and yet not spending (Chidambaram, 2006). As on 21 November 2008, the investment by state governments in all the treasury bills of the Reserve Bank of India (RBI) was `70,443 crore. Even the so-called Bihar, Madhya Pradesh, Rajasthan, Uttar Pradesh (BIMARU) states, with a track record of abysmally low provision of basic needs, have joined the rich states’ club with large amounts of cash surplus. So, why do the states not spend this surplus? This question forms the focus of the present paper. Is it due to governance failure, as the Union Finance Ministry has been arguing, or something more fundamental affecting the fiscal powers of the state governments? In this chapter, we shall start with a brief analysis of the emergence of the phenomenon of cash surpluses in state government treasuries 178

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(Section II), and then go on to analyze the factors responsible for the phenomenon from the receipts side and on the expenditure side. We argue that the limits to expenditure increases set through legislation are primarily responsible for the cash surplus phenomenon. The constraint on expenditures is imposed by the Fiscal Responsibility and Budgetary Management (FRBM) Acts passed by the Centre and most state governments (Section III). We argue that the cash surplus phenomenon is a perverse outcome of the FRBM Acts.

II The phenomenon of cash balance surplus of states

When state governments’ day-to-day disbursement requirements are in excess of receipts, temporary accommodation is sought from the RBI in the form of Ways and Means Advances (WMA). Ceilings have been determined for each state and when the WMA exceed the ceiling, the state gets into a position of Overdraft (OD). Persistence of OD beyond a specified period would result in temporary suspension of treasury operations by the RBI. state finances in India, from the latter half of the 1980s, were distinctly characterized by the persistence of cash balance deficits and consequent WMA and OD positions. However, from the early 2000s, the situation began to change; the extent to which state governments availed WMA from the RBI declined sharply. As Table 6.1 shows, 14 non-special category states availed normal WMA for 200 days or more in 2000–01; in 2007–08, no state had to avail normal WMA for 200 days or more. In 2007–08, 15 out of 18 states were not in WMA for even a day. The two states that availed WMA for 100–199 days in 2007–08 were Kerala and West Bengal. Among special category states, no state had availed WMA for more than 99â•¯days in 2007–08, as compared to only three states in 2000–01. When there is a surplus balance in the treasury, the RBI invests the surplus in the intermediate treasury bills of the central government on behalf of the states. Surplus in cash balances, which was 179

T. M. Thomas Isaac and R. Ramakumar Table 6.1â•…Distribution of the Number of States that Availed Normal WMA, by the Number of Days the State Government Treasuries Availed WMA, 2001–02 to 2007–08 Number of days in WMA A. Non-special category states: 0–99 100–199 200 and above B. Special category states: 0–99 100–199 200 and above

2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08

3 0 14

5 1 11

5 3 9

10 (4) 2 5

3 2 4

3 1 5

5 1 3

4 (1) 4 1

16 (13) 17 (15) 16 (15) 0 0 2 1 1 0 9 (1) 0 0

9 (4) 0 0

9 (4) 0 0

Sources: RBI (2005b); RBI (2006); RBI (2008). Note: Figures in brackets show the number of states that had availed WMA for zero days.

a relatively rare phenomenon in the 1990s, began to be a regular feature of the states’ treasuries in the 2000s (Figure 6.1). Between 1998 and 2001, not only were the volumes of investment low, but they were also declining. On 28th of December 2001, the total investment by states in all denominations of treasury bills was only `1,988 crore. Within this amount, the investments in longer duration treasury bills were almost negligible. However, from the beginning of 2002, longer duration investments started rising slowly, reaching `2,926 crore as on 9 January 2004. After January 2004, there was a phenomenal and continuous rise in the investment by states in the treasury bills. As on 28th of March 2008, treasury cash balance of all states was at an astonishing level of surplus: `106,210 crore. The composition of securities within the total investment also changed between 2004 and 2008. states began to invest much more in the longer duration securities, such as the 91-day, 182-day and 364-day treasury bills. Around 7 per cent of the investment by states (about `4,806 crore) was in 364-day treasury bills as on 21â•¯November 2008. 180

Sources: Weekly Statistical Supplement, Reserve Bank of India; various issues.

Figure 6.1:â•…Investment Outstanding of State Governments in Intermediate Treasury Bills, Quarterly Estimates, 1998 to 2008 (in ` Crores)

T. M. Thomas Isaac and R. Ramakumar

The RBI has begun to publish state-wise data on the investment outstanding in 14-day intermediate treasury bills from 2005–06 (RBI, 2005a). In 2001–02, majority of the states did not have any outstanding investment in treasury bills (Table 6.2). By 2007–08, all state governments had significant investment outstanding in 14-day intermediate treasury bills. Gujarat, with more than `8,200 crore investment, was in the forefront. Interestingly, Bihar and Uttar Pradesh were also part of the group of states that had above `4,000 crore as investment in treasury bills. The phenomenon of significant investment by states in treasury bills is worrisome for a number of reasons. First, the investments by states in the 14-day intermediate treasury bills of the Centre earn them a return of 5 per cent per annum. However, as we shall see, the average cost of mobilization of funds for the states is much higher. In 2007–08, the interest rate on borrowings of states against small savings was 9.5 per cent per annum (the costliest debt in the market) and the average interest rate on market borrowings was around 7 per cent per annum. The total transfer of National Small Savings Fund (NSSF) loans from the Centre to states was `58,830 crore in 2006–07. At the end of the same period, the total reverse investment by states in the treasury bills was `39,217 crore, or about two-thirds of its NSSF borrowing from the Centre! Even the RBI, in its study on state finances, commented that this situation implies a ‘reverse transfer of resources from states to the Centre’ (RBI, 2005a: 52).1 Second, the Centre has also been recycling the cash surplus of states to itself at a very low rate of interest for treasury security operations. In the recent years, the Centre has been enjoying a surplus cash balance for most months. For 2005–06, the RBI had pointed out that ‘had it not been for the investments of states’ surplus cash balances in 14-day Intermediate Treasury Bills, the centre 1 One argument has been that it is the Centre that provides tax incentives to investors in small saving accounts. However, this argument is not tenable, as the loss to the Centre due to tax incentives affects the receipts of States as well through the lower share in taxes devolved.

182

139 – 91 352 – – – 1,482 1,885 – – 857 – – – – – – – – 4,943

Andhra Pradesh Assam Bihar Chhattisgarh Gujarat Haryana Himachal Pradesh Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Tripura Uttar Pradesh Uttarakhand West Bengal All states

Source: RBI (2005a: S99).

2001–02

States 190 – 943 589 747 149 – 217 388 – 27 1,021 – – – – 103 407 311 – 5,594

2002–03 1,183 – 299 271 289 632 – 1,259 296 – – 1,831 102 – 179 – 8 240 77 – 6,856

2003–04 1,701 – 2,845 335 227 1,571 – 1,139 2,033 – 200 1,095 653 – 930 – 297 – – 935 14,314

2004–05 2,076 1,378 2,848 882 3,420 3,861 337 147 4,213 147 646 3,255 1,722 1,527 1,805 2,944 476 3,234 118 3,302 38,983

2005–06 3,416 2,549 1,674 1,121 2,105 2,898 – 963 1,597 828 2,507 4,711 2,621 457 – 3,407 538 5,481 133 1,136 39,217

2006–07

Table 6.2:â•…Investment outstanding in 14-day intermediate treasury bills, all States, 2001–02 to 2005–06, as on end-March (in ` Crores)

6,380 4,447 4,446 1,641 8,223 845 1,122 1,467 3,488 840 2,761 6,495 4,821 730 3,389 5,279 578 5,451 – 2,121 67,477

2007–08

T. M. Thomas Isaac and R. Ramakumar

would have been in WMA’ (RBI, 2005a: 52). Also, the centre deploys its cash balances in securities held by the RBI (which fetches the Centre a yield higher than the 5 per cent), thus saving on the interest to be paid on the dated securities held by the RBI (ibid.). This has enabled the Centre to make profits, through positive spreads, from the states’ cash surpluses. Many states have openly stated that they do not want to borrow from the NSSF. The Centre responded to this criticism by forming a sub-committee of selected Chief Ministers and state Finance Ministers, whose progress of work has been tardy. Reading through the minutes of the deliberations of various official forums, one is amazed at the total absence of discussions on how the surplus cash balances can be fruitfully employed to meet the basic needs of the people. There is a peculiar myopia towards the expenditure side of the problem. A discussion on the reasons behind the cash surplus phenomenon has to take into account both the receipts and expenditure sides of state finances. We shall first discuss the receipts side. Trends in States’ Receipts

The sources of receipts of a state government can be broadly divided into central transfers (shareable taxes and grants), own revenue (own-tax receipts and own non-tax receipts) and capital receipts (loans from the Centre and other sources). Central Transfers

The significant increase in transfers from the Centre to the states has been cited as a prominent factor leading to the phenomenon of cash surpluses (RBI, 2005a: 52). Data show, first, that the ratio of central grants to GDP tended to decline from around 2.4 per cent in the late 1980s to 1.7 per cent in the late 1990s (Figure 6.2). However, there was a significant rise in the ratio of grants to GDP between 2004–05 and 2005–06. Secondly, the ratio of share of 184

Source: Handbook of Statistics on the Indian Economy, Reserve Bank of India, various issues; RBI (2006).

Figure 6.2:â•… Share of Different Components of Devolution of Resources from Centre to States to GDP, in Per cent to GDP

T. M. Thomas Isaac and R. Ramakumar

central taxes to GDP was more or less stagnant till the mid-1990s, but fell between 1997–98 and 2002–03. After 2002–03, the ratio of share of central taxes to GDP increased, but in 2005–06 it was still below the corresponding ratio for 1997–98. Finally, the ratio of total central transfers (i.e., share in central taxes plus grants) to GDP, after stagnating from the late 1980s at around 5 per cent, declined from 1997–98 and improved significantly between 2002–03 and 2007–08. In absolute terms, the total central transfers increased from `101,825 crore in 2002–03 to `272,772 crore in 2007–08. Own Revenue

The ratio of own revenue to GDP, particularly of own-tax revenue, of state governments has increased in the recent years (Table 6.3). The own-tax revenue of states increased from an average of 5.1 per cent of the GDP between 1995 and 2000 to 6.1 per cent between 2005 and 2009. As a result, the total own receipts of states as a ratio to the GDP also rose from 6.7 per cent between 1995 and 2000 to 7.5 per cent between 2005 and 2009. Due to the rise in central transfers and own revenues, the ratio of total revenue receipts to GDP also rose from 10.7 per cent between 1995 and 2000 to 12.9 per cent between 2005 and 2009. Table 6.3:â•… Selected Features of the Pattern of Revenue Receipts of State Governments, 1980 to 2009 (as Percentage to GDP at Current Market Prices) As a ratio to GDP (%) Period average 1980–85 1985–90 1990–95 1995–00 2000–05 2005–09

Total revenue receipts

Total own receipts

Own-tax receipts

Own non-tax receipts

11.0 12.0 12.0 10.7 11.2 12.9

6.8 7.2 7.2 6.7 7.0 7.5

4.8 5.3 5.3 5.1 5.6 6.1

1.9 1.9 1.8 1.6 1.4 1.4

Source: RBI (2006, 2008), State Finances Report.

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Capital Receipts

The ratio of capital receipts to GDP of states rose sharply from 3.1â•¯ per cent in 1996–97 to 6.4 per cent in 2004–05 and 4.6 per cent in 2005–06. After 2005, there was a fall in the ratio of capital receipts to GDP, which was primarily due to a fall in the amount of NSSF loans to states. Among capital receipts, loans from the NSSF had risen significantly after 1999–2000 till 2005–06. The ratio of NSSF loans to GDP rose from 1.3 per cent in 1999–2000 to 2.7 per cent in 2004–05 and 2.2 per cent in 2005–06 (Table 6.4). However, after 2005, the amount of NSSF loans declined sharply; the share of NSSF loans in the total capital receipts of states fell from 48 per cent in 2005–06 to 12 per cent in 2007–08. Even though the share Table 6.4:â•… Selected Features of the Pattern of Capital Receipts of State Governments, 1990–91 to 2007–08 (as Percentage to GDP at Current Market Prices) As a ratio to GDP at current market prices (%) Year 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 RE

Capital receipts

Special securities issued to NSSF

4.33 4.16 4.00 3.29 4.25 3.59 3.05 3.86 4.87 5.22 5.22 5.08 5.74 7.47 6.36 4.60 3.44 2.86

– – – – – – – – – 1.29 1.48 1.49 1.99 2.28 2.66 2.19 1.42 0.33

Share of NSSF loans in capital receipts – – – – – – – – – 24.8 28.3 29.3 34.8 30.5 41.8 47.7 41.2 11.7

Sources: Indian Public Finance Statistics, Ministry of Finance, various issues; State Finances: A Study of Budgets, various issues; RBI (2006, 2008).

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of NSSF loans fell after 2005, the accumulation of receipts between 1996 and 2005 was massive for the states.2 In sum, the ratio to GDP of (a) own-tax revenue of states, (b) total central transfers to states and (c) high-cost NSSF loans (till 2005–06) have risen in the recent years. Even if we grant that the increase in receipts made a significant difference to state finances, it still begs the question: How are the states spending these increased receipts to meet the needs of people? Trends in States’ Revenue Expenditures

A distinct feature of state finances from the early 2000s has been the decline of total expenditure as a ratio to GDP. Between 2000–01 and 2007–08, the ratio of total expenditure to GDP of states fell from 16.2 per cent to 15.9 per cent, after recording a peak level of 18.7 per cent in 2003–04 (Table 6.5). The relative decline in total expenditure by states took place, as we have seen, in a period of increase in the ratio of revenue and capital receipts of states to GDP. The fall in the ratio of expenditure to GDP of states in the 2000s has been associated with stagnation in the ratio of developmental expenditure to GDP. On the other hand, the revenue deficit of states, expressed as ratio to GDP, sharply fell from 2.9 per cent in 1999–2000 to –0.5 per cent in 2007–08 (see Figure 6.5 in section III of the chapter). Similarly, the fiscal deficit of states fell from 4.7 per cent in 2 Till 1999–2000, loans from the NSSF were considered as loans from the Centre; from 1999–2000; however, they were considered as internal debt and classified separately as ‘Special Securities Issued to NSSF’. Currently, the entire collection of NSSF in each State is returned to the respective State governments by the Centre in the form of borrowings. Till 2004–05, States had access to only 60 per cent of the net small savings collection, but from 2005–06 onwards, they are forced to borrow the entire small savings collection even if they do not require it. The interest rate on NSSF borrowings is 9.5 per cent per annum with the States bearing the additional burden of the special incentives that are provided under the small savings scheme.

188

Challenges to Fiscal Policy in India in the Era of Reforms Table 6.5:â•… Selected Features of the Pattern of Expenditure of State Governments, 1990–91 to 2006–07 (as Percentage to GDP at Current Market Prices) As a ratio to GDP at current market prices (%) Within developmental expenditure Year 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07

Total Developmental expenditure expenditure 16.0 16.5 15.9 15.5 15.7 14.7 14.5 14.7 14.9 15.8 16.2 16.2 16.7 18.7 17.6 15.7 15.9

10.1 10.4 9.8 9.6 9.5 9.0 8.9 8.9 8.8 9.0 9.5 9.0 8.8 9.3 9.2 9.2 9.5

Social services

Economic services

Nondevelopmental expenditure

5.1 5.0 4.8 4.7 4.7 4.7 4.6 4.7 4.9 5.2 5.2 5.0 4.9 4.7 4.9 4.5 4.6

5.0 5.4 5.0 4.9 4.8 4.3 4.3 4.2 3.9 3.9 4.2 3.9 3.9 4.6 4.4 4.3 4.5

3.9 4.1 4.2 4.4 4.8 4.6 4.5 4.6 4.9 5.4 5.7 6.0 6.1 6.1 6.1 5.3 5.1

Sources: Indian Public Finance Statistics, Ministry of Finance, various issues; State Finances: A Study of Budgets, various issues; RBI (2006, 2008).

1999–2000 to 2.3 per cent in 2007–08. In other words, the decline in revenue deficit and fiscal deficit were achieved by states by not spending the additional revenue receipts and capital receipts. This conclusion becomes evident from the changes in the ratio of revenue expenditure to revenue receipts of states: this ratio fell continuously from 1.3 in 1999–2000 to 1.0 in 2005–06 and 0.9 in 2007–08. The overall stagnation, if not decline, in the ratio of expenditure to Gross State Domestic Product (GSDP) of state governments cannot be the result of lack of ‘absorption capacity’ of states, as the Union Finance Ministry has been arguing. As per disaggregated data, states like Haryana, Karnataka, Gujarat and Tamil Nadu, 189

T. M. Thomas Isaac and R. Ramakumar

which have been characterized by many as fiscally ‘better managed’, have also exhibited a falling trend in the expenditure to GDP ratio. There are, of course, many state-specific factors that would have to be considered, but a factor common to almost all the state governments is the compulsion, set by the FRBM Acts, to eliminate revenue deficits by 2008–09. A discussion on the FRBM Acts and their implications for expenditure of states is attempted in the next section.

III FRBM Acts and expenditure contraction State Finances: The Genesis of the Crisis

The FRBM Acts were the neoliberal response to the fiscal crisis of the state in the latter part of the 1990s. The roots of the crisis in state finances in India have to be traced to the post-independence evolution of Centre-State economic relations. Nevertheless, the present deterioration in state finances began in the mid-1980s when states as a whole started recording revenue deficits. This period also marked the end of the era of low and administered interest rates. The interest rates sharply increased thereafter, but as Chaudhury (2000) has pointed out, its impact was masked by the presence of pre-existing cheap debt that the states had availed. From the latter half of the 1990s, the high cost debts incurred since the mid-1980s took their toll on the interest burden of states and started a process of debt escalation. The earlier policy of the cancellation of part of states’ debts by Finance Commissions was given up by then. The severe imbalance in state finances in 1980s and 1990s has been the topic for many scholarly enquiries (Bagchi, Bajaj and Byrd, 1992; Rao, 1992; Kurian, 1999; Chaudhury, 2000; Vithal and Sastry, 2001; Rao, 2002; EPWRF, 2004). The role of the central government was critical in the process of deterioration of state finances. The rates of interest on borrowings 190

Challenges to Fiscal Policy in India in the Era of Reforms

of states were sharply increased after the mid-1980s, and especially so after 1990–91 (Table 6.6). The coupon rates of state government securities were raised sharply by the RBI from 1990–91 onwards. The weighted average of coupon rates, which was 11.5 per cent in 1990–91, reached its historic peak of 14 per cent in 1995–96. In the same period, the interest rates on small saving borrowings by states also increased from 13 per cent in 1990–91 to 14.5 per cent in 1992–93, and remained stable till 1997–98. These rates of interests that the states had to pay were clearly usurious, much higher than the growth rate of the GDP and thus, a sure recipe for a financial disaster. Even though the interest rates started falling thereafter, the financial burden that these periods of high rates of interest placed on state finances was significant. The interest payments of Table 6.6:â•… Key Interest Rates on State government Borrowings from the Centre and the Market, 1990–91 to 2005–06 (in Per cent Per Annum)

Year 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08

Coupon rates on state Interest rates on small Interest rates on plan government securities savings borrowings by and non-plan loans (weighted average) states from the centre 11.5 11.8 13.0 13.5 12.5 14.0 13.8 12.8 12.4 11.9 11.0 9.2 7.5 6.1 6.4 7.6 8.1 8.3

13.0 13.5 14.5 14.5 14.5 14.5 14.5 14.5 14.0 13.5 12.5 11.0 10.5 9.5 9.5 9.5 9.5 9.5

Sources: EPWRF (2004); RBI (2005c); RBI (2005d); RBI (2006).

191

10.3 10.8 11.8 12.0 12.0 13.0 13.0 13.0 12.5 – – – – – – – – –

T. M. Thomas Isaac and R. Ramakumar

states increased from `8,655 crore in 1990–91 to `21,932 crore in 1995–96 and `62,489 crore in 2001–02. As a ratio to total revenue receipts, these interest payments amounted to 13 per cent in 1990–91, 16 per cent in 1995–96 and 24 per cent in 2001–02. In the period in which the Centre was raising the rates of interest on states’ borrowings, the rates of interest on the Centre’s borrowings were not only lower in levels, but were also rising at a much slower rate (Figure 6.3). The result was that the differential between the rates of interest faced by the Centre and the states widened significantly in the 1990s, which has continued into the 2000s (Chandrasekhar and Ghosh, 2005a; EPWRF, 2004). In fact, the differential in every year in the 2000s was higher than the differential for any year between 1980 and 2000. The average rate of interest of states’ borrowings was above 10 per cent even in 2004, while that of the Centre had dipped below 7 per cent. In 1997–98, there was another shock to state finances when the recommendations of the Fifth Pay Commission were implemented. Figure 6.3:â•…Average Rates of Interest on the Liabilities of the Centre and All States, 1980 to 2004, Per cent Per Annum

Source: Chandrasekhar and Ghosh (2005a).

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Challenges to Fiscal Policy in India in the Era of Reforms

This measure sharply raised the levels of revenue deficit of states from 1997–98 onwards. In just one year, the revenue deficit of states more than doubled—from 1.1 per cent in 1997–98 to 2.5â•¯per cent in 1998–99. While we do not wish to neglect other factors, the rise in interest burden and higher salary payments constitute the two most prominent factors responsible for the deterioration of state finances. The outcome of these two factors was a sharp rise in the debt burden of states. As a ratio to GDP, the total outstanding liabilities of states increased from 21 per cent in March 1997 to 26.1 per cent in March 2000 and 32.6 per cent in March 2006 (Figure 6.4). These changes are clearly visible when we analyze the long term trends in the levels of revenue deficit and fiscal deficit of all states (Figure 6.5). Through the 1970s, states as a whole were enjoying a revenue surplus. It was only by the late 1980s that the revenue account of states fell into deficit. The revenue deficit increased gradually between 1986–87 and 1997–98, and thereafter increased sharply till 1999–2000. Interestingly, the fiscal deficit of all states was rarely above 3 per cent till 1997–98. However, driven by the rise in the revenue deficit, the fiscal deficit of states rose sharply after 1997–98. The Introduction of FRBM Acts

It was in this context that the FRBM Bill was introduced in the Parliament in 2000. The Task Force appointed by the government on the FRBM Act noted: The gravity of the situation, and the multi-year process of debate and discussion, led to a far-sighted response. All political parties voted in favour of the Fiscal Responsibility and Budgetary Management Act 2003… It is the deeply held view of the Task Force that their implementation will reshape our destiny, and take India to a commanding position in the world economy (GoI, 2004: 13).

193

Sources: RBI Bulletin; State Finances: A Study of State Budgets, Reserve Bank of India, various issues.

Figure 6.4:â•…Total Outstanding Liabilities of All Indian States as Per cent of GDP, 1991 to 2008, as on end-March (in Per cent)

Sources: Ministry of Finance (2006); RBI (2006).

Figure 6.5:â•… Revenue Deficit and Fiscal Deficit of States, 1970–71 to 2007–08 (as Per cent of GDP)

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It was thus firmly believed in the neoliberal circles, exemplified by the report of the Task Force, that ‘there is an innate synergy between acceleration of GDP growth and fiscal consolidation’ (GoI, 2004). As the first step, the government appointed the E. A. S. Sarma Committee to prepare a draft of the legislation; this Committee submitted its report in July 2000. The FRBM Act was passed by the Lok Sabha on 7 May 2003 and by the Rajya Sabha on 29 July 2003. The Bill was passed by a voice vote, and not unanimously, as the Task Force erroneously claimed. Members from the Left parties had raised their serious objections to the provisions in the Bill (Ray, 2003). The Bill was notified as an Act on 26 August 2003. In this version of the Act, the government had to eliminate the revenue deficit to zero by 2005–06. In Julyâ•¯2004, the Act was amended to postpone the year of elimination of revenue deficit to 2008–09. In February 2004, the Task Force was appointed by the government to ‘draw up the medium term framework for fiscal policies to achieve the FRBM objectives’, and ‘also formulate the annual targets indicating the path of adjustment and required policy measures’ (GoI, 2004: 201). Introducing its projections on fiscal consolidation, the Task Force noted that ‘states finances would obtain an enormous boost under the proposals of this report’ (ibid.: 11). Concurrently, the Centre was also forcing the hands of the states to pass similar Acts in their state assemblies. The Finance Commissions chose to have a narrow definition of ‘constitutional transfers’ to mean only the divisible pool. The other grants and benefits were held to be over and above the ‘constitutional transfers’ and thus could be tied to specific conditions. For the first time, the Eleventh Finance Commission started the process of linking resource transfers and other benefits from the Centre to fiscal consolidation by states. The passage of the FRBM Acts at the state-level became an indicator of the progress achieved by states in fiscal consolidation. states were asked to model their legislations on the legislation prepared by the Centre. Karnataka was the first state in India to pass an FRBM Act in August 2002. Kerala, Tamil Nadu and Punjab followed suit in 2003. Uttar Pradesh passed its legislation in 2004. 196

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Most other state governments passed their FRBM Acts in 2005 and 2006. In 2007, Jharkhand passed its FRBM Act. By 2007, 27 states had passed FRBM Acts (Table 6.7). Table 6.7:â•… Year of Passing of State FRBM Acts and the Proposed Year of Elimination of Revenue Deficits, India Year of passage of FRBM Act 2002 2003 2004 2005

Proposed year of elimination of Revenue Deficits 2006

2007

2008

2009

2010

Other/special cases

Karnataka Kerala

2006

2007

Tamil Nadu Uttar Pradesh Assam Gujarat Orissa, Maharashtra, Rajasthan, Haryana, Chhattisgarh, Madhya Pradesh, Andhra Pradesh and Uttarakhand Bihar, Mizoram, Arunachal Pradesh, Goa and Meghalaya Jharkhand

Punjab Andhra Pradesh, Himachal Pradesh, Tripura, Manipur, Nagaland Jammu and Kashmir

Source: RBI (2005a, 2008).

The hurried passage of these legislations by most states in 2005 and 2006 had to do with the conditionalities put forward by the Twelfth Finance Commission (TFC). states had to pass the FRBM Act in 2005 itself to take advantage of the debt waiver scheme offered by the TFC. The main elements of the FRBM Acts passed by the states were the following: 1. Two to 3 per cent target for fiscal deficit to be achieved by 2005–06 to 2010–11. 2. Elimination of revenue deficit by around the same time. 3. Limits to state government guarantees on debt. 4. Limits to overall liabilities that could be incurred. 197

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5. Formulation of a medium-term fiscal plan to reach these targets. 6. Institution of a complaint redressal mechanism. The specific point of our interest in this paper is the targets for revenue deficit, which are summarized in Table 6.7. The surprising rapidity with which FRBM Acts were passed by the states is an issue that requires some examination by political scientists. Vouching from the personal experience of one of the authors of this paper, most legislators in states knew pretty nothing about what they were passing. The legislature in Kerala, in a fit of reform fury, determined a 2 per cent ceiling for fiscal deficit by 2006–07. This was later de facto amended, but the fact that any political leadership could even propose a 2 per cent ceiling for fiscal deficit is indeed intriguing. The key players in this process were the bureaucracy of the state governments, who had so totally internalized the neoliberal reform rhetoric. How else could one explain the proposal of a 2 per cent ceiling for fiscal deficit? The Role of the Finance Commissions

There have been a number of criticisms on the TFC exceeding its constitutional brief in proposing conditionalities on central transfers. The Constitution of India has defined the role of the Finance Commissions as to make recommendations on ‘the distribution between the Union and the states of the net proceeds of taxes’ and set ‘principles which should govern the grants-in-aid of the revenues of the states out of the Consolidated Fund of India’. In other words, the Commissions were supposed to act as a neutral umpire to fix the levels of transfer of resources from the Centre to states as well as the distribution of these transferred resources across states. However, in the recent years, extra-constitutional powers have been given to the Finance Commissions through the issue of additional terms of reference by the central government. These powers were provided to the Commission in order to tune their reports to 198

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dovetail the policies of the central government. For instance, the terms of reference of the Eleventh Finance Commission (EFC) included the mandate to ‘draw a monitorable fiscal reforms programme aimed at reduction of revenue deficit of the states and recommend the manner in which grants to States…may be linked to progress in implementing this programme’. In fact, under Article 275 of the Constitution, the Finance Commissions have no powers to impose conditionalities on resource transfers to states. According to the report of the EFC, 15 per cent of the revenue deficit grants were explicitly linked to the progress achieved in the implementation of the fiscal reforms programme (that even included a forced reduction of subsidies and privatization of the power sector). The TFC had similar terms of reference, including the mandate to: [R]eview the state of the finances of the Union and the States and suggest a plan by which the governments, collectively and severally, may bring about a restructuring of the public finances [by] restoring budgetary balance [and] achieving macro-economic stability and debt reduction along with equitable growth. (GoI, 2005)

The TFC was also given powers to ‘review the Fiscal Reform Facility introduced by the central government on the basis of the recommendations of the Eleventh Finance Commission, and suggest measures for effective achievement of its objectives’. The TFC recommended a fiscal restructuring plan in its report, according to which (a) the revenue deficit had to be eliminated by 2008–09; (b) the fiscal deficit had to be brought down to 3 per cent in 2008–09 and (c) annual targets were set for the reduction of revenue deficit and fiscal deficit (0.4 percentage points for the revenue deficit and 0.3 percentage points for the fiscal deficit for all states put together). Each state had to enact a fiscal responsibility legislation to this effect. The TFC, in order to address the rising debt burden of states, also recommended a general scheme of debt relief and a loan write-off scheme. As per the general scheme, all loans from the Centre (excluding the high-cost loans under NSSF) 199

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were to be consolidated and a uniform interest of 7.5 per cent charged on them. Under the loan write-off scheme, repayments on loans from the Centre between 2005–06 and 2009–10 were to be written off, with the quantum of write-off linked to the absolute amount of reduction of revenue deficit of the state in each successive year as well as the containment of the fiscal deficit at the level of 2004–05. The benefits of both these schemes were to be made available to only those states that had passed fiscal responsibility legislations. Such has been the environment generated by the neoliberal reformers that few states are willing to break the rules. The West Bengal government has refused to pass an FRBM Act. The new government of Kerala, in its revised budget for 2006–07, has declared that its FRBM Act would be amended. Nevertheless, as can be seen from Figure 6.5, state governments on the whole have been moving fast to meet the targets set by FRBM Acts and the TFC. The revenue deficit for all states has declined from 2.9 per cent of the GDP in 1999–2000 to 0.7 per cent of the GDP in 2005–06. As we have seen already, this contraction has been achieved mainly by cutting important social sector expenditures. The states are thus set to reach the target of elimination of revenue deficit by 2009. Same is the case with respect to the fiscal deficit; it declined from 4.7 per cent of the GDP in 1999–2000 to 3.2 per cent in 2005–06 (Figure 6.5). Economists from the Left have been the most consistent critics of the central policies of framing legislations to cap revenue and fiscal deficits (Chandrasekhar and Ghosh, 2000, 2001, 2005a, 2005b; Patnaik, 2000, 2001). More recently, the Union Planning Commission had also underlined the adverse implications of continuing with the FRBM Acts (GoI, 2006). The Planning Commission, in its attempt to have ‘faster’ but ‘more inclusive’ growth in the Eleventh Five Year Plan, had outlined a strategy that includes a number of new initiatives, such as the expansion of school education, programmes for provision of health care, drinking water, rural infrastructure and schemes for ‘bridging the divides’. In the approach paper to the Eleventh Plan, the Commission noted that 200

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‘the very thrust of the approach to the 11th Plan…may be defeated if the FRBM discipline is insisted upon’ (GoI, 2006). The approach paper also noted that state governments would have no option but to postpone capital investments as they have a double bind—apart from being forced by the FRBM Acts to cut fiscal deficits, they are also bound by the much stiffer targets set by the TFC that has linked such adjustments to resource transfers. The International Experience with Fiscal Responsibility Legislations

It may be useful here to look at the experience of countries that have passed and implemented fiscal responsibility legislations. In the Unites States, the ‘Gramm-Rudman-Hollings Act’ of 1985 and 1987 has been amended many times to incorporate clauses that allow the government to raise deficits. In the European Union, the ‘Growth and Stability Pact’ was adopted to enforce budgetary discipline among all countries using the Euro. Germany was the main mover behind the introduction of the Pact. The irrationality of the Pact was soon understood by Germany itself, when Germany and France passed through a major economic recession in the early 2000s. For four years in succession from 2002, Germany broke the ceiling of 3â•¯per cent set by the Pact for budget deficits. As on 2005, six of the 12 Euro-area countries were facing procedural action under Article 104 of the EC Treaty for excessive deficits (Zeitler, 2005). In seven countries, the consolidated gross debt ratio in 2004 was above the 60â•¯per cent reference value for debts (ibid.). There has been a spate of election defeats in Europe, reflecting the public anger, for governments that have tried to cut social sector spending to respect the deficit ceilings set by the Pact. Joseph Stiglitz remarked thus in a speech criticizing the Growth and Stability Pact: The good news for economic theory is that the insights of Keynes have been verified over and over again. The bad news is that the countries where these experiments [of fiscal adjustment] have been tried have suffered enormously. The problem in Europe is that many of these 201

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mistaken ideas have been converted into rules and institutions; the ‘Growth and Stability Pact’ which should really be called the ‘NonGrowth and Instability Pact’ has tied Europe’s hands. The head of the EU, Prodi, was very forceful in describing this particular idea—I think the word he used was ‘stupid’—it may not be an elegant description but I think it was an accurate description of the notion.3

The series of fiscal stimulus packages announced by the G-20 countries, as noted in the beginning, has again raised the levels of fiscal deficits in these countries beyond the levels mandated by their respective fiscal responsibility legislations. ‘Sound finance’ as a concept has been dumped in the developed world itself.

IV Summing up

Public expenditure by states on social and economic services, a crucial necessity for fulfilling the basic needs of people, is low in India by any standard and needs urgent enhancement. However, in the 1990s and 2000s, the ratio of expenditure by all states to the GDP has declined. At the same time, all states together have an investment outstanding of over ` 70,443 crore in the treasury bills of the Centre. Why do the states not spend this money? The dominant argument by the central government has been that states are ‘unable to spend’ because they do not have the ‘absorptive capacity’. Our position in this paper has been that this is a false and misleading argument. States do not spend because there are legal constraints on spending. The Finance Ministry and the successive Finance Commissions Stiglitz’s speech is available at http://www.europarl.europa.eu/sides/getDoc. do?pubRef=//EP//TEXT+CRE+20021021+ITEM-004+DOC+XML+V0// EN&language=MT (accessed on 31 January 2007). The exact quote from the then EU Commission President Romano Prodi in October 2002 was: ‘I know very well that the Stability and Growth Pact is stupid… The pact is imperfect. We need a more intelligent tool and more flexibility.’ 3

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have forced the states to pass fiscal responsibility legislations in their Assemblies. As per these legislations, states have to eliminate the revenue deficit and reduce the fiscal deficit to 3 per cent of the GSDP by 2008–09. In line with these targets, the revenue deficit and fiscal deficit of states declined sharply in the 2000s. This decline in deficit was achieved by compressing the expenditure to GDP ratio, even while there was an increase in receipts to GDP ratio of states. The states could have raised revenue expenditures by making use of the increased receipts, and still kept the revenue deficit constant. This, however, would have been contrary to the targets set for the elimination of revenue deficit by 2008–09. Even the increased capital receipts—in the form of NSSF borrowings—were not routed to revenue expenditures because of the fear of rising revenue deficit. The cash surplus phenomenon, thus, is a perverse outcome of the FRBM Acts. Fulfilling any commitment to raising public expenditure in India requires more flexibility in the FRBM Act provisions. Demands for more flexibility are also fully endorsed by international experiences with fiscal responsibility legislations. As we have argued, the FRBM Act has to go off the rulebook or be drastically amended. This demand is today in the centre stage of Centre-State relations in India. References Bagchi, Amaresh, J. L. Bajaj and William A. Byrd (eds). 1992. State Finances in India. New Delhi: Vikas Publishing House. Chandrasekhar, C. P. and Jayati Ghosh. 2000. The Market that Failed. New Delhi: LeftWord. Chandrasekhar, C. P. and Jayati Ghosh. 2001. ‘Fiscal Responsibility—To Whom?’. Available online at www.macroscan.com (accessed on 31 January 2007). Chandrasekhar, C. P. and Jayati Ghosh. 2005a. ‘The Crisis of State Government Debt’. Available online at www.macroscan.com (accessed on 31 January 2007). Chandrasekhar, C. P. and Jayati Ghosh. 2005b. ‘The Death of Fiscal Federalism’. Available online at www.macroscan.com (accessed on 31 January 2007).

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Chaudhury, Saumitra. 2000. ‘State Government Finances’, Money and Finance, ICRA Bulletin, 2 (1) May–June: 34–51. Chidambaram, P. 2006. ‘Intervention During the Combined Discussion on the Budget for 2006–07, Supplementary Demands for Grants for 2005–06 and Demands for Excess Grants for 2003–04, XIV’, Lok Sabha, New Delhi. Economic and Political Weekly Research Foundation. 2004. ‘Finances of State Governments: Deteriorating Fiscal Management’, Economic and Political Weekly, Special Statistics: 37, 39 (18) May 1–7: 1841–57. George, K. K. 1999. Limits to the Kerala Model of Development. Trivandrum: Centre for Development Studies. Government of India. 2004. Report of Task Force on Implementation of the FRBM Act. Report submitted to the Ministry of Finance, July, New Delhi. Government of India. 2005. Report of the Twelfth Finance Commission, Ministry of Finance, New Delhi. Government of India. 2006. Towards Faster and More Inclusive Growth: An Approach to the 11th Five Year Plan, Planning Commission, June, New Delhi. Kurian, N. J. 1999. ‘State Government Finances: A Survey of Recent Trends’, Economic and Political Weekly, XXXIV (19): 1115–25. Ministry of Finance. 2006. ‘Note for the Third Meeting of the Consultative Committee Attached to the Ministry of Finance’, Government of India, New Delhi. Mohan, R. and D. Shyjan. 2005. ‘Taxing Powers and Developmental Role of the Indian States: A Study with Reference to Kerala’, Working paper no 375, Centre for Development Studies, Trivandrum. Patnaik, Prabhat. 2000. ‘On Some Common Macroeconomic Fallacies’, Economic and Political Weekly, 35 (15) April 8–14: 1220–22. Patnaik, Prabhat. 2001. ‘On Fiscal Deficits and Real Interest Rates’, Economic and Political Weekly, 36 (14–15) April 14–20: 1220–22. Rao, M. Govinda. 1992. ‘A Proposal for State-level Budgetary Reforms’, Working paper 19, National Institute of Public Finance and Policy, New Delhi. Rao, M. Govinda. 2002. ‘State Finances in India: Issues and Challenges’, Economic and Political Weekly, XXXVII (31): 3261–85. Ray, Subhas. 2003. ‘The Week in Parliament’, People’s Democracy, August 10, 27 (32). Reserve Bank of India. 2005a. State Finances: A Study of Budgets of 2005–06, December, Mumbai. Reserve Bank of India. 2005b. Report on the Advisory Committee on Ways and Means Advances to State Governments, Chair: M. P. Bezbaruah, October, Mumbai. Reserve Bank of India. 2005c. Annual Report 2004–05, August, Mumbai.

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Reserve Bank of India. 2005d. Handbook of Statistics on the Indian Economy 2004–05, September, Mumbai. Reserve Bank of India. 2006. Annual Report 2005–06, September, Mumbai. Reserve Bank of India. 2008. Annual Report 2007–08, September, Mumbai. Vithal, B. P. R. and M. L. Sastry. 2001. Fiscal Federalism in India. New Delhi: Oxford University Press. Zeitler, Franz-Christoph. 2005. ‘What remains of the Stability and Growth Pact?’, speech presented at the Executive Board of the Deutsche Bundesbank, Salzburg Seminar, Salzburg, 26 August.

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7 Fiscal Devolution in the Era of Liberalization The Indian Experience Jayati Ghosh

Because India has a federal system of government—and indeed, because the very survival of the polity probably requires a more open and pronounced acceptance of such federalism—it is important that this be reflected in economic decision making. The Constitution of India recognizes this basic fact, which is why there is such a detailed listing of the powers and responsibilities of the central and state governments respectively, with separate and concurrent lists. Under the Constitution, state governments have always had very significant responsibilities for maintaining law and order, ensuring infrastructure development, providing public services for health, education, agriculture, sanitation—to name just a few. However, at the same time the state governments have not had commensurate powers either to raise resources or to influence broader trends that create the context or enabling conditions for fulfilling these responsibilities. This is why the fundamental fiscal difference between Centre and states—that state governments face a hard budget constraint unlike the central government—is so important. This obviously puts direct limits upon the capacity of state governments to fulfil even their constitutional responsibilities towards their citizens. 206

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This in turn creates further areas of decision, because the pattern of revenue sharing between Centre and states must necessarily evolve as the economic context itself changes. This is why there are periodic Finance Commissions which are empowered to suggest guidelines for such revenue sharing. The statutory job of the Finance Commissions is usually twofold: to determine the principles for the distribution of the net proceeds of shared tax revenues between the Centre and the states; and to provide for revenue deficit grants from the Centre to those states whose normative expenditures are likely to exceed normative revenue. However, successive Finance Commissions have failed to achieve this. And a substantial part of the problem is that the Centre itself has failed on the revenue mobilization front, especially since the early 1990s, such that central transfers to the states have been falling as a share of Gross Domestic Product (GDP). More recently, the central government has taken it upon itself to extend the terms of reference of Finance Commissions to cover issues of fiscal sustainability. The terms of reference of recent Finance Commissions have therefore gone beyond the simple allocation of tax revenues between the Centre and different states according to a given formula, to allowing and even proposing conditional transfers, even if this goes against the basic principle of federal devolution. Thus the Twelfth Finance Commission suggested a plan for restructuring the debt of state governments, which involved such stringent conditionalities that the basic tenets of fiscal federalism were violated. Implications of the Twelfth Finance Commission’s Report

The most stringent and egregious condition imposed by the Twelfth Finance Commission was the requirement that states enact fiscal responsibility legislation as a precondition for availing of debt relief. Even the nature of such legislation was specified, with the following features deemed to be necessary for all states: 207

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Eliminating the revenue deficit by 2008–09. l Reducing the fiscal deficit to 3 per cent of Gross State Domestic Product (GSDP) or its equivalent defined as a ratio of interest payments to revenue receipts. l Bringing out annual reduction targets of revenue and fiscal deficits. l

In addition, the Twelfth Finance Commission also stated that ‘States should follow a recruitment and wage policy, in a manner such that the total salary bill relative to revenue expenditure net of interest payments and pensions does not exceed 35 per cent.’ It further demanded the reduction of the public sector: ‘In the period of restructuring, that is 2005–10, state governments should draw up a programme that includes closure of almost all loss making SLPEs (state level public enterprises).’ The problems with these arbitrary limits to revenue and fiscal deficits are now well known across the world and have also become evident in India, consequent upon the enactment of the national level fiscal responsibility legislation. These rigid numerical constraints are not just awkward and unnecessary but also procyclical, since they operate to intensify and prolong slumps and even convert them into depressions. They are also foolish, since they can prevent important and socially necessary public expenditure which is required to improve current welfare and future growth prospects. There is no reason to keep capital expenditure within some predetermined numerical limit, since even debt sustainability depends on the relation between the interest rate and anticipated return from public investment. Clearly, any level of debt-financed capital investment that generates a rate of return that is higher than the rate of interest is sustainable. So restricting capital account deficits to 3 per cent of GSDP makes little sense. Even if the anticipated monetary rate of return is lower than the rate of interest, as long as the social rate of return is higher there is still a case for such spending, financed by future taxes. Requiring the states to keep the salary bill within a prespecified limit, and demanding the closure of loss-making public enterprises, ignores the social role that can 208

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be played by public employees and even loss-making public enterprises that fulfil some social functions. At the central government level, one response to this legislation has simply been to circumvent it, by effectively moving a range of expenditures ‘off-budget’ and this concealing the amount of the true fiscal and revenue deficits. This sleight-of-hand, made necessary by the excessively rigid legislation, has led to the central public finances becoming more opaque and less transparent to the public at large. For example, the fiscal deficit in 2008–09 is estimated to be less than 3 per cent of GDP, but the off-budget spending will add at least another 3 per cent of GDP! But this much larger public sector borrowing requirement of the central government turn has also exposed the mistaken nature of the economic philosophy under-pinning such legislation, which is that large public deficits are necessarily inflationary and/or involve large balance of payments deficits. However, while the economic idea behind such legislation may be invalid for both Centre and states, for state governments the problem cannot be so easily dealt with by simply moving items off budget. State governments are therefore forced into the same neoliberal economic policy straitjacket that the Centre has chosen to function within. They have been effectively prevented from exercising their own options with respect to how much revenue and capital spending they can undertake; they have therefore been limited in terms of how many people they can employ even in essential and necessary public and developmental services; they are forced to close down loss-making state-owned enterprises even if these are contributing to the public good; in the absence of other resources, they are forced to turn directly to market borrowing or access loans from multilateral institutions that also carry similar conditionalities. These problems are compounded by the fact that state governments’ powers to raise resources are constrained by the distribution of revenue-generating powers between Centre and states, in the context of the changing composition of national income. State governments are empowered to impose only certain taxes, most 209

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importantly sales taxes, and cannot impose their own taxes upon incomes including from services. It is worth noting in this context that the revenue raising capacity of the states is limited, more so since the Centre has taken upon itself all power to tax service sector incomes, which are likely to be the most buoyant source of tax revenues in future given the growing share of services in GDP. If revenue deficits are to be progressively reduced and brought down to zero, this necessarily means that revenue expenditures will have to be cut. In most states, by far the largest item of expenditure on the revenue account is in fact that for salaries. It is completely wrong to see these as unnecessary or unproductive expenditures, since these are for those who are to provide the important public services that everyone acknowledges to be essential. Since state governments are responsible for almost all of the expenditures that affect the quality of life of ordinary citizens on the ground, from infrastructure and sanitation to health and education, preventing expenditure on wages and salaries for those who would perform these functions is bizarre in the extreme. So the pattern of fiscal devolution from Centre to states is of the utmost significance for most developmental issues as well as basic socio-economic rights of the citizens in the country as a whole. Recent Patterns of Fiscal Devolution

In this context, what is the current situation with respect to the fiscal health of states and financial devolution? Figure 7.1 describes the pattern of deficit among all state governments taken together. It is evident that the severe fiscal crisis of the states that was so marked in the early years of this decade is no longer as pervasive. All the major deficit indicators have been declining since 2004, and the revenue and primary deficits are now close to zero for the states as a whole. Even the fiscal deficit total is under 3 per cent of GDP. It is generally supposed that this improved fiscal health is the result of the Twelfth Finance Commission’s award, which is perceived to have substantially increased grants to states and also 210

Fiscal Devolution in the Era of Liberalization Figure 7.1:â•… Deficit Indicators of All State Governments (as Per cent of GDP)

Source: RBI, Report on State Finances: A Study of Budgets, 2009–10.

allowed some debt write-off to those states that agreed to pass the controversial fiscal responsbility legislation. It was expected that this would increase the ability of state governments to raise captial resources through borrowing. However, Figure 7.2 indicates that such a conclusion is not justified. In fact, the significant increase has been in tax receipts of the state governments themselves, which in 2006–07 accounted for more than 55 per cent of their total fiscal resources. The share in central taxes has remained small and has shown hardly any increase as a proportion of total receipts. Even all non-tax receipts (which include grants from the Centre as the biggest chunk) have not increased very much and remain at less than a quarter of total receipts. It is worth noting that the share of capital receipts has declined very sharply in recent years, in direct contradication of the expectation following the debt relief package for states. The relatively low and even declining share of central taxes is confirmed by the evidence on the states’ share of central taxes as a 211

Jayati Ghosh Figure 7.2:â•…Composition of Total Receipts of State Governments (Per cent)

Source: RBI, Report on State Finances: A Study of Budgets, 2009–10.

proportion of the total central tax collection. Figure 7.3 shows that this has been declining since the most recent peak of 2001–02, and that the average of the last three years (2004–05 to 2006–07) is well below the average of the three-year period of a decade earlier. All the state governments taken together currently receive just around one quarter of central tax revenues, even though they are directly responsible for most of the public service delivery that directly affects the lives of people. What of the total financial devolution, that is, including grants and all other mechanisms? In current nominal terms that has certainly been rising, as indicated by Figure 7.4 which shows the nominal rate of growth on the right hand scale. However, as share of GDP of states they have been mostly stagnant in the recent period, and indicate some evidence of medium-term decline compared to the early 1990s. 212

Source: RBI, Report on State Finances: A Study of Budgets, 2009–10.

Figure 7.3:â•…States’ Share of Total Tax Revenues of Centre (Per cent)

Source: RBI, Report on State Finances: A Study of Budgets, 2009–10.

Year

Figure 7.4:â•… Gross Devolution from Centre to States

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It was noted earlier that capital receipts had been declining as a percentage of total state governments’ receipts, and stood at only 21 per cent in 2006–07. Within this, however, the share of market borrowings increased, as evident from Figure 7.5 which examines the nature of financing the fiscal deficit for all states. In the last three years described here there has also been a sharp increase in use of small savings (the NSSF or National Small Savings Fund) which reflects the shift in personal savings away from bank deposits to small savings because of interest rate differentials. This of course means that state governments have had to pay relatively higher rates of interest on borrowing even in the period of lower interest rates on average, but at least they automatically receive most of these funds. More recent evidence relating to 2007–08 suggests that this source of resources was not forthcoming last year, which has had an adverse impact on some states in particular. Meanwhile, loans from the central government have declined to the point of irrelevance. It is sometimes believed that grant funds, which are noninterest bearing and supposedly untied, allow a greater degree of comfort and flexibility to states, and indeed the Twelfth Finance Figure 7.5:â•…Sources of Financing Fiscal Deficit of States (Per cent of States’ GDP)

Source: RBI, Report on State Finances: A Study of Budgets, 2009–10.

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Commission put more emphasis on grants for those reasons, as well as because of the perceived decline in aggregate tax–GDP ratios. However, a substantial proportion of the grants provided to the states come in the form of central Schemes and Centrally Sponsored Schemes (CSSs). Figure 7.6 shows that not only are these significant, but they have also been increasing as a proportion of total grants in the recent period. Figure 7.6:â•…Central Schemes as Per cent of Total Grants to States

Source: Compiled from the State Finances: A Study of Budgets 2007–08.

Problems with Grants from the Centre

Strictly speaking, transfers for central schemes should not be included in such grants at all or even counted as part of devolved resources, since they reflect central government expenditure that is simply administered by states, with absolutely no freedom of manoeuvre for the administering authority. Such central schemes now account for nearly 5 per cent of grants made to states. However, CSSs are also problematic since they are completely determined by the Centre, in terms of content, structure, format and process. State governments have little control over them in either design or implementation, and the excessively centralized and rigid 216

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format of most of these schemes makes them often ill-suited to the particular requirements of different states, but state governments can do little about this. Further, CSSs typically require matching expenditure by states, of varying proportions according to Scheme, which puts budgetary pressure on states to provide resources for projects and schemes over which they have no control in terms of design or prioritization. For all the talk of decentralization, this actually amounts to a greater centralization of government finances. This is made much worse by the recent tendency for all central allocations to states to be covered by conditionalities, even if they are egregious or unsuitable to the state in question, or simply not desired by the political economy configurations in that state. An important case in point is the manner of transfer of funds under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM). Municipalities that wish to avail of these funds for urban reconstruction and necessary infrastructure are forced to implement various conditions, which are not only too rigid but also amount to an enforcement of a particular approach to economic policy without allowing for any variation. One of the most problematic measures required is the elimination of stamp duty by recipient state governments. In several cases, this means that the state government can lose more in the form of foregone stamp duty revenues than it receives in the form of JNNURM transfers. Similarly, JNNURM requires the imposition of user charges for various utilities and necessary services, which can have a very adverse impact on the incomes and access to such services of the urban poor. There is no allowance of other approaches that put a greater emphasis on cross-subsidization or ensuring free or low-priced basic services to be funded by taxation. Thus, the Centre’s own current market-oriented and privatizing approach is sought to be imposed upon the state governments irrespective of their own constraints, requirements or desires. It is often argued that these are technocratic requirements that should be divorced from political exigencies and that therefore it is just as well that such conditions are uniformly imposed on all state governments regardless of politics. However, such an argument is 217

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fundamentally fallacious. All economic policies that have a distributive implication (which certainly includes such decisions as taxation, pricing of public utilities and services, privatization and resource allocation) are necessarily also political in content, and what may appear to be ‘apolitical’ decisions are essentially implicit political choices made in favour of or against particular groups in society. To continue with the same example, a reduction or elimination of stamp duty disproportionately benefits those involved in large-scale asset transactions, who are obviously the richer groups, while the imposition of higher user charges for essential public services disproportionately hurts the poor who use these services. Therefore this is not a simple technocratic measure devoid of political content; rather, it is a clear distributive policy choice in favour of the rich and against the poor. To impose this upon all state governments regardless of the internal political and policy choices of each state is not only unfair and unjust but also contrary to the basic principles of federalism. Another problem with CSSs, even when they do not impose the same type of undesirable conditionalities, is that they are often extremely rigid and inflexible in design and in manner of provision of funds. This can reduce the effectiveness of the resources because they cannot be used flexibly according to different contexts. This can also mean that in some cases the resources are simply not used at all or not used to the full extent, leading to significant underutilization of the available funds in several CSSs. An important example of this is the experience with the Sarva Shiksha Abhiyan (SSA). Some of these problems with the way funds are transferred to states under the SSA include: Very rigid norms on unit costs and on what is allowed in terms of spending, which do not recognize the diverse requirements of different states or of particular regions. l Inadequate financial provisions for infrastructure such as buildings, etc., especially for some states and cities, which leads to the creation of poor quality infrastructure. l

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An inflexible accounting system that does not allow transferring funds across heads to meet particular or changing requirements, and therefore inhibits full utilization and also prevents synergies from developing. l Insufficient allocation for repair and maintenance of infrastructure. l Treating rural and urban schools in the same manner even though the requirements are often very different (e.g., urban government schools may require different infrastructure and facilities in order to attract students). l Treating all districts and geographical areas in the same manner regardless of the degree of backwardness, topographical conditions, etc. (this is especially a problem for schools in hilly or heavily forested areas or those with poor physical connectivity, for which per capita allocations are the same as for other more accessible areas). l Problems in the timing of fund transfer, as well as uncertainties in fund provision created by the insistence on matching funds and the fact that plan ceilings keep changing every year. l

Therefore, in SSA as well as in a number of other CSSs, the current system of funds transfer and the accounting rules create unnecessary rigidities that often do not allow the state governments to use the money in the most efficient or desirable way, and also lead to less than complete utilization of the budgetary allocation. Another attempt to undermine federalism and the authority of elected state governments comes in the arguments for fiscal provisions by the Centre directly to panchayats at district level. With norms for expenditure determined by the Centre, as well as ‘capacity building’ of panchayat members by the Centre, this amounts to an extremely centralized notion of decentralization, where the real decisions are made at the very top of national government rather than being delegated to states and then to panchayats. The tendency is for a department in New Delhi to decide the pattern of decisionmaking at the district panchayat level, rather than allowing state 219

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governments the freedom to create an overall context within which panchayats themselves will function, and allowing panchayats in each state to reflect the socio-economic realities of that state. It is ironic—but also alarming—that the social and political fallout of such apparently ‘technocratic’ decisions is not recognized. Depriving people of necessary public services and reducing the possibilities of sustained development are not only likely to make those at the helm of particular state governments unpopular, but are also likely to increase disaffection with the entire national, supposedly federalist system and thereby encourage extremely dangerous separatist tendencies. Further, since such budgetary limits are strongly procyclical, they tend to sharpen and prolong periods of slump or economic depression. Obviously, that makes such policies even less popular among the general public. This is not idle speculation: across the world there is wide-spread public reaction to the effects—in terms of reduced public spending on necessary infrastructure and social services—of governments trying to conform to what have turned out to be irrational and economically unnecessary fiscal guidelines of the sort that are now being sought to be imposed upon state governments in India. The evident reaction of people in many parts of the European Union to a similar project provides a telling example. The ‘Growth and Stability Pact’ which specified similarly foolish fiscal constraints upon EU member governments has created even higher unemployment than before and has implied levels of economic activity well below potential, and has therefore led to a popular backlash. This public response has not only meant that the economic policies are being questioned, it has also led to greater questioning of the entire project involved in the European Union. The reason is that the policies—and even the proposed Constitution—were seen as driven by corporate interests and operating against the interest of people and the broader social good, which cannot be calculated in terms of market principles. Policy makers in India should take note: there is no reason why such policies should not lead to similar backlash in our own federal structure. The urge to control fiscal policies in order to please 220

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international capital markets must not lead to strategies that undermine economic democracy and social cohesion, especially in countries that are as heterogeneous and essentially federalist as India. All in all, this amounts to a direct attack on the fiscal autonomy of states, and therefore in effect a betrayal of the spirit of the Constitution, which recognizes the possibility of different economic approaches by different state governments. All this not only suggests that fiscal federalism still remains somewhat of an empty promise in India, despite all the protestations to the contrary, but also that it is becoming even more empty as the centralizing forces of market fundamentalism dominate economic policy making. This is particularly important now that the arguments of market fundamentalists have been revealed to be so fallacious through the financial market meltdowns globally and even in India. Given the overall failure of the neoliberal model, it is more important than ever for state governments in India to be given the flexibility to create their own economic strategies of development, without being bound to a set of failed policies simply because they continue to be espoused by the central government.

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8 Thirteenth Finance Commission Core Issues and New Challenges D. K. Srivastava

I Introduction

The constitutional provision of setting up of a Finance Commission every five years has served as a well considered idea of the makers of the Indian constitution.â•¯The discontinuity provides an opportunity of remaining independent and objective and scope for evolving a new approach. The periodicity ensures that changed contexts are duly taken into account while addressing the core problems. For the Thirteenth Finance Commission, there is a sea-change in the context. The Commission will be finalizing its recommendations in the midst of an unprecedented economic crisis affecting both central and state finances. The ongoing economic and financial crisis is rooted in global recession and the timing of resumption of normal growth remains unpredictable. After a tangible improvement in the profile of fiscal imbalance of the Centre and the states from 2003–04 to 2007–08, there are clear signs of the reemergence of fiscal imbalances. Apart from sustainability of debt and deficit, macro-stabilization and the role of 222

Thirteenth Finance Commission

Centre and states in achieving this has become an issue. Even while the world at large is trying to cope with the global recession, there are other longer term issues of climate change and management of environment, which cannot be ignored any more. Climate change and environment have significant fiscal implications both in terms of policy instruments and impact on poverty and vulnerability. There are contextual references to the Thirteenth Finance Commission for taking into account considerations of ecology and environment in making their recommendations. In addition, there are India-specific contextual changes such as the planned move towards a comprehensive goods and services tax. These issues are interlinked and have clear a bearing on the Commission’s core tasks of resolving vertical and horizontal imbalances. In this paper, we look at the following contemporary challenges before the Finance Commission in the context of their core tasks: 1. Economic crisis and commission’s projections. 2. Sustainability of debt and deficit: issues of macrostabilization. 3. Move towards Goods and Services Tax (GST): implications for transfers. 4. Climate change and environment: fiscal implications. 5. Resolving vertical imbalance. 6. Resolving horizontal imbalance.

II Economic Crisis and the Commission’s Projections

One requirement of examining the issue of fiscal transfers every five years is that the Finance Commission must make projections for the period under reference. These projections have so far followed a methodology where projections start out from a base year and apply growth rates on the base year’s figures that may reflect norms, prescriptions or simply historical trends. The Finance Commission 223

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is required under its terms of reference to use 2008–09 as the base year. Under Clause 3 of the Terms of Reference (ToR), it is specified: In making its recommendations, the Commission shall have regard, among other considerations, to—(i) the resources of the Central Government, for five years commencing on 1st April 2010, on the basis of levels of taxation and non-tax revenues likely to be reached at the end of 2008–09.

Clearly, given the impact of the economic crisis on the central finances, it would be most inappropriate to use figures of tax and non-tax revenues of the central government for 2008–09 as these will be unrepresentative of the potential central revenues in the recommendation period. If this were to be done, the availability of resources that could be shared with the states will be seriously underestimated. The last time we have gone through a slowdown in the GDP growth was in the early years of the current decade. At that time, the average growth for three years was only a little more than 4â•¯per cent, some three percentage points below trend growth rate. We expect GDP growth rate in 2008–09 and 2009–10 to be much below trend growth rate. The saving rate is lower both because of a sharp fall in corporate savings and because of conversion of government savings into dis-savings. The trend growth has moved to about 9â•¯per cent but we may get an actual average annual growth of a little above 6â•¯per cent during 2008–10, possibly 3 percentage points below the potential growth (Figure 8.1). The quick estimates for 2008–09 place the growth rate of GDP at 7.1â•¯per cent. The interim budget for 2009–10 has considered 7â•¯per cent growth of GDP for 2009–10. Most independent analysts place the likely growth in 2009–10 to be in the range of 6â•¯per cent to 6.5â•¯per cent. The challenge before the Finance Commission is to realistically project the central and state tax revenues from out of these highly unrepresentative figures in the two years immediately preceding their recommendation period. 224

Source (basic data):â•‡ Indian Public Finance Statistics and CSO.

Figure 8.1:â•‡ GDP Growth at 1999–2000 Prices: Actual and Potential

D. K. Srivastava

Apart from the base year figures, there has also been an impact on the tax buoyancy, which in turn will impact on the buoyancy-based growth rates of tax revenues. Table 8.1 indicates the sharp erosion in the annual buoyancy of gross central taxes and its components during 2008–09 and 2009–10. Table 8.1:â•…Annual Buoyancy of Central Taxes Items Gross tax revenue Corporation tax Income tax Customs Union excise duties Service tax Non-tax revenue Total revenue receipts

2001–02 2002–03 2003–04 2004–05 2005–06 –0.10 2.03 1.44 1.39 1.47 0.30 3.39 3.08 2.10 1.64 0.09 1.97 1.00 1.33 1.00 –1.82 1.48 0.69 1.29 0.95 0.70 1.74 0.84 0.64 0.89 3.14 3.22 7.48 5.58 4.56 2.52 0.86 0.51 0.40 –0.39 0.54 1.90 1.17 1.12 0.95 2006–07 2007–08 2008–09 2009–10

Gross tax revenue Corporation tax Income tax Customs Union excise duties Service tax Non-tax revenue Total revenue receipts

â•¯

â•¯ â•¯

1.91 2.77 2.23 2.13 0.37 4.12 0.54 1.67

1.76 2.34 2.55 1.43 0.35 2.53 1.60 1.72

0.39 1.01 1.31 0.25 –0.83 1.79 –0.41 0.25

0.63 0.91 0.95 0.18 0.19 0.55 1.49 0.77

Source (basic data): Central Budget Documents and National Income Accounts.

III Revisiting Management of Debt and Fiscal Deficit

The Thirteenth Finance Commission has been given a supplementary ToR, by the Presidential Order issued on 25 August 2008, requiring the Commission to deliberate on the issue of fiscal consolidation. This clause itself largely arose out of the impact of the economic crisis and its handling by the central government on central finances. 226

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Having regard to the need to bring the liabilities of the Central Government on account of oil, food and fertilizer bonds into the fiscal accounting, and the impact of various other obligations of the Central Government on the deficit targets, the Commission may review the roadmap for fiscal adjustments and suggest a suitably revised roadmap with a view to maintaining the gains of fiscal consolidation through 2010 to 2015.

Table 8.2 indicates how sharply the revenue and fiscal deficits of the central government have deteriorated in 2008–09 and 2009–10. Their impact on the Centre’s fiscal imbalance will continue in the Commission’s recommendation period. A difficult fiscal situation of the Centre would adversely affect the volume of transfers that can be recommended for the states. When the Twelfth Finance Commission had come out with an incentive scheme for the state governments to enact their fiscal responsibility legislations, the central government had already enacted its own legislation. It was expected that the central government would adhere to its own targets of fiscal deficit and revenue deficit. In fact, it was expected that the central government would set an example for the state governments. But the performance of the two tiers of governments had been quite Table 8.2:â•… Central Budget 2009–10: Selected Variables (` Crore) Items Revenue receipts Tax revenue Capital receipts Borrowing and other liabilities Total expenditure Revenue expenditure Capital expenditure Revenue deficit Revenue deficit as % of GDP Fiscal deficit

Fiscal deficit as % of GDP

2007–08 Actual

2008–09 RE

2009–10 BE

2008–09 BE

541,925 439,547 170,807 126,912 712,732 594,494 118,238 52,569 –1.1 126,912

562,173 465,970 338,780 326,512 900,953 803,446 97,507 241,273 –4.4 326,515

609,551 497,596 343,680 332,835 953,231 848,085 105,146 238,534 –4.0 332,835

602,935 507,150 147,949 133,287 750,884 658,119 92,765 55,184 –1.0 133,287

–2.7

–6

–5.5

–2.5

Source (basic data): Central Budget Documents and National Income Accounts.

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asymmetric. The central government missed out on the both the revenue and fiscal deficit targets by significant margins and this was happening well before the onset of the current crisis. Not only did the Centre miss out on the targets but it also tried to be quite non-transparent about it by pushing considerable amounts of fiscal deficit off-budget. States, on the other hand, achieved both the revenue and fiscal deficit targets. Even before the debt-GDP ratio of the Centre could fall to levels at which stabilization was being attempted as per the scheme of restructuring suggested by the Twelfth Finance Commission, which required an adjustment phase (Rangarajan and Srivastava, 2005), the Centre’s debt-GDP ratio has started rising. With the economic crisis, the issue of macro-stabilization and the relative role of the Centre and states in achieving this has also become important. In this context, the new challenges before the Finance Commission may be considered as follows: 1. Given the cyclical pressures, the Commission has to convert the fixed fiscal deficit targets into cyclically adjusted targets. This is the way that the Maastricht Treaty norms were also modified by the Growth and Stability Pact in the European context. A variable target regime, however, cannot be handled without a permanent supervisory arrangement like a Loan Council, which was suggested by the Twelfth Finance Commission but has not been implemented yet (Government of India, 2005). 2. The states have successfully moved on to a market borrowing regime as was recommended by the Twelfth Finance Commission and Centre’s intermediation of states’ borrowing has been successfully discontinued except for external loans. In a market determined regime, however, it is important to ensure that the central government does not overexploit the available resources for borrowing thereby pushing up the cost of borrowing for the state governments. Similar issues arise in the supply driven borrowing through the National Small Savings Scheme where the states are the main borrowers but 228

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they have no say in determining either the interest rates of the small saving instruments or the amount that they must necessarily borrow from the National Small Saving Fund (NSSF). A more even-handed and less rigid NSSF arrangement is called for under the supervision of a joint body like the loan council. 3. Another issue relates to the relative role of the central and state governments in macro-stabilization. While in theory much of the stabilization role is generally allocated to the central government, in India nearly 55â•¯per cent to 57â•¯per cent of the combined government expenditure of the central and state governments comes from the state governments. State governments have to not only play a role in stabilizing the state economy but also consider together the national economy. This requires a suitable coordination framework in which state governments may augment Centre’s fiscal effort for stabilization although the responsibility will remain primarily that of the Centre.

IV Moving from Value Added Tax (VAT) to GST

The issue of considering the implications of the proposed changeover from VAT to a GST in April 2010 happens to coincide with the start of the recommendation period of the Commission. Para 6(vi) of the ToR to the Finance Commission says that, ‘[i]n making its recommendations, the Commission shall have regard, among other considerations, to … the impact of the proposed implementation of Goods and Services Tax with effect from 1st April, 2010, including its impact on the country’s foreign trade’. It is a critical issue as the changeover from the present combination of Cenvat, State VAT and service tax to GST will make the existing revenue profiles of the Centre as well as state governments quite unsuitable for projecting forward their revenues in the 229

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Commission’s recommendation period. Much will depend on the rate structure of GST for the central and state GST components as also for the services and goods components. For implementing a comprehensive GST both at the Centre and the states, several options are being considered ranging from a completely centralized levy of GST to a system of extensive state GSTs. However, a consensus that seems to be emerging is likely to favour a dual system consisting of a GST with two components: a central GST (CGST) and a system of state GSTs (SGST). The Empowered Committee of the state Finance Ministers continues to work on a suitable variant of the Goods and Services tax. Some of the main features of the proposed GST seem to be clear and others are being discussed. For the Centre, the following taxes are likely to be subsumed under the GST: Central Excise duties (extended up to the retail level), Additional Excise duties, Additional Duty of Customs or CVD, Central Sales Tax (CST) and Service Tax including all cesses and surcharges. The CVD, which is essentially an excise on imports would be subsumed under GST and would be made up of the same two components viz. the CGST and the SGST. The major state taxes likely to be subsumed under GST are: VAT or Sales Tax, Entertainment Tax, Luxury Tax, Octroi or Entry Tax, Taxes on Lotteries, Betting and Gambling, Purchase Tax, Electricity Duty and any cesses and surcharges levied by the state governments. The Centre shall levy one component (CGST) and the states/ Union Territories shall levy the other (SGST). Both CGST and SGST should be applicable to all transactions of goods and services. Harmonized System of Nomenclature (HSN) classification for goods should be used both for CGST and SGST. Separate accounts will be maintained for the CGST and the SGST. While input tax credit (ITC) should be permitted within each of the taxes, cross flow between the CGST and the SGST will not be permitted. Exports will be fully zero-rated, that is, exports should be relieved of the burden of all embedded taxes and levies, both of the Centre and the states. Demerit goods such as alcoholic beverages and 230

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tobacco may be brought under GST with ITC. However, Excise duties (without ITC) should be levied over and above the GST by both the Centre and states. Crude oil and petroleum products will be kept out of the purview of the GST. This would reflect current practice in India that does not allow ITC of petrol and diesel to downstream users. Inter-state sales should be governed by the destination principle and CST would be eliminated. The key issues that are being discussed presently relate to the rate-structure including list of exempted items, determination of thresholds and arrangements for input tax credit. The issue of compensation to the states for revenue loss in moving to GST and due to the abolition of CST is also being discussed, and the Finance Commission will have to take a call on this as the states are banking on the Finance Commission to recommend compensation and determine the amount of such compensation. The levy of GST will have significant revenue implications although it is bound to be revenue buoyant in the longer rum as overall efficiency in production and sales will go up while compliance costs will go down. But these changes will definitely make the history of tax revenue growth of at least some of the major taxes redundant for the projection exercises undertaken by the Finance Commission. Also, there will be some redistribution of tax revenues in favour of the consuming states facilitating achievement of equalization a little easier.

V Climate Change and Environment

It is for the first time that a Finance Commission has been specifically asked, under Clause 3(viii), in making its recommendations, to take into account ‘the need to manage ecology, environment and climate change consistent with sustainable development’. Promotion of environment in a sustained way can be pursued by an extensive use of economic instruments. Eco-taxes on polluting inputs and 231

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outputs provide a highly potent instrument in the hands of the central and the state governments for achieving environmental objectives. These instruments are now being extensively used internationally. In general, eco-taxes should be embedded in an overall scheme of reforms relating to taxation of goods and services. Since both the GST and concerns of ecology and environment are referred to the Finance Commission, the Commission is in an ideal position to consider GST and eco-taxes together. It is well recognized that pollution has local, regional and global dimensions. The local effects largely relate to air, soil and water resulting from industrial emissions and discharges, noise and smell. The regional effects are due to eutrophication, contaminants in the soil and water and landscape changes due to mining or agriculture. The global effects relate to changes in the climate due to ozone depletion and the greenhouse effect. In 2005, India occupied the fifth rank among countries arranged in order of carbon emissions, after the United States, China, Russia and Japan. It may however be recognized that in terms of per capita GDP, the pollution load in India still compares favourably with many industrialized and emerging economies. Recent trends indicate that carbon emissions are increasing in India at a fast rate given the explosive growth in the number of vehicles and increasing demand for energy. Proponents of eco-taxes argue for a ‘green shift’ in taxation of goods and services, which implies that the overall tax burden does not increase on the system so that inefficiency costs of excess taxation such as deadweight losses, compliance costs and administrative costs do not increase. Some economists consider that in fact such a green shift will yield a double dividend by raising overall efficiency without reducing the overall size of tax revenues. It will also improve inter-generational equity by spreading better among different generation the use of natural resources and fossil fuels as compared to their overexploitation by the present generation. In any case, when the social welfare function is seen in the broader context where various positive externalities of green development and negative externalities of pollution are internalized, any 232

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‘green shift’ in taxation is likely to be welfare improving without affecting the growth momentum adversely. It is therefore imperative that in the analysis undertaken by the Finance Commission of a comprehensive GST, a thrust towards the eco-taxes is taken up as the crucial core of tax reforms. There are some apparent conflicts between the GST norms and eco-taxes. In a VAT regime, input taxes are fully rebated. As such, taxation of polluting inputs will be ineffective as the tax paid on the inputs will be fully rebated, unless a non-rebatable cess is levied on the inputs. This cannot be done on a large scale as it will make the tax system very complex and defeat the objective of tax reform. The more appropriate method would be to tax outputs and introduce ecological considerations by taxing at a higher rate, outputs that are either polluting or use highly polluting inputs. However, this calls for differentiated rate structures. As is done in the European Union and other countries, the environmental considerations within the framework of a comprehensive GST requires that on certain outputs non-rebatable special duties be levied. Some of the items that may be covered under this provision are petroleum and related products, motor vehicles, products involving extensive use of coal, plastics, lead, metals and alcoholic beverages, the production of which involves pollution. Most of these items are the ones that have relatively inelastic demand. As such, these can also serve as an instrument providing flexibility the states to take into account local conditions in determining the relevant rates of special duties. These can also help the states in at least partially absorbing the revenue impact of moving to GST. Also, since environmental taxes will generate sizeable revenues, this can be used to determine a much lower revenue-neutral overall GST rate than would otherwise be the case. An additional consideration relates to the special economic zones and export oriented units, which are given inputs including polluting inputs on a zero-rated basis. While their products may be exported or treated as imports if sold in the domestic economy, much of the pollution that they generate is affecting the geographical area in which they are located. Polluting inputs 233

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in their case should not be zero-rated. They should also be subject to all other applicable regulatory measures for pollution control. If ecological considerations lead to some regressivity for some polluting but mass-consumed good as a result of taxation at a higher rate, this should be adequately neutralized by a well-designed subsidy. Apart from the reforms related to integrating eco-taxes in the GST, the Thirteenth Finance Commission may also give specific grants to support states that have special ecological and environmental problems. It may be noted that even though a specific mention about ecological and environmental concerns was not included as part of the ToR of the earlier Finance Commissions, some special grants were given for this purpose by some of the earlier Finance Commissions, particularly the Ninth Commission onwards. In the case of the Twelfth Finance Commission, considerable amounts of grants were recommended that had a clear bearing on ecological and environmental problems of the states.

VI Resolving Vertical Imbalance

In a scheme of fiscal transfers, the core issues relate to resolving the vertical and horizontal imbalances. In considering the vertical dimension of transfers, that is, the sharing of resources in relation to responsibilities, we may look at the profile of the respective shares of Centre and the states in the combined pool of revenues as well as expenditures during the periods covered by the previous Twelfth Finance Commissions. Leaving the three years of the Twelfth Finance Commission, Table 8.3 indicates that the share of states in the total transfers as percentage of revenue receipts peaked in the period of the Ninth Finance Commission at slightly above 39â•¯per cent of the Centre’s Gross Revenue Receipts (CGRRs). In fact, it was close to above 38â•¯per cent for the 15 years covered by the recommendation periods of Seventh, Eighth and the Ninth Finance Commissions. A similar 234

Thirteenth Finance Commission Table 8.3:â•‡ Transfers Relative to Centre’s Gross Revenue Receipts Transfers as percentage of Finance Commission

CGRR

GDPmp

23.9 30.7 25.1 31.1 34.7 31.8 38.2 38.1 39.1 35.6 35.9 40.8

1.2 2.0 2.3 2.6 3.3 3.5 4.4 4.8 4.8 4.1 4.2 5.2

Share

First Second Third Fourth Fifth Sixth Seventh Eighth Ninth Tenth Eleventh Twelftha

Share

Source (basic data): Indian Public Finance Statistics and CSO. Note: a average of three years.

pattern is reflected in terms of transfers as percentage of GDP. In the case of the Twelfth Finance Commission, the total transfers have gone up again crossing 40â•¯per cent but we need to wait to see what will be the impact of the ongoing slowdown on Centre’s resources. In spite of the fall from the peak in the level of transfers, states have got a progressively increasing share in the combined revenue receipts of the Centre and the states. Table 8.4 shows the share of the Centre and the states in the combined revenue receipts before and after transfers. In this case also, the long-term trend indicates a progressive increase until the share of states seems to stabilize around 64â•¯per cent in the time of the Ninth Finance Commission with a small fall in subsequent years. The corresponding share of the states in the combined revenue and total expenditures do not show a similar increasing pattern. Instead, there is a much greater stability reflected there. Table 8.5 gives the relative shares of the Centre and the states in revenue and total expenditures. This stability is particularly noticeable for revenue expenditures. The share of the centre in the

235

D. K. Srivastava Table 8.4: Share of Centre and States in Revenue Receipts: Before and After Transfers (Average for Finance Commission Periods) (Per cent) Before transfers

After transfers

Finance Commissionsâ•¯

Centre

States

Centre

States

First Second Third Fourth Fifth Sixth Seventh Eighth Ninth Tenth Eleventh

58.1 62.4 66.3 65.0 65.6 65.6 64.2 64.8 62.5 61.3 60.9

41.9 37.6 33.7 35.0 34.4 34.4 35.8 35.2 37.5 38.7 39.1

44.2 42.8 48.1 43.3 41.2 43.6 38.5 38.5 35.9 37.0 36.7

55.8 57.2 51.9 56.7 58.8 56.4 61.5 61.5 64.1 63.0 63.3

Twelftha

62.8

37.2

36.5

63.5

Source (basic data): Indian Public Finance Statistics and CSO. Note: a Average of three years (2005–08). Table 8.5:â•‡Relative Shares of Centre and States in Revenue and Total Expenditures (Per cent) Relative shares Total expenditure

Revenue expenditure

Average for finance commission periods

Centre

States

Centre

States

First Second Third Fourth Fifth Sixth Seventh Eighth Ninth Tenth Eleventh Twelftha All-period average

43.83 49.47 50.51 47.69 43.14 47.35 44.79 47.86 45.58 43.35 43.77 43.18 45.88

56.17 50.53 49.49 52.31 56.86 52.65 55.21 52.14 54.42 56.65 56.23 56.82 54.12

40.77 41.83 46.10 41.77 40.00 44.19 41.98 44.22 43.45 43.18 44.03 43.52 42.90

59.2 58.2 53.9 58.2 60.0 55.8 58.0 55.8 56.5 56.8 56.0 56.5 57.1

Source (basic data): Indian Public Finance Statistics, various years. Note: a Average of three years (2005–08).

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revenue expenditure has remained around the all-period average of 43â•¯per cent through out the award periods covered by the First to Twelfth Finance Commissions. At the highest, it was 46â•¯per cent in the Third Finance Commission period and at the lowest, it was 40â•¯per cent in the period of the Fifth Finance Commission. Correspondingly, the share of states in the combined revenue expenditures has been around 57â•¯per cent. At the highest, it was at 60â•¯per cent and at the lowest, it was 56â•¯per cent. As far as total expenditures are concerned, the share of the Centre has been slightly higher at around the average of 46â•¯per cent and correspondingly that for states has been around the average of 54â•¯per cent. For the periods covered by the Tenth to Twelfth Finance Commissions both revenue and total expenditures seem to be remaining closely around the averages of 43â•¯per cent and 57â•¯per cent respectively for the Centre and the states. Figure 8.2 shows the year-wise figures over period from 1950–51 to 2007–08. The long-term picture indicates that the stability in the relative shares of the Centre and the states in expenditures was accompanied Figure 8.2: Share of States in Combined Revenue and Total Expenditures

Source (basic data):â•‡ Vithal and Sastry (2001) and Reports of the Finance Commission.

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by a rising share of states in revenues and a rising share of the Centre in borrowing. This pattern is not likely to be maintained in the future as under the respective FRBM Acts, the Centre and the states are required to follow roughly similar fiscal deficit targets as percentage of GDP. In the context of the vertical dimension of transfers, several issues are critical. First, the Centre spends an inordinately large amount on subjects that according to the constitutional scheme of assignment are in the state list. Second, the central government has continued with large amount of cesses and surcharges that are not sharable with the state governments under the provisions of Article 270. Even when the central government passes on some amounts to be spent by the states, the distribution of that amount among the states is arbitrarily done by the concerned ministries and often not transparent. Third, much of the pattern about stability in the shares of expenditure noted earlier coexisted with a falling share in revenues and a rising share in borrowing of the Centre. With the fiscal responsibility legislations, and guidelines given by the Twelfth Finance Commission, if the Centre and the states have similar levels of borrowing, say 3â•¯per cent of GDP each (leaving out the current crisis period), then the historical pattern of relative shares of expenditures cannot be maintained. Fourth, the centre has continued to insist on implementation of a plethora of Centrally Sponsored Schemes (CSS), imposing its own priorities and preferences. This may be understandable for one or two areas. But the Centre finds ways of proliferating the number of areas and schemes without any rationale. Further, states have to bear a substantial part of the expenditure from their own resources as part of states’ share of expenditure on the CSS and the states have to follow numerous guidelines pre-empting a lot of administrative resources for this purpose. The Empowered Committee of the State Finance Ministers has argued and presented to the Commission that of the projected total central assistance for the eleventh plan period of about `325,000 crore, nearly two-thirds will be on the CSS. Further, in order to make sure that such a large space remains for the CSS, the Thirteenth Finance Commission 238

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has been asked to take into account the gross budgetary support to the central plan that is supposed to comprise primarily of such CSS. Also, in many cases, the Centre bypasses the state governments and incurs expenditure in state jurisdictions through ad hoc local bodies. This must be avoided. If the Finance Commission wants to maintain the stability in the vertical transfers, as highlighted in the preceding discussion, as shown by Rangarajan and Srivastava (2008), states’ share in the central taxes will have to go up by the margin of excess of the Centre’s tax revenue buoyancy over that of the states comparing the period of the Twelfth Finance Commission with the anticipated buoyancies in the period of recommendation of the Thirteenth Finance Commission. This task is quite complicated because the respective buoyancies will be affected by the way the transition to GST is made and whether or not the central cesses and surcharges are merged with the GST.

VII Resolving Horizontal Imbalance

Resolution of horizontal imbalance is the central task of the Finance Commission. The richer- and middle-income states are unhappy because they contend that they are contributing far more to the central taxes but getting a progressively falling share. Low-income states are unhappy that a proper equalizing transfer has never been achieved and there is growing inequality in the standard of services. Special category states are unhappy saying that their extraordinary difficulties are not being fully taken into account. There are four competing groups of states: southern states (largely middle-income states), high-income states, low-income states and the special category states. Figure 8.3 and Table 8.6 show the relative shares of these four groups of states in total transfers. Comparing the changes between the Third and Twelfth Finance Commissions, it is quite clear that in total transfers the major 239

D. K. Srivastava Figure 8.3:â•‡Share of Groups of States in Total Transfers

Source (basic data): Vithal and Sastry (2001) and Reports of the Finance Commission. Table 8.6:â•‡Share in Total Transfers for Different Groups of States (Per cent) Finance Commissionsâ•¯

Southern states

High-income states

Low-income Special category states states

Third Fourth Fifth Sixth Seventh Eighth Ninth (1) Ninth (2) Tenth Eleventh Twelfth Twelfth-Third

27.86 29.33 23.77 22.90 23.19 21.46 20.43 19.99 21.89 19.17 18.36 –9.50

20.01 16.52 17.02 14.81 16.47 13.35 13.53 12.69 13.05 9.60 11.17 –8.84

45.87 44.73 49.37 49.17 51.08 51.60 50.08 52.62 49.77 56.65 56.43 10.55

6.25 9.42 9.84 13.13 9.26 13.59 15.97 14.70 15.29 14.58 14.04 7.79

Twelfth-Fifth

–5.41

–5.85

7.06

4.20

Source (basic data): Vithal and Sastry (2001) and Reports of the Finance Commission.

gainers are the low-income states and the special category states and the major losers are the high-income states and the southern states. It is also apparent that the larger relative loss has been for the middle-income states. For the southern states, representing the 240

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middle-income group, there has been a loss of about 9.5 percentage points in their share taken together as compared to the other categories of states from nearly 28â•¯per cent to just above 18â•¯per cent of total transfers. The low-income states and the special category states have gained respectively 10.6 and 7.8 percentage points. Because of the changes in the organization of states, it may be better to make a comparison between the Twelfth and Fifth Finance Commissions. In this case, the erosion of the relative share in total transfers of the southern states is 5.4 percentage points and the gain for the low-income states (7.1 percentage points) and the special category states is 4.2 percentage points (Table 8.7). Total transfers consist of tax devolution and grants. Tables 8.7 and 8.8 show the changes in the shares of the different groups of the states in respect of tax devolution and Finance commission grants. In the case of tax devolution, the major losers are the high income states. The loss of share of the southern states in tax devolution has been about 5 percentage points from 24.5â•¯per cent to below 20â•¯per cent comparing the Twelfth and the Third Finance Commissions. The major gainers are the low-income group states. Table 8.7:â•‡Share of Different Categories of States in Tax Devolution (Per cent) Finance Commissionsâ•¯â•¯ Third Fourth Fifth Sixth Seventh Eighth Ninth (1) Ninth (2) Tenth Eleventh Twelfth Twelfth-Third

24.52 24.47 24.06 24.84 24.70 22.90 22.51 22.15 22.39 21.07 19.79 –4.73

22.75 21.96 19.68 19.30 17.71 14.22 13.82 14.13 13.14 9.75 11.20 –11.55

48.13 48.11 52.05 51.08 52.81 52.21 53.16 51.46 51.01 61.88 60.85 12.71

4.60 5.46 4.21 4.79 4.78 10.68 10.51 12.27 13.46 7.30 8.17 3.57

Twelfth-Fifth

–4.28

–8.48

8.80

3.96

Source (basic data): Vithal and Sastry (2001) and Reports of the Finance Commission.

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D. K. Srivastava Figure 8.4:â•‡Share of Different Groups of States in Tax Devolution

Source (basic data): Vithal and Sastry (2001) and Reports of the Finance Commission.

Figure 8.4 highlights the large shift in favour of the special category states in the case of the Eighth Finance Commission and a large shift in favour of the low-income group of states in the case of the Eleventh Finance Commission. In the case of grants by the Finance Commission, the pattern is quite different. The erosion in the share of the southern states has been more pronounced (Table 8.8). At its peak, the share of the southern states was nearly 44â•¯per cent. It has now fallen to about 12â•¯per cent of total grants, a fall of nearly 30 percentage points. But as far as the gainers are concerned, the pattern is different from that in the case of sharing in central taxes. In the case of grants, the relative gain for the low-income states has been small whereas the gainers are the high-income states who started getting some share in grants mainly from the Eighth Finance Commission onwards. The gain to the high-income states in grants seem to a perverse move against equalization.

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Thirteenth Finance Commission Table 8.8:â•‡Share in Finance Commission Grants (Per cent) Finance Commissionsâ•¯

Southern states

High-income states

Third Fourth Fifth Sixth Seventh Eighth Ninth (1) Ninth (2) Tenth Eleventh Twelfth Twelfth-Third Twelfth-Fifth

41.80 44.09 21.87 16.53 3.11 5.52 5.74 8.17 17.17 9.08 11.68 –30.12 –10.19

8.61 0.00 0.00 0.00 0.00 3.61 11.48 4.83 12.19 8.79 11.03 2.42 11.03

Low-income Special category states states 36.48 34.44 32.18 42.85 28.06 44.81 28.37 58.98 38.17 28.91 35.68 –0.80 3.50

13.11 21.47 45.95 40.62 68.83 46.06 54.41 28.02 32.47 53.21 41.61 28.50 –4.34

Source (basic data): Vithal and Sastry (2001) and Reports of the Finance Commission.

The pattern in resolving horizontal imbalances over time through the aegis of the Finance Commission is therefore quite clear. There has been a move towards equalization as well as correction of need and cost disabilities reflected in the position of the special category states. The use of tax devolution and grants for achieving equalization has been at cross-purposes. If grants were used more for equalization, the need for dependence on tax devolution for this purpose would have been more moderate.

VIII Concluding Observations

The Thirteenth Finance Commission has to contend with issues that are old and challenges that are new. With the Indian economy slowing down, there is a likelihood of the reemergence of fiscal imbalances, after considerable improvement in the last few years. We expect the GDP growth in 2008–09 and 2009–10 to be below trend growth by a margin of 2.5 to 3 percentage points. The challenge before the Finance Commission is to realistically 243

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project the central and state tax revenues from out of these highly unrepresentative figures in the two years immediately preceding their recommendation period. In regard to fiscal consolidation, the new challenges before the Finance Commission may be summarized as follows: 1. Given the cyclical pressures, the Commission has to convert the fixed fiscal deficit targets under the respective FRBM Acts into cyclically adjusted targets. A variable target regime, however, cannot be handled without a permanent supervisory arrangement like a Loan Council, which was suggested by the Twelfth Finance Commission but has not been implemented yet. 2. In a market-determined borrowing regime, it is important to ensure that the central government does not overexploit the available resources for borrowing thereby pushing up the cost of borrowing for the state governments. In the case of NSSF also, a more even-handed and less rigid regime needs to be developed. Here also, a joint body like the Loan Council would be far more fair and transparent. 3. In the context of macro-stabilization, while the main responsibility is with the central government, there is need for developing a coordination framework in which state governments may augment the Centre’s fiscal effort for stabilization, given their large share in overall government expenditure. In the context of vertical transfers, while the states are asking as a group for a 50â•¯per cent share in the sharable pool of central taxes, some increase has to be brought about as the Centre’s tax buoyancy in recent years, leaving 2008–09 and 2009–10, has been higher than that of the states’. There also has to be less reliance on cesses and surcharges on the part of the centre. This task is also going to become more complicated because the respective buoyancies will be affected by the way the transition to GST is made and whether or not the central cesses and surcharges are merged with the GST. 244

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The following suggestions can be made in regard to resolving the horizontal imbalances: 1. A large part of equalization should be delivered through grants rather than through devolution. This will create the possibility of reducing the weight attached to the distance formula a little more and arrest the fall in the share of highincome and middle-income states. 2. In determining upgradation and other special purpose grants, more objective approaches should be adopted so that this does not become a vehicle for redistribution towards higher income states. 3. In the case of education and health, equalization should be attempted with reference to the three highest per capita expenditure states and at least major need and cost disabilities should be taken into account. References Government of India. 2005. Report of the Twelfth Finance Commission (2005–10), Ministry of Finance, Government of India, New Delhi. Rangarajan, C. and D. K. Srivastava. 2005. ‘Fiscal Deficits and Government Debt in India: Implications for Growth and Stabilisation’, Economic and Political Weekly, 40 (27): 2919–33. Rangarajan, C. and D. K. Srivastava. 2008. ‘Reforming India’s Fiscal Transfer System: Resolving Vertical and Horizontal Imbalances’, Economic and Political Weekly, 43 (23) 7 June: 47–60.

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9 Horizontal Imbalances in Indian Federalism Tapas K. Sen

I Regional Inequalities in India and Horizontal Imbalance

There are two types of imbalances discussed in fiscal federalism— vertical and horizontal. Both of these imbalances refer to the relative sufficiency of financing expenditures of a level/unit of government with its own resources. While vertical imbalance refers to the relative position of the central government vis-à-vis the sub-national governments as a whole, horizontal imbalance refers to the position of different sub-national units as compared to other such units at the same level. In the specific context of India, it would essentially boil down to the indicator (own revenue capacity/normative total expenditure) at the state level.1 That such an indicator is likely to be strongly correlated with the relative development status of a state is fairly easy to see; while revenue receipts are broadly (and empirically speaking, overwhelmingly) determined by any There are finer points about whether all expenditures should be considered or some suitably modified figure, but I am ignoring those in favour of the general point. Some of these issues enter our discussions in subsequent chapter sections, particularly Sections V and VI. 1

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measure of state domestic product with a positive relationship, expenditures (at least per capita expenditure needs) are inversely related to the same. As such, the degree of horizontal imbalance is likely to be highly correlated to the degree of regional inequality. There can be, and have been, exceptions, but such exceptions only prove the rule. Because of this high correlation, ‘horizontal imbalance’ and ‘regional inequality’ can be used almost interchangeably in the Indian public finance literature. Figure 9.1 plots the degree of horizontal imbalance2 of Indian states in descending order of per capita Net State Domestic Product (NSDP) (2004–05). The rising trend line clearly shows the high negative correlation between the two. In the discussions that follow, this basic fact will shape much of the contents. This is being emphasized at the outset because there have been sporadic attempts to obfuscate this issue by bringing in factors of efficiency, openness to reforms in public Figure 9.1:â•… Horizontal Imbalance in Non-Special Category States

Source: Author (based on budgetary data compiled from individual states). 2 I have taken the estimates of (normative gap/GSDP) provided in Table 10 of Rao, Sen and Jena (2008).

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financial management and such other, trying to make out that the horizontal imbalances are not connected to regional inequalities, and that the states with higher imbalances are somehow responsible for it themselves. I wish to bring out clearly that while there may be some truth to these insinuations with respect to one or more specific states, as a general proposition, the relationship between horizontal imbalances and regional inequality is too stark to be refuted.

II Convergence or Divergence?

A priori expectations about different regions converging or diverging are not clear. In the neoclassical world, capital will flow to those regions that yield the highest rate of return, and in general, if there are large differences in initial endowments, the regions with the larger endowments will provide the higher rate of return so that there would be divergence. This roughly describes both the pre- and post-liberalization situations in India too. If there were natural or market forces that would counteract this tendency towards regional inequality, then one might argue that there is no need for interventions designed to bring about regionally balanced development. One possible strand of reasoning may be as follows. Surely, in a dynamic world, things do not remain the same forever. There are some natural limits to economic growth within a given region that completely depend on various resources available within the region. To push these limits, it becomes essential to draw on resources from other regions as well. If this process is relatively costless, as in the case of colonialism, then there is little spillover of the growth process. But if this process is market-based, as is the case in India, then there is some amount of spillover that gradually reinforces the endowments of the less fortunate regions as well. Eventually, this process may raise the rate of return in those regions 248

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to a competitive level, resulting in greater inflow of capital and higher growth.3 While there is some truth in this line of reasoning, such an outcome will be conditional upon several factors, mainly to do with institutions preventing full play of the process sketched above. Moreover, even if there were no counteracting factors, it is not possible to predict how long this process will take, and whether a nation can afford to wait for this process to play out fully. The unclear theoretical position has given rise to a spate of empirical studies, both across nations and within, led by the Barro and Sala-i-Martin (1991). The empirical studies, it must be kept in mind, cannot give a categorical answer that we are seeking to the question asked. That is because the real world data include the effects of various kinds of public intervention to bring about regional balance, and rarely can the effects of these interventions be clearly separated from the more inherent process of divergence or convergence as the case may be. Even so, there are no clear answers from the empirical studies either, since there is considerable diversity on the issue of convergence/divergence among Indian states. However, one might venture that the weight of conclusions appears to support absolute divergence.4 This is so despite more than 60 years of public intervention professing to bring about ‘balanced regional growth’ obviously implies the inadequacy of such interventions in terms of design or extent or both. In what follows, we look at various aspects of deliberate equalization policy, beginning with a discussion of the theoretical insights, mainly in the context of intergovernmental equalizing transfers. The process described here is similar to that described by Myrdal (1957); however, Myrdal described two secondary processes—‘backwash effects’ that reinforce the original divergence and ‘spread effects’ similar to what has been outlined here. I do not emphasize the backwash effects because it only prolongs and strengthens the initial regional inequality; whereas I am looking for anything that may counter it. 4 There are several studies on this issue using Indian data: a comprehensive survey is provided by Krishna (2004). A more recent study by Purfield (2006) may be mentioned in this context. 3

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III Public Intervention: Case for Equalization

It must be appreciated at the outset of this discussion that equity as a concept is properly applied to individuals and not to regions. This is because it is impossible to make a case for regional equalization through transfers, if the transfers to the poorer regions always end up with the richest few within the region, to take an extreme example. Ruling out such an outcome, the basic issue is: Can one progress from notions of individual equity to regional equity in the context of intergovernmental transfers? In the public finance literature, there is a well-known strand that discusses the case for and against—indeed there is a case against— equalizing transfers. In particular, the long drawn-out debate involving Buchanan, Musgrave, Scott and others in the 1950s and the 1960s is notable. The central point Buchanan (1950) made was that since net fiscal benefit (benefit of public expenditures minus taxes paid) was to be equalized for all equals across states, differences in fiscal capacity among states would create inequalities even if the state and central governments were acting equitably at their own levels. These differences could be corrected by the central government either through a regionally differentiated tax rate or equalizing transfers. Since differentiated tax rate was a less practical and otherwise distortionary proposition, equalizing transfers were indicated. This view was contested and it was shown that intergovernmental transfers were neither necessary nor sufficient to ensure interpersonal equity across jurisdictions. Besides there were questions about measuring net fiscal benefits and whether net fiscal benefits were the correct indicator for well-being at all. Subsequently, this issue was more rigorously dealt with by Boadway and Flatters (1982), who also recognized formally that in a federal system there are at least two levels of government, the actions of which may contribute to the final outcome. They concluded that equalizing transfers was not only necessary for ensuring

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inter-personal equity across states (assuming away as unlikely pure benefit taxation by sub-national governments), but was also efficient in the sense of bringing about a true equilibrium in marginal productivity of labour that would include the net fiscal benefit. Even though it may appear that theory thus provides some justification for equalizing transfers, there is little policy guidance from theory. The design of the transfers and extent has to be based on identification of the sources of inequality and the amounts estimated to eliminate these inequalities. As such, it provides a window for the policymaker to select the objectives of equalizing transfers—it is possible to make a case for equalizing only a few basic services (like the Twelfth Finance Commission’s selective—but unfortunately partial—equalization of health and education services), without trying to equalize general indicators of well-being like per capita income as long as a connection between the specific services and the general indicator is convincingly argued. This is indeed of great help, since the issue of equalization becomes far more tractable and manageable. But essentially, the stronger justification for equalizing transfers has to come from constitutional, judicial or simply societal requirements rather than from economic theory.

IV Equalization as a Formal Requirement

It may be surprising to many that the Indian Constitution does not explicitly require public interventions for the purpose of equalization, not even in the context of intergovernmental transfers. In contrast, there are countries that do have such requirements written into their Constitution. For example, the Canadian Constitution requires the federal government to ensure similar availability of basic public services to all the citizens of the country at similar tax costs. Closer home, Article 154R(5) of the Sri Lankan

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Constitution provides elaborate guidelines regarding the principles to be adopted in recommending grants to Provincial Councils ‘with the objective of achieving balanced regional development in the country’. This clearly implies a constitutional obligation to promote equalization. This goal is to be pursued through the inter-state distribution of grants based on population, per capita income and the need to progressively reduce the distance between the highest per capita income among the provinces and the per capita income of the other provinces. These detailed guidelines, of course, are not generally interpreted to be exhaustive, and the Finance Commission is thought to be competent to consider other criteria—which it does—as long as the basic thrust towards equalization remains the same. In the United States, there is no explicit constitutional requirement, but established judicial interpretations are a part of their Constitutional Law, and the landmark 1971 California Supreme Court judgement in the Serrano vs Priest case (school finances should be independent of local wealth and education should be available to all localities at equal cost), has been rightly invoked to ensure equalization with respect to all basic public services. In the Indian Constitution, however, there are clear pointers. First, in the Directive Principles, there is a clause [38(2)] inserted in 1979 that says, ‘The State shall, in particular, strive to minimise the inequalities in income, and endeavour to eliminate inequalities in status, facilities and opportunities, not only among individuals but also amongst groups of people residing in different areas or engaged in different vocations’ (emphasis mine). This, if not equalization as such, is close to it. Further, the provision regarding grants (Article 275 of the Constitution) puts it as grants-in-aid of revenue. Obviously, such assistance is not intended for all states indiscriminately, nor has it ever been so in practice. Clearly, grants are to be provided to ‘such States as Parliament may determine to be in need of assistance’, and the amounts of grants can vary from one state to another, which together translate to the equalization principle. 252

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V Equalization in India: Institutions

Public interventions for equalization can be effected essentially through three possible channels in India: (a) intergovernmental transfers, (b) Union government expenditures, including investments in its public enterprises and (c) redistribution of financial resources using publicly owned financial institutions. The institutions involved in Point (a) are the Finance Commission, the Planning Commission and the Line Ministries of the Union government providing grants to state/local governments. The Union government and its public enterprises are the institutions involved in Point (b), while Point (c) mainly involves the nationalized banks and financial institutions owned by the Union government along with various sectoral financing agencies like Power Finance Corporation (PFC), National Co-operative Development Corporation (NCDC) and National and Housing and Urban Development Corporation (HUDCO). Of these, the last, that is, the redistribution of financial resources through financial institutions were never equalizing; if anything, they were the opposite (Banerjee and Ghosh, 1998). The nationalized banks have always had higher credit-deposit ratios in the relatively developed states and regions as compared to the less developed ones (Rao and Sen, 1996). The supply of funds by other financial institutions has also been skewed in favour of more developed states. In general, this has been more so because of demand factors than anything else. Credit advances and longterm financing by financial institutions depend heavily on feasible and financially viable project proposals. There have been fewer, and smaller in scale, of such proposals in less developed states as compared to the relatively developed states and regions. The inter-state distribution of the Union government’s nontransfer expenditures is as yet unknown. There is an obvious information constraint in allocating these expenditures across states. In many cases, the spending authorities may not be 253

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maintaining information in a way that would facilitate estimation of regional distribution of such expenditures. Nevertheless, it can be reasonably safely hypothesized that major items of expenditure of the government of India have a distribution that favours the developed states to some extent. This would certainly be the case with large parts of central expenditures like its investments in public enterprises and railways, food and fertilizer subsidies, subsidies in the petroleum sector and several other items of expenditure. For what it is worth, Rao and Sen (1996) used investment in central public enterprises as a proxy for central expenditures; these investments were heavily skewed towards more developed states, making no contribution to balanced regional development. Between the Planning Commission and the Finance Commission, it is the latter which is seen to be at least making an attempt at equalization (Rao, Sen and Jena, 2008). The Planning Commission transfers have been based on a formula (since the 1970s) that does give considerable weight to factors that may be considered progressive, but the Planning process ensures that the end result of it is not equalizing. This is mainly because of two reasons: (a) the state plans are broadly financed by resources raised by the states themselves (largely loans) and (b) the Plan ‘transfers’ until recently comprised of loans and grants in a 70:30 ratio, implying that even though the total amount of the ‘transfers’ were progressive, it only meant that the poorer states had a larger debt burden haunting them in subsequent years. Now, the loan part of the Plan ‘transfers’ that constituted Plan loans of the Union government to the states has been substituted by market borrowings. Thus, the basic problem of the less developed states—finding resources for their own Plans— continues to constrain the process of development convergence, despite the oft-repeated slogan of balanced regional development in the Plan documents.5

5 For a somewhat dated empirical documentation, see Bagchi and Sen (1991: p. 51). More recent data do not seem to warrant a change in the views expressed therein.

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Given that the regional inequalities are primarily attributable to initial conditions, there is little hope of levelling the field unless these are at least approximately evened out. If the burden of this evening out is on the state governments, and if the state governments are constrained in this process because of inadequate resources that are a function of the level of development of the economy, then it follows that the required extent of ‘evening out’ is never going to happen. The entire Plan financing system is designed in a way that maintains the status quo of uneven development and perhaps even widens the inter-state disparities. The vicious circle that this represents, and which the Planning system fails to break, is given in Figure 9.2 that is admittedly a somewhat simplified version, but essentially valid. Figure 9.2:â•…Vicious Circle of Public Intervention for Development

Source: Author.

Transfers through the non-plan non-statutory grants essentially depend on the way such transfers are designed. These being specific purpose in nature, the purpose itself often determines how equalizing, or for that matter, how spread out (over individual states) the grants are. One feature of these transfers that goes contrary to the spirit of equalization is the matching requirement that is generally built into these grant schemes; such requirements are always uniform across the states. Often, this implies that either 255

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the poor states are unable to take full advantage of these grant schemes, being unable to provide the necessary matching amounts, or are forced to cut expenditures in more important areas to put up the matching amounts (the more likely scenario). Despite these problems, one would expect these grants to be equalizing because (a) the bulk of these grants are for poverty alleviation and other basic services and (b) at least in principle, the inter-state allocation of the transfers are based on the incidence of the problem being addressed. The following graphs (Figure 9.3) show the inter-state distribution of grants under Centrally Sponsored and Central Plan schemes. Clearly, the distribution is not systematically equalizing in any of the three years observed, either for the special category sates or the other states. The Finance Commission has, in contrast, consciously attempted to be more equalizing over the years. It does have the advantage that it recommends only current transfers and can also relieve the debt burden of the states through consolidation, rescheduling and/or write-off. However, there are certain features of the Financing Commission recommendations that make them less equalizing than they would be otherwise. We examine these in detail in Section VI.

VI The Case of the Finance Commission

The discussion so far has shown that the entire burden of equalization has fallen on the Finance Commission transfers—both of tax devolution and grants. Granting that, we have also seen that there is not much of convergence taking place among states of India. The obvious question then is, can the Finance Commissions be more equalizing? Are there ways in which the degree of equalization is falling short of expectations? The answer to both these questions is yes, and setting these problems right should considerably improve the degree of equalization in Indian fiscal federalism. 256

Source: Author (based on budgetary data compiled from individual states).

Figure 9.3:â•… Per Capita Grants Received under CPS and CSS

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The two channels of Finance Commission–mandated transfers are the tax devolutions and grants, each decided on the basis of very different methods. Tax devolution is based of a formula that includes preferred variables and corresponding weights decided by each Commission. Apart from (one or more) scale variable(s), the formula usually includes a variable that broadly indicates relative revenue capacity, another representing revenue/tax effort and other variables considered important by a each Finance Commission. The Commission also makes its own assessment of revenue expenditures and revenue capacity, arriving at the non-plan revenue deficits of each state. These assessed deficits are reduced by the estimated tax devolution and the states that are left with deficits even after tax devolution are awarded grants to fill the remaining non-plan revenue deficit. There are several problems with this method in principle and in practice. The biggest weakness of this approach is the partial view of public finances of states implied by the exclusion of revenue expenditures in the Plan account and all capital expenditures from its own purview. The implicit assumption is that all states can raise the necessary resources for these expenditures on their own, as supplemented by Plan and other grants. A cursory look at the trends in state finances shows this assumption to be completely false. Of greater concern is the fact that these exclusions are systematically biased against the less developed states, since the deficits in the excluded parts are likely to be the largest in such states. The usual rebut to this criticism is that (a) the excluded parts are the concern of the Planning Commission and (b) there are often specific Terms of Reference restricting the scope of the Finance Commission. I would suggest that as the sole constitutionally prescribed institution overseeing various aspects of fiscal federalism in India, the Finance Commission must take a holistic view and recommend whatever it considers necessary for healthier public finances, irrespective of the Terms of Reference. Turf limitation is not an acceptable excuse in matters of great importance such as this. If a feasible method of making the Finance Commission deliberations more comprehensive and mitigating this problem was 258

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looked for, surely our ingenuity would have suggested such a method. One possibility may be to first make the estimates of resource deficits from all parts of the budget, adjust these with estimated/predetermined amounts of Plan (and other) grants and arrive at a figure of overall deficits to be tackled by the Finance Commission itself. The Finance Commission may decide to cover the whole or a part of the assessed deficit based on any chosen principle, but at least the methodology would be comprehensive. To allow for actual plan and other grants being substantially different from those estimated by it, it may even make its own grant amounts contingent upon the actual turnout of the estimated/ predetermined transfers. It is essentially a question of the Finance Commission making up its mind to shed its inhibitions. In the scheme of public finances, the developmental imperatives would require both higher capital expenditure and larger revenue expenditures (e.g., on doctors, teachers, etc.) by the less developed states. The past practice of Finance Commissions assessing future expenditure requirements based on data for a base year is unfair to less developed states as it in effect condemns them to a low level equilibrium for ever. To be progressive, the expenditure assessments have to be based on some measurement of expenditure needs rather than past trends. This is particularly important for low-income states that are heavily dependent on central transfers, of which the Finance Commission awards constitute the bulk. The third methodological correction relates to debt liability of states. It is no coincidence that the most debt-stressed states in India are the less developed states, barring one or two exceptions arising from excessive and short-sighted pandering to vested interests in the electorate. Existing horizontal imbalances, coupled with the developmental aspirations of the less developed states have resulted in such states trying to bridge the gap, on their own as well as with guidance from the Planning Commission, with investments financed by large doses of borrowings in the past. However, given the lack of substantive revenue base (a consequence of the relatively low levels of development) in these states, servicing 259

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the loans adequately has proven difficult, resulting in slide towards progressively higher fiscal deficits and unsustainable debt levels. There is a fundamental inconsistency in a fiscal stance that tries to fund large developmental expenditures with borrowings— eventually such developmental expenditures are crowded out by contractual obligations. It is relatively recently that this has come to be appreciated by these states, and they have tried to rein in their borrowings by cutting down expenditures. Also, the high growth rates in the recent past, the debt swap mechanism and the phasing out of Plan loans has helped to slow down the rise in debt-GSDP ratios of poorer states. The basic problem, however, remains, and cannot be wished away. From available indications, the state government bond market appears to be considering states’ income levels rather than the status of the states’ finances to determine the risk involved. In such a situation, a fully market-based solution of the debt issue is likely to work against the interests of the less developed states and some assistance by the Government of India in raising state debt is perhaps necessary.6 Also, given their backlog of developmental expenditures, any home-grown effort at creating necessary infrastructure facilities will inevitably cause some accumulation of debt by such states. Thus, the relevance of debt restructuring and write-off remains. However, to keep such measures free from perverse incentives and ‘moral hazard’, it is important to make them conditional upon the states’ own efforts at tackling this issue. Macroeconomic considerations point to continued need for fiscal responsibility, and this may be a convenient conditionality for debt relief measures, but with somewhat different content. Since many states have achieved revenue surpluses and low fiscal deficits; the conditionality will have to be changed from reduction in deficits to maintenance of low levels of deficit. More importantly, the permissible deficit levels for individual states will have to be different, corresponding to the long-term development resource 6

A more detailed discussion of this issue can be found in Sen (2003).

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shortfalls of each state. This will be a difficult issue to tackle, but not impossible to resolve. All other issues examined by the Finance Commission need to be treated in ways consistent with the basic approach outlined above. For example, the problem of calamity relief has to be approached with the understanding that there are two aspects to this issue of disaster management: preparedness and relief. Past expenditure data on calamity relief are poor indicators of need because of existing horizontal imbalances. Entitlements for calamity relief should depend on only two factors: some independent and objective assessment of the severity of the disaster, and the concerned state’s ability to bear the needed relief expenditure. Contributions (for any Fund relating to expenditures in the area of disaster preparedness), in contrast, should depend on the ability of the state to contribute only, perhaps modified on the basis of a priori likelihood of occurrence of disasters.

VII Summary and Conclusions

Starting from the notion that horizontal imbalance in India is by and large synonymous with regional inequality, I have adduced evidence to show that both are highly correlated and show no significant reduction over the years. To see whether there may be a converging tendency, which may then make public intervention less important or even unnecessary, I turn to a priori theoretical reasoning first. Since theory does not provide a clear answer, empirical studies are examined next. The latter yields a tentative answer that there is probably little absolute convergence among Indian states, meaning without public intervention, the gap between states will persist and may even become wider. Clearly, if policy makers value regional equity, then public intervention is called for. 261

Tapas K. Sen

Looking for justification for equalizing transfers in public finance literature, one finds some controversy but eventual resolution in terms of some theoretical justification; such transfers are not only equitable, they are expected to promote efficiency as well. But the strongest justification for such transfers comes from constitutional mandate, judicial requirements or societal desire across nations. In India, though there is no explicit constitutional requirement of equalization, I argue that combining the pointers contained in the Directive Principles and the specific provision regarding grants-in-aid, the intended principle of equalization can be made out. Examining the possible ways in which public intervention may bring about equalization, we find that there is no evidence that financial intermediation by the public sector or the expenditures of the Union government have had any equalizing impact, leaving the entire burden of this task on the intergovernmental transfers. Even the Planning Commission, with its avowed objective of balanced regional development professed in several Plan documents, has failed to promote equalization in practice, it is found. Only Finance Commission transfers appear to have some equalizing impact. A detailed consideration of usual Finance Commission methodology reveals that there is scope to further improve some aspects of it that would have a greater equalizing impact. I argue that it is not only possible to carry out these improvements, but also necessary given the constitutional status of the Finance Commission as the sole authority on federal fiscal relations. The basic changes required are (a) covering the entire state budget instead of confining itself to only the non-plan revenue account, (b) jettisoning the projection of expenditure needs on the basis of past trends or base year values in favour of estimated needs and (c) appreciating the compulsions of less developed states regarding higher indebtedness and making allowances for it in all debt-related prescriptions. I argue that these basic methodological changes and the underlying logic thereof should inform Finance Commission recommendations in other areas like calamity relief and grants for local bodies as well. 262

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References Banerjee, Soumya S. and Saibal Ghosh. 1998. ‘Regional Disparities in the Allocation of Institutional Credit’, in Biswajit Chatterjee and Harendranath Sur (eds), Regional Dimensions of the Indian Economy, pp. 171–91. Kolkata: Allied Publishers. Barro, Robert and Xavier Sala-i-Martin. 1991. ‘Convergence across States and Regions’, Brookings Papers on Economic Activity, 1 (1): 107–82. Boadway, Robin and Frank Flatters. 1982. Equalization in Federal State: An Economic Analysis, Economic Council of Canada. Ottawa: Canadian Government Publishing Centre. Buchanan, J. M. 1950. ‘Federalism and Fiscal Equity’, American Economic Review, September, 40 (4): 25–43. Krishna, K. L. 2004. ‘Patterns and Determinants of Economic Growth in Indian States’, Working Paper no. 144, ICRIER, New Delhi. Myrdal, Gunnar. 1957. Economic Theory and Underdeveloped Regions. London: Methuen. Purfield, Catriona. 2006. ‘Mind the Gap—Is Economic Growth in India Leaving Some States Behind?’, Working Paper no. 103, International Monetary Fund, Washington DC. Rao, M. Govinda and Tapas K. Sen. 1996. Fiscal federalism in India: Theory and Practice. Delhi: Macmillan. Rao, M. Govinda, Tapas K. Sen and Pratap R. Jena. 2008. ‘Issues before the 13th Finance Commission’, Economic and Political Weekly, 43 (36) 6 September: 41–53. Sen, Tapas K. 2003. ‘Improving Sub-national Fiscal Responsibility in the Federal Context of India’ (ed.), India Infrastructure Report 2003, pp. 85–91. New Delhi: Oxford University Press.

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10 Regaining the Constitutional Identity of the Finance Commission A Daunting Task for the Thirteenth Commission K. K. George and K. K. Krishnakumar

States in India have been plagued by recurrent and severe fiscal crisis from the middle of the 1980s. Mismanagement of the finances by the state governments is the reason for the crisis, most often highlighted during the current discussions on the issue. The role of the central government, pivotal under the existing Centre–State financial relationship, is seldom mentioned as a possible reason, though it has been well established that Indian federal state is only a semi federal one and the existing constitutional allocation of financial powers between the Centre and the states is heavily skewed in favour of the former. It is well established that the Indian Constitution places considerable constraints on the states’ capacity for resource mobilization while saddling them with enormous expenditure responsibilities. The Constitution of India, however, envisaged a rather unique fiscal transfer mechanism to transfer funds from the central government to the states, taking into account the disproportion between the financial powers and expenditure responsibilities of the two tiers of government.

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Role of Finance Commission (FC)

The provision for a FC to be appointed by the President every five years or earlier under Article 280 of the Constitution is the only difference between the Government of India Act, 1935 and the Indian Constitution with regard to the distribution of financial powers between the central and the state governments. The Commission is visualized as a semi-judicial body and is entrusted with the twin responsibilities of apportioning central government revenues between the Centre and the states on the one hand and among the individual states on the other. But, over the years, the impartial arbitrator’s role of the FCs is being undermined by the central government in a number of ways. The turf of this constitutional body had been encroached upon to a large extent, by the Planning Commission, an extra constitutional body and the Union Ministries during the era of central planning. The fault for allowing this encroachment lies partly with the successive FCs which abdicated their constitutional responsibilities and limited their role, in tune with the wishes of the central government. In the context of the ongoing work of the Thirteenth Finance Commission (FC 13), this paper examines the record of the recent FCs with the objective of suggesting how best the present FC can and should assert itself unlike its recent predecessors and follow a new independent approach. Terms of Reference (ToRs): Fetters on the FC

Binding the Commissions by larger and larger number of ToRs is a measure increasingly adopted by the central government which undermines the umpiring role of the FCs. The ToRs are framed without consulting the states. It is as though the rules of the game are written by one of the teams in its favour when the game is about to be started. As late as August 2008, a new ToR was added to the FC13. These ToRs are unnecessary as the Constitution itself has defined the ToR of the FCs. According to the Constitution, this body is to determine the allocation of central revenues to be 265

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transferred to the states by way of sharing central tax revenue and providing grants to the states ‘in need of assistance’. Of course, the President can refer any other matter ‘in the interests of sound finance’ under Article 280. In addition to the constitutional impropriety, the present spate of ToRs are objectionable as they are loaded heavily in favour of the central government. The ToRs give a detailed road map on how and in which direction the FCs should proceed, thus limiting the freedom and flexibility of this constitutional body. The FC13 has been saddled with six ToRs. The third ToR has 10 sub-ToRs which include ‘the need to manage ecology, environment and climate change consistent with sustainable development!’ No doubt, ecology, environment, climate change and sustainable development are all important. But the only doubt is how this ToR fits in with ‘the interest of sound finance’ envisaged in the Constitution. Another sub-clause asks the FC to assess the impact of the proposed implementation of Goods and Services Tax with effect from 1 April 2010, including its impact on the country’s foreign trade! Also, this ToR does not come strictly under the purview of the FC. In fact, one can argue that the FCs should take into account the revenue loss of VAT suffered by exporting states due to central government’s insistence that the states cannot tax commodity exports not only at the point of exports but also at the penultimate stage of sale. Many of the ToRs reflect the economic philosophy of the central government which need not necessarily be subscribed to by many states ruled by different political parties. Already, some of the ToRs (e.g., ToR 2, ToR 3.4) have become obsolete in view of the recession creeping into the Indian economy. No doubt, the FCs are not duty bound to be tied by ToRs. But no recent FCs, constituted as they are, were prepared to assert its independence from the ToRs. Some of them were only too willing to be the cheerleaders for the agenda of the central government. Though funds through any channel, whether it is through FC or the Planning Commission or through the different Union Ministries are welcome to the states starved as they are of funds, 266

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they prefer funds coming through the FC channel. There are two main reasons for this. First, the states consider the funds coming by way of statutory transfers as their constitutional right as the FC unlike the Planning Commission is a constitutional body. Second, the funds through the FC are intended to be transferred to the states unconditionally for use by them according to their own priorities. Funds from the FC are to be received automatically and should be free from interference from the central government. As will be seen later, these intentions of the Constitution makers are gradually being negated by the recent FCs by making their transfers more and more conditional, linking them even to state-specific purposes and binding them to particular schemes to be monitored by the central government. The Context of the FC13

The FC13’s working may be seen in the context of (a) the deteriorating fiscal position of the states, (b) the logic of the central government’s own reforms agenda and (c) the onset of recession in the economy. The poor fiscal position of the state is too well established for any elaboration. But the implications of the central government’s economic reform agenda call for some elaboration. The reforms envisage the governments to reduce their role in economic activities and concentrate on providing social and community services like education, health care, social security, food security, etc. Under the constitutional dispensation, almost all these services come largely under the states’ or Concurrent jurisdiction. This suggests the need for increasing substantially the share of states in Centre’s revenue. But what has been done by the recent FCs in this direction is at best only marginal. The FC13 is deliberating at a time when the grip of recession on the economy is getting tighter. In the present times, some of the ToRs on fiscal discipline have become outdated. They stand in the way of governments both at the Centre and states providing fiscal stimulus to the economy by running deficits in their budgets. 267

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In recessionary times, the role of the state governments becomes all the more critical as it is they who have to shoulder primarily the responsibility of providing unemployment relief, food security and other welfare measures for the victims of economic slow down. Some Issues in Vertical Transfer

The Twelfth Finance Commission (TFC) had stepped up the states’ share in total central taxes only marginally, to 30.5â•¯per cent from the 29.5â•¯per cent fixed by the Tenth and the Eleventh Finance Commissions. This is despite the strong plea made by all the states unanimously to raise their share substantially. What is more, the stipulated 30.5â•¯per cent is not that of gross tax revenue but is that of revenue after excluding cesses and surcharges and after deducting the cost of collection. Consequently, despite fixing the share of states in total central taxes at 29.5â•¯per cent by the Tenth and Eleventh Finance Commissions, the limit was touched only in one year (1997–98) during the entire 10-year period covered by their awards. The gap between the actual ratios and the stipulated ratio has been widening during the award of the TFC as may be seen from Table 10.1. The exclusion of cesses and surcharges from the shareable pool of central taxes and the increasing resort to these measures by the central government are the major reasons for this shortfall. During the five-year period which ended in 1999–2000, cesses and surcharges accounted for nearly 3â•¯per cent of the gross tax revenue. In the next two years, their share was 2.7â•¯per cent.1 According to the TFC’s estimate, the share of cesses and surcharges were expected to go up steeply to about 12â•¯per cent during their award period.2 The FC13 should recommend some measures to 1 Based on Report of the Twelfth Finance Commission, (2005–10) p. 409, Chairman Dr C. Rangarajan, Government of India, 2004, New Delhi. 2 Based on Report of the Twelfth Finance Commission, (2005–10), op. cit. p. 381.

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Regaining the Constitutional Identity of the Finance Commission Table 10.1:â•…Share of States in Central Government Revenue (Figures in Percentages) Year 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07

Share of tax share of states in gross tax revenue of centre 25.73 25.35 25.67 27.50 29.36 26.91 26.33 27.23 31.28 27.22 25.32 27.41 28.25 25.95 25.86 25.77 25.78 25.41

Share of total revenue transfers to gross revenue of centre – 41.10 40.84 40.46 43.85 38.95 36.65 36.51 37.57 34.56 32.62 37.27 37.60 35.04 34.47 35.08 38.60 40.11

Sources: EPW Research Foundation, ‘Finances of Government of India’, Economic and Political Weekly, Different Issues; RBI, State Finances 2007–08; RBI (2007); RBI (2008).

arrest the increasing tendency of the central government to keep a good portion of central tax revenue out of the reach of the state governments. Alternatively, the cesses and surcharges should also be made part of the divisible pool. The TFC like its predecessor had suggested capping of the overall revenue transfers to states from the Centre’s gross revenue. It fixed the states’ share to 38â•¯per cent, an increase of just half aâ•¯per cent from the share stipulated by the Eleventh Finance Commission. It appears that there is no need for fixing the maximum for central revenue transfers as there is no corresponding minimum fixed for such transfers. Also, the ceiling of 38â•¯per cent proposed by the TFC was much lower than the actual states’ share during the first five years of the 1990s covered by the Ninth Finance Commission’s

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award. Then, the states’ share rarely reached the ceiling of 37.5â•¯per cent during the years since 1995–96. In 2005–06 and 2006–07, the state’s share exceeded the stipulated limit of 38â•¯per cent. But this was more on account of the proliferation of Centrally Sponsored Schemes (CSSs), not the most preferred means of transfers to the states. Use of Excess Funds with the Centre

Leaving too much funds with the central government beyond meeting its expenditure responsibilities in its own subjects and may be to a limited extent in the subjects in the Concurrent List does lead to proliferation of central plan and CSSs. The number and variety of CSSs in the state and Concurrent subjects are ever on the increase. Besides, only some of the traditional CSSs now go through the states’ budgets. The number of CSSs bypassing the state Budget altogether and reaching the para-state agencies and local bodies directly is increasing. It is estimated that the total outlay of all these varieties of CSSs in 2005–06 represented 38â•¯per cent of the Gross Budgetary Support (GBS) for Plan, 49.4â•¯per cent of the GBS for Central Plan, 165â•¯per cent of the total GBS for State Plans and 403â•¯per cent of the Normal Central Assistance (NCA) to states (Garg, 2006). The governments seem to have lost count of the schemes. The estimates of the number of schemes range between 155 (Expert Group of the Planning Commission, 2006) to 190 (Garg, 2006). The annual plan document of Kerala lists 200 CSSs against which funds are shown as anticipated from the central government. The present tendency of the Planning Commission is to bypass the route of Gadgil Formula for financing State Plans. Instead, more and more funds are being routed to the states by way of CSSs. The grant component of central assistance to states/UTs plan in the GBS of the Eleventh Plan has decreased from what has been realized in the Tenth Plan (from 26.4â•¯per cent to 22.8â•¯per cent).

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On the other hand, the allocation of CSSs has increased from 1.4â•¯per cent of GDP during the Tenth Plan to 2.35â•¯per cent of the GDP in the Eleventh Plan. The projected central assistance to the states/UTs for the Eleventh Plan under various schemes is `3,24,851 crores. Of this, normal plan assistance for all states is just `1,11,053 crores. CSSs constitute `2,13,798 crores, that is, 65.8â•¯per cent of the total (Isaac and Chakraborty, 2008). The FC which is enjoined ‘to improve the quality of public expenditure to obtain better outputs and outcomes’ must assess the productivity of these schemes especially after the end of each plan period when the central funds cease to come. In addition to the issues of efficiency of CSSs, the FC must also look into the equity and autonomy dimensions of the ever-expanding CSSs. In addition to CSSs routed through the state governments and other bodies, the central government, flush with funds is entering the state and the concurrent subjects through its own institutions. There have been instances of cash-rich central government taking over many of the institutions developed by the state from its own funds, avowedly to make them ‘Centres of Excellence’. The recent attempts to take over the Cochin University of Science and Technology and the Bengal Engineering and Science University and to convert them into Indian Institutes of Engineering Science and Technology (IIESTs) are examples of the central government taking over some of the institutions of the states, made first to starve for funds due to inadequate transfers by both the Finance and Planning Commissions. There are numerous other proposals now on the anvil to start heavily funded educational institutions in the central sector while the state institutions are getting debilitated due to paucity of funds with the state government. A classic case is the proposal of the central government for starting sixteen Central Universities, fourteen ‘World Class’ Universities, eight Indian Institutes of Technology (IITs) and five Indian Institutes of Science Education and Research (IISERs). There is also the proposal to start universities in every district which does not have a university at present. 271

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Shortfall in the Centre’s Revenue Collection: Implications for the States

The FCs had been wielding a big stick for disciplining the states by limiting the volume of grants barely enough to meet their deficits in non-plan revenue account, determined normatively by them. But no such stick is used in the case of the central government. All FCs had failed to discipline the Centre by linking the states’ minimum share to the central revenue determined normatively by the Commission for the next five years and not to what is actually collected by the Centre. This is evident from Table 10.2, which shows the revenue normatively estimated by the Eleventh Finance Commission and the actual revenue collected by the Centre. There was considerable shortfall in actual revenue mobilization by the Centre from what was envisaged by the FC in its norma tive estimates. The states lost heavily as a result of this laxity of the central government which upset their finances very badly. There seems to be a welcome reversal of the trend during the award period of the TFC. The FC should take note how the magnanimity of the central government in granting tax concession for the corporates is hurting the finances of the states. The Union Finance Minister had confessed that his ‘endeavour to increase the effective rate of corporate tax paid by the corporations are not entirely successful because of the demand for continuing exemptions or for introducing new exemptions’ (The Hindu, 2008). According to the statement of revenue forgone, tabled along with the Budget documents of 2007–08, the provisional tax expenditure in 2005–06 was estimated to be `2,06,700 crore. For 2006–07, the estimate is still higher at `2,35,191 crore. Some studies have shown that the effective corporate tax rate is only 20.6â•¯per cent as against the statutory tax rate of 33.66â•¯per cent. The de facto tax rates are higher regressive in nature. While the smaller companies pay tax at the rate of 25.4â•¯per cent, the larger companies pay at the rate of 19â•¯per cent. For the public sector companies, the rates are more than for the large private sector companies. It may also be noted that the 272

57,464 55,947 –1,517 255,690 244,550 –11,140 228,768 226,782 –1,986 77,425 85,234 7,809

FC estimate Actual Difference

FC estimate Actual Difference

FC estimate Actual Difference

FC estimate Actual Difference

Non-tax revenue

Total revenue receipts

Non-plan revenue expenditure

Revenue deficit

71,785 100,162 28,377

248,788 239,954 –8,834

298,162 254,834 –43,328

67,201 67,774 573

230,961 187,060 –43,901

2001–02

63,369 107,880 44,511

270,718 268,074 –2,644

347,684 288,556 –59,128

78,499 72,290 –6,209

269,185 216,266 –52,919

2002–03

51,552 98,262 46,710

294,732 283,502 –11,230

405,432 331,244 –74,188

91,599 76,896 –14,703

313,833 254,348 –59,485

2003–04

35,593 78,338 42,745

321,018 296,396 –24,622

472,780 381,121 –91,659

106,778 75,100 –31,678

366,002 306,021 –59,981

2004–05

65,202 92,299 27,097

310,676 327,903 17,227

413,838 443,350 29,512

70,135 77,198 7,063

343,703 366,152 22,449

2005–06

48,684 80,222 31,538

326,122 372,191 46,069

473,345 556,717 83,372

80,205 83,205 3,000

393,140 473,512 80,372

2006–07

Sources: Reports of the Eleventh and Twelfth Finance Commissions; EPW Research Foundation (2005); for 2005–06 to 2007–08, RBI (2008).

198,226 188,603 –9,623

FC estimate Actual Difference

Tax revenue

2000–01

Table 10.2:â•…Assessment and Actuals: Central Finances as per Eleventh and Twelfth Finance Commissions’ Awards (` in Crores)

K. K. George and K. K. Krishnakumar

IT-enabled Services (ITES) and BPO industries pay at the rate of 7.36â•¯per cent only. Software development companies pay at a still lower tax rate of 6.38â•¯per cent (Sridhar, 2008). Increasing Conditionalities of Debt Relief and Grants

In their debt relief recommendations, both the Eleventh Finance Commission and the TFC had violated the spirit of the Constitution by making debt relief conditional and linking it to fiscal reforms as conceived by the Centre. The rescheduling of loans was subject to the enactment of the Fiscal Responsibility Act. The quantum of write-off was linked to the amount by which revenue deficits are reduced during the award period. Going by the track record of most of the states in containing revenue deficits despite accepting the Medium Term Fiscal Reform Programme, it is quite unlikely that states will be able to gain substantially from the debt relief schemes of the TFC. It may be noted that many states had been able to avail of only two yearly installments of the Incentive Fund constituted as per the recommendations of the Eleventh Finance Commission. The increasing conditionality of statutory transfers is becoming evident in the way the grants were provided by the TFC. TFC had raised the share of grants in total transfers to 19â•¯per cent from 13.5â•¯per cent under the Eleventh Finance Commission and 9â•¯per cent under the award of the Tenth Finance Commission. Of the grants, the normatively determined unconditional deficit grants formed only 40â•¯per cent. More than a quarter of the grants were made for meeting specific purposes, most of them conditional and some of them very discretionary. Grants were extended for meeting specific purposes like health, education, maintenance of roads and bridges, maintenance of public buildings, maintenance of forests and heritage conservation. The Commission should have realized that there are a number of CSSs already operating in these areas. This leads to duplication, overlapping and conflict of jurisdiction. All the criticisms against CSSs are equally valid for FC sponsored 274

Regaining the Constitutional Identity of the Finance Commission

schemes. Besides, not all the grants of the FCs had a strong equitable bias (Table 10.3). In some cases, as in the case of grants for meeting state specific needs, the Commission’s discretion bordered on arbitrariness or mere caprice or whims. Sometimes, TFC went overboard and went into minor details regarding how the schemes financed by the grants should be utilized. Take this sample: In the case of the urban local bodies we have already stressed the importance of public-private partnership to enhance the service delivery in respect of solid waste management. The Municipalities should concentrate on collection, segregation and transportation of solid waste. The state governments may require the Municipalities…to prepare a comprehensive scheme including composting and waste to energy programmes to be undertaken in the private sector for appropriate Table 10.3:â•… Per Capita Grants-in-aid to Major States Recommended by the Twelfth Finance Commission (Figures in `)

State

Non-plan revenue deficit grants

Andhra 0.00 Pradesh Assam 105.37 Bihar 0.00 Gujarat 0.00 Haryana 0.00 Karnataka 0.00 Kerala 140.12 Madhya 0.00 Pradesh Maharashtra 0.00 Orissa 124.97 Punjab 1,205.99 Rajasthan 0.00 Tamil Nadu 0.00 Uttar Pradesh 0.00 West Bengal 354.95 All the states 519.14

Specific purpose grants

Grants for state Grants for specific Grants for calamity needs local bodies relief

Total grants

165.07

62.17

243.81

177.29

648.34

928.73 574.42 245.16 152.56 314.99 237.07 270.37

44.81 44.04 245.38 43.40 106.88 148.95 44.91

200.28 194.43 185.99 207.89 215.72 337.81 302.99

264.71 65.22 185.99 223.71 84.64 105.55 151.39

1,543.90 878.10 676.52 627.57 722.23 969.50 769.65

147.28 642.43 225.12 163.61 233.97 535.20 121.36 344.08

28.82 43.53 36.96 72.08 45.97 43.51 103.75 64.83

266.46 232.25 190.56 232.26 220.96 187.37 193.98 228.27

88.74 307.11 232.97 275.90 132.77 64.02 108.84 146.09

531.30 1,350.29 1,891.59 743.85 633.67 830.11 882.88 1,302.41

Source: Report of the Twelfth Finance Commission.

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funding from the grants-in-aid recommended by us. Grants-in-aid shall, however be available to support the cost of collection, segregation and transportation only, as the activities to be taken up by the private sector should be commercially viable once the Municipality is able to discharge its role effectively. (Rangarajan, 2004)

The largesses of the TFC can be seen in the sanctioning of a zoological park in one state and a botanical garden in another. In fact, TFC went to the extent of providing for multi-gym complexes and sports complexes at Taluk headquarters in Karnataka, by no means a fiscally disabled state (Annexure 10A.1). Many such schemes involved capital expenditure. In these matters, the TFC was making provision for new schemes, which normally find a place under the state plans. As noted earlier, according to the spirit of Article 275 of the Constitution, the statutory grants through the FCs should be mostly automatic and unconditional. No doubt, it was envisaged that in exceptional cases, the grants could be directed to broad but well-defined purposes. But the TFC had distorted the spirit of Article 275 and allotted more than one-third of the grants on conditional basis. The TFC had imposed its own priorities on the states. Besides, many ‘one size fits all’ schemes applicable to all parts of the country, which do not take the local specificities, distort the states’ priorities.3 The FC13 must steer clear of the past approach of the FCs in tying up statutory transfers to specific purposes and schemes. Finance Commission Awards and the State Plans

As noted earlier, the FC13 had been enjoined by the central government that it should have regard to the ‘demands on the resources 3 Perhaps, the Commission should have learnt from the pre-1969 experience of linking central plan financing to centrally designed individual schemes. This practice of linking plan finance to individual plan schemes was replaced by the Gadgil formula only because of its complexity, cumbersomeness, red-tapeism, inefficiency and arbitrariness.

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of the central government, in particular on account of the projected Gross Budgetary Support(GBS) to the central and the state plan…’. But FC13, instead of providing funds to the central government for GBS to state plans can and should provide such support directly as its own, by providing adequate non-plan surpluses through larger tax shares and grants. It is the policy of the FC with regard to tax sharing and grants that largely determines the surpluses in the states’ non-plan revenue account. But the FCs leave little or no surplus in the non-plan account of many states after devolution and gap grants. These states start with an initial handicap with regard to balance on current revenue, the nucleus for plan financing for the states (Table 10.4). For the states as a whole, the actual surpluses were less than the FC estimates except in the case of the Sixth FC. During the Seventh and the Eighth FCs, the shortfalls from the FC estimates of surpluses were quite large. From the Ninth FC onwards, the FC surpluses actually turned out to be deficits. This implies that the states as a whole started with negative balance in current revenue account to finance their plans. The distribution of non-plan surpluses among states after devolution and grants shows a regressive trend. For instance, the per capita non-plan revenue surplus of Assam, Bihar, Orissa, Rajasthan, Uttar Pradesh and Madhya Pradesh under the award of the TFC was much less than that of Haryana, Karnataka, Gujarat, Tamil Nadu, Maharashtra and Andhra Pradesh (Table 10.5). Thus, the relatively backward states faced a major handicap with respect to their plan financing as a result of the TFC’s award. Conclusion

If the FC13 does not want to remain as a pale shadow of its constitutional self, it has got to assert itself and find its own track. It should not go by the beaten track of its predecessors. It should also ignore those terms of reference which are not mandated by the Constitution. If it has to gain the acceptance of the states, it has to find an equidistant attitude towards the Centre and the states. 277

VI VII VIII IX (1989–90) IX (1990–95) X (1995–2000) XI (2000–04) XII (2005–06) XII (2006–07) XII (2007–08)

–5,531.3 –13,457.4 –36,385.0 –13,543.1 –121,548.0 –290,722.5 –450,923.3 –108,162.0 –99,698.3 –123,208.0

1,063.0 –6,633.6 –25,964.2 –7,975.5 –65,682.0 –168,397.0 –299,871.9 –44,279.0 –47,569.3 –67,239.0

505.0 12,409.3 25,261.7 6,218.0 32,016.0 84,017.5 125,252.6 27,492.0 52,482.0 64,060.0

FC estimates 4

2,734.7 7,264.0 1,858.6 –455.8 –22,598.9 –102,683.6 –226,022.1 –14,138.0 20,594.7 24,926.3

Actual 5

2,229.7 –5,145.3 –23,403.1 –6,673.8 –54,614.9 –186,701.1 –351,274.7 –41,630.0 –31,887.3 –39,133.7

Variance 6(5–4)

Sources: George, K. K., Limits to Kerala Model of Development, (1999), op.cit; Computed from Reserve Bank of India (RBI), State Finances, for various years. Note: Figures for 2007–08 are revised estimates.

–6,594.3 –6,823.8 –10,420.8 –5,567.6 –55,866.0 –122,325.5 –151,051.5 –63,883.0 –52,129.0 –55,969.0

Finance commission

Variance 3(2–1)

All states

Actual 2

All states

FC estimates 1

Surplus(+)/Deficit(–) after devolution of tax shares

Surplus(+)/Deficit(–) before devolution of tax shares

Table 10.4:â•…Non-plan Revenue Surplus/Deficit of All States (1978–2010) Finance Commission’s Forecasts and Actuals (` in Crores)

Regaining the Constitutional Identity of the Finance Commission Table 10.5:â•…Non-plan Revenue Surpluses after All Transfers under the Award of the Twelfth Finance Commission

States Andhra Pradesh Assam Bihar Gujarat Haryana Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal All the states

Post-tax devolution nonplan revenue Total grants surplus/ deficit in aid ( ` crores) ( ` crores) 1 2 37,779.30 1,866.72 21,457.02 35,635.54 25,379.85 58,910.94 3,884.87 33,924.41 57,979.91 2,580.79 –1,395.90 11,748.87 42,506.22 60,981.48 9,802.11 387,474.37

5,214.58 4,478.71 7,975.79 3,708.28 1,445.98 4,054.40 3,254.51 5,141.37 5,531.06 5,273.30 4,913.59 4,643.91 4,135.39 15,262.00 7,573.37 142,639.60

Total revenue surplus after all transfers ( ` crores) 3 (1+2)

Per capita revenue surplus after all transfers ( `) 4

42,993.88 6,345.43 29,432.81 39,343.82 26,825.83 62,965.34 7,139.38 39,065.78 63,510.97 7,854.09 3,517.69 16,392.78 46,641.61 76,243.48 17,375.48 530,113.97

5,346 2,187 3,240 7,178 11,643 11,216 2,127 5,848 6,101 2,011 1,354 2,626 7,147 4,147 2,026 4,840

Source: Report of the Twelfth Finance Commission, 2005–10. Note: Population projection by Census of India for 2006 is used for per capita calculations.

Annexure Table 10A.1:â•… Grants-in-aid Recommended by the Twelfth Finance Commission for State Specific Needs Grants-in-aid ( ` crores)

State

State-specific needs

Andhra Pradesh

Drinking water supply to fluoride affected areas

325

Improving the socio-economic conditions of the people living in the remote areas Arunachal Pradesh Treasury buildings

175 10

(Table 10A.1 continued )

279

K. K. George and K. K. Krishnakumar (Table 10A.1 continued ) Grants-in-aid ( ` crores)

State

State-specific needs

Assam

Development of urban areas Health infrastructure Technical education Establishment of Administrative training institute e-Governance Construction of homes under Juvenile Justice Act and improvement of remand home, after-care home and residential school for the handicapped Improvement of urban water supply and drainage Fire services Construction of residential schools and hostels for SC/ST/OBC Development of the state capital at Raipur Improving the police infrastructure Health infrastructure Salinity ingress Water logging/salinity and declining water table

Bihar

Chhattisgarh Goa Gujarat Haryana

Himachal Pradesh Development of urban areas Jammu and Tourism related schemes Construction of public service commission Kashmir building in Jammu Jharkhand Development of the state capital at Ranchi Special needs of the police force Karnataka General administration Youth services and sports facilities Improvement of police administration Improvement of health services Kerala Inland waterways and canals Coastal zone management Improvement of quality of school education Madhya Pradesh Development of tourism Development of road infrastructure Development of urban areas

121 9 50 50 40 20

180 10 50 200 100 10 200 100 50 90 10 200 130 250 100 100 150 225 175 100 67 208 25

(Table 10A.1 continued )

280

Regaining the Constitutional Identity of the Finance Commission (Table 10A.1 continued ) Grants-in-aid ( ` crores)

State

State-specific needs

Maharashtra

Infrastructure for women and child development programme Coastal and eco-tourism Secretariat complex Sports complex Loktak lake Zoological Park Botanical garden Bamboo flowering Sports complex Health facilities Assembly secretariat Consolidation and strengthening eco-restoration work in the Chilika lake Sewerage system for Bhubaneswar Stagnant agriculture Indira Gandhi Nahar Pariyojana Meeting drinking water scarcity in border and desert district Construction of airport Development of urban areas Sea erosion and coastal area protection works Construction of capital complex Establishment of a 150-bedded hospital for Dhalai district at Kulai Construction of a model prison at Bishalgarh Renovation of more than 100-year old collectorate buildings Accelerating development of Bundelkhand and eastern regions Development of urban areas Development of the state capital Promotion of tourism Health infrastructure Arsenic contamination of ground water Problems relating to erosion by Ganga-Padma river in Malda and Murshidabad districts Development of Sundarbans region

Manipur Meghalaya Mizoram Nagaland Orissa Punjab Rajasthan Sikkim Tamil Nadu Tripura

Uttar Pradesh

Uttarakhand West Bengal

Total for all states Source: Derived from the Report of the Twelfth Finance Commission.

281

50 250 3.5 15 11.5 30 5 40 25 15 30 30 140 96 300 150 100 250 50 28 11 10 60 700 40 200 35 5 600 190 100 7,100

K. K. George and K. K. Krishnakumar

References Annexure V.2, Twelfth Finance Commission Report, p. 381. Annexure VII.3, Twelfth Finance Commission Report, p. 409. PW Research Foundation, ‘Finances of Government of India’, Economic and Political Weekly, 30 July–5 August, 2005. Garg, Subhash Chandra. 2006. ‘Transformation of Central Grants to States’, Economic and Political Weekly, 41 (48) 2 December: 4977–84. Isaac, T. M. Thomas and Pinaki Chakraborty. 2008. Disquieting Trends in Indian Fiscal Federalism and the Thirteenth Financing Commission, Thiruvananthapuram: Kerala State Planning Board. Khusro, A. M. 2000. Report of the Eleventh Finance Commission (2000–2005). New Delhi: Government of India. Pant, K. C. 1994. Report of the Tenth Finance Commission (1995–2000). New Delhi: Government of India. Thiruvananthapuram. Planning Commission. 2006. Report of the Expert Group to Develop Concrete Proposals for Restructuring the Centrally Sponsored Schemes, Report submitted to Government of India. Rangarajan, C. 2004. Report of the Twelfth Finance Commission (2005–10). New Delhi: Government of India. RBI, ‘Union Budget 2007–08, Review and Assessment’, RBI Bulletin, May, 2007. Sridhar, V. 2008. ‘Corporate India has no Reason to Sulk’, The Hindu, 1 March, Cochin. RBI, State Finances: A Study of Budgets, Annual Issues, Reserve Bank of India, various years, Mumbai. RBI, ‘Union Budget 2008–09’, Review and Assessment’, RBI Bulletin, May, 2008. The Hindu, 2008. ‘New Income Tax Code Soon’, Special Correspondent Report, April 30, Cochin. RBI, 2009. Union Budget 2008–09: Review and Assessment, RBI Bulletin, May, 2008.

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11 Towards a Rational and Progressive Fiscal Policy What Role for Local Governments? M. A. Oommen

For forms of government let fools contest What e’er is best administer’d is best. —Alexander Pope

The above couplet is a poet’s way of arguing for good governance. Whatever be the form of government, good governance cannot be independent of the way its policy framework is conceptualized and implemented. This brief paper addresses the role of local governments under the new dispensation of fiscal federalism in India following the 73rd/74th constitutional amendments. In this presentation, I proceed on the assumption that local governments can contribute significantly in shaping a progressive fiscal policy framework and outcome for the country. Given the neoliberal1 fiscal 1 The fiscal policy theoretic underlying the neoliberal approach is exemplified in the Pareto-optimal efficiency and equity approach. An economic activity or fiscal intervention with reference to its outcome in a community is regarded as Pareto-optimal when no one can be made better off without making someone else worse off. Under such a regime when Rome is burning, the fiddling Nero cannot be disturbed because that will make him worse off. This approach is totally unacceptable to us.

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reforms currently well under way in India, it is widely accepted that India has lost its progressive fiscal character. A detailed examination of this is beyond the scope of the paper. The term ‘progressive’ is understood here to mean equity, ‘justice as fairness’2 and efficiency reckoned in terms of raising resources by way of taxes, non-taxes, beneficiary contributions, voluntary contributions and the like. The Third Stratum and the Emerging Fiscal Federalism

The Indian federation was originally designed as a two-tier system comprising the union and the states. As per the Constitution, the functional and financial domains are listed in the union, state and concurrent lists (Schedule VII of the Constitution). Local governments figure in the state list. The Constitution is designed with a built-in bias towards the Centre (Union). In the Indian federation, not only do the residuary powers rest with the Centre and several enabling provisions favour centralization, there is also a clear mismatch between resources and responsibilities. While the Centre has command over major sources of revenue and monetary resources, the states have to bear a larger share of the developmental responsibilities. The provision to establish a Finance Commission at the Union level (Article 280) to rectify the vertical and horizontal imbalances in the federal system through a rational system of intergovernmental transfers was done because of the built-in mismatches in revenues and responsibilities. While vertical imbalance (between the Centre, the State and now Local Governments) is largely fiscal, horizontal (i.e., inter-state/ inter-regional differences) imbalances arise out of disparities in demography, geography, local development resource endowments and so on which require fiscal corrections. The 73rd/74th Constitutional amendments which sought to create a third stratum of local self government institutions have significantly modified this

2

This is the approach of John Rawls (1971).

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fiscal federal structure. Indian federalism now will have to work within a multi-level public finance. In what follows in this Section, I shall try to critically evaluate the role of local governments in India’s fiscal federal arrangements. The traditional theory of fiscal federalism that assigns only a minor instrumental role to local governments3 does not (and surely should not) apply under the new dispensation. Even so, a major failure of the 73rd/74th amendments that created Part IX and Part IXA of the Constitution was that it did not spell out a local list of functions and financial domains. Instead, the constitution mandated the state legislatures to endow the local bodies with adequate powers and responsibilities in regard to expenditure and revenue assignments. Of course, an illustrative list of 29 subjects for panchayats (rural local bodies) and 18 subjects for urban local bodies are given respectively under schedule XI and Schedule XII of the Constitution to facilitate this. There is no mention of revenue sources and powers in the two schedules. The absence of a local list significantly affected the place of local governments in the fiscal federal setting of India for a variety of reasons. First, the Union government which made deep roads into the local government domain is left out from the reform process. Second, the threefold listing of functional subjects (Schedule VII of the Constitution) is not valid for the local governments whose functional responsibilities have to be spelled out into activities and sub-activities, mapping out the domains of the state on the one hand and that of local bodies on the other with a further three-tier demarcations for the Panchayati Raj Institutions (PRIs). It is to be noted that every local government activity is state-concurrent and there is no relevant alternative to activity mapping to evolve some operational role clarity. Third, looking back we find that very few states took to

There are strong exceptions like the Nordic Model (Denmark, Norway and Sweden) and the Switzerland model where local governments enjoy more autonomy and power than the Centre. 3

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valid operational activity mapping.4 It was in this context that the newly created Union Ministry of Panchayati Raj (July 2004) initiated a series of Memorandum of Understandings (MOUs) to hasten the process of decentralization with particular focus on activity mapping. Clarity in regard to functional responsibilities is an essential aspect of fiscal federalism which continues to be an unfinished agenda in India. The earlier this is sorted out, the better it is for the Indian federal polity. Fourth, it is to be noted that the multiple channels of fund flowing to the same functional activity is a clear case of wastage of resources. This is happening on an increasing scale, making governance unproductive and costly. The Constitution neither anticipated this nor provided for it. Both the Union and state governments are guilty of this malaise. The Constitutional Parameters

A systematic and rational flow of funds with a proper accountability mechanism is the key to any efficient fiscal relations in a multi-level federal system. Although one can point out that several conformity legislations and the rules framed thereof do not give much operational flexibility towards decentralization, I think there are at least four constitutional mandates which are binding and common to all states which help to design a good state sub-state level fiscal system, of course, within the Indian fiscal federalism. One, local governments have to work as ‘institutions of selfgovernment’ (Article 243G and 243W). Although what this means is not defined in the Constitution, it is obvious that adequate funds and fiscal autonomy with respect to the assigned functions along with administrative autonomy in regard to the management of the concerned functionaries will have to be ensured. If we are

The Committee on Decentralization of Powers of Kerala (1996–98) popularly known as the Sen Committee (after its first chairman Subrato Sen) was the first to suggest activity mapping which the Kerala government implemented. 4

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not moving on these lines, we are in the fiscal doldrums as regards fiscal decentralization. Fiscal decentralization means the fiscal empowerment of local governments as regards taxing powers and spending responsibilities. Two, each local government has to ‘plan for economic development and social justice’ and implement the projects and programmes planned (Article 243G). Needless to say, in this respect local governments have to stay within their functional domains. Read Article 243ZD along with this, which provides for the creation of a District Planning Committee (DPC) that has the responsibility to consolidate the plans at the various local government levels sectorally, and spatially there is a plausible case for building a progressive fiscal system. If the planners and policy makers of this country respect these constitutional mandates, a new regime of fiscal federalism that is equitable and progressive could be designed and implemented, through a strategy of decentralized planning and district development plan. Three, the most important fiscal instrument with reference to the state sub-state level fiscal relations is the creation of State Finance Commission (SFC) (Article 243I and 243Y). SFC is a counterpart of the Union Finance Commission (UFC) at the national level. SFC is expected to put the federation’s inter-governmental transfer system at the state sub-state level on a rational and surely an equitable basis. Here it is important to note that Article 280 of the Constitution which provides for the creation of the UFC has been amended as part of the 73rd/74th Amendments to add sub-Clauses 3 (b) and (c) which mandate the commission (UFC) to recommend 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’. These provisions clearly show the organic link between the sub-state level fiscal arrangements with the federal fiscal structure of the country. Indeed, the quality of sub-state level fiscal relations as well as the type of fiscal policy outcomes will depend a great deal on the quality of the financial 287

M. A. Oommen

‘review’ (expected as per Article 243I) and the recommendations made by the SFCs. The primary task of the SFCs is to usher in a rule-based equitable transfer system at the state sub-state level. Indeed the local governments are no longer to be viewed as an appendage of the state departments but only as viable units of local governance. Four, the gram sabha/ward sabha, which the Constitution has created for ventilating the choices and preferences of the citizens, is a crucial democratic institution the counterparts of which are seldom found anywhere else in the world. It is also the mechanism to ensure what we may call downward accountability to the community. It is the sovereign concept of citizen and not the commercial concepts like client, customer, and consumer found in western fiscal literature that should occupy the centrestage in decision-making and collective choice. Nowhere in the history of local governance do you find local governments mandated to plan for ‘economic development and social justice’ along with the task to prepare a draft development plan for the district. The institution of gram sabha/ward sabha, which is an assembly of citizens, is meant to give expressions to their preferences and priorities in development. Tiebout (1956) postulates that individuals (households) ‘shop’ among a large local jurisdiction in an effort to balance marginal site costs (including all tax ‘price’) with the marginal evolution of public-services packages. It is important to note that such costless out-migration of ‘consumers’ in search of their preferred public-good packages or ‘voting by feet’ as Tiebout (1956) puts it, is untenable in the context of a country like India where the majority of people depend on land for a living. The concept of consumer choice does not gel well with the concept of citizen’s participatory rights and agency role.5 The Panchayat Municipality Acts of several states (e.g., Kerala, Madhya Pradesh, West Bengal Agency here does not mean acting on behalf of a higher government but as capability to set and pursue one’s own goals and interests (for information on agency, see Sen, 1999). 5

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and Orissa) have conferred substantial overseeing functions to gram sabha/ward sabha. The key to the success of an accountable local democracy depends very much on the development of an effective accountability relationship between the panchayats and the local community. Towards a Progressive Fiscal Policy Framework

I shall now try to spell out the possible role of local governments in formulating a progressive fiscal framework for the country, given the relevant constitutional parameters some of which we have outlined in the earlier section. The most important issue to be recognized is the need to restructure the traditional macro-level public finance to suit a multilevel fiscal system which is made mandatory following the 73rd/74th constitutional amendments. The Terms of Reference (ToR) of the Eleventh and Twelfth Finance Commissions required them to suggest a plan for restructuring public finance, of course with focus on restoring budgetary balance and achieving macroeconomic stability. Obviously the mandate was to work within the neoliberal fiscal reform agenda (e.g., the Fiscal Reform and the Budget Management Act) The ToR to ‘review the state of finances of the Union and the States and suggest a plan by which the governments collectively and severally may bring about a restructuring of the public finances’ implicitly involve the local governments as well. No restructuring of federal finance could leave them out. But the Eleventh and Twelfth Finance Commissions totally ignored them. The whole issue has to be addressed de novo or by the Thirteenth Finance Commission (FC13) which is presently underway. True, the ToR of the FC13 do not include the issue of restructuring public finance. But there are innumerable ways to address this suo motto as part of the various ToR-related issues they have to address, notably those relating to panchayats and municipalities. Moreover, by assigning a share of the divisible tax pool to the local governments along with that to the states, the 289

M. A. Oommen

ThFC can take a major step towards a comprehensive public finance in the Indian federal system. It is important to recall here that the conventional wisdom that local governments are irrelevant for macroeconomic management and stabilization is strongly refuted on the basis of strong empirical evidence by Anwar Shah (2008). Restructuring of public finance is no sinecure task. Several issues have to be simultaneously addressed. A view has to be taken regarding the multiple channels of fund transfer arrangements to the states and local bodies. The transfer system consists of three sources: (a) statutory transfers made on the recommendations of the UFC, (b) assistance given by the Planning Commission for plan purposes and (c) transfers by central ministries on schemes designed by them. The last two are not constitutionally permitted transfers but still form part of the extant transfer arrangements. UFCs no longer function as the sole arbiter of intergovernmental transfers in India. The SFCs at the state sub-state level will have to steer clear of the historical perversities to which the UFCs passed through at the federal level. From the third UFC onwards, they have chosen to limit the scope of their recommendations largely to non-plan areas. The SFCs will have to take a total view of finance. This is critical. A serious constraint that inhibits state sub-state level fiscal policy has been the progressive in-roads made by the union ministries through the Centrally Sponsored Schemes (CSSs). These are specific purpose discretionary plan expenditure and operate through state governments or through state agencies or local governments. Nearly 63â•¯per cent of CSSs bypass the state budgets. The CSSs which are nearly 200 in number have become important levers with which the Centre affects the choices and priorities of the states and local governments and block the emergence of ‘institutions of self-government’ at the local level. It is desirable to model special purpose grants from the Centre on an ‘a la carte’ basis, with the states’ share in aggregate grant funds determined on a formula-driven objective basis and the states allowed to choose the schemes from a menu of CSSs and spend as much money 290

Towards a Rational and Progressive Fiscal Policy

on any particular scheme, according to their preferences, out of the total share allocated to them (Garg, 2006: p. 4984). Instead of continuously multiplying unilaterally various CSSs, the latest being the major flagship programmes, this would have been a better alternative that safeguards the autonomy of the lower tiers of government. In the system of multi-level public finance in India that we postulate, local governments have to play a major role in ensuring equity notably horizontal equity as well as in providing minimum standards of public goods and services. Indeed this is an important way to accommodate the large diversity in the demand for nonmarket goods by the public. I may mention two agencies which are crucial in this regard. They are (a) the 2.4 lakh strong gram panchayats among the local governments and (b) the State Finance Commission. An important way to achieve spatial equity in providing quality primary schools, primary heath care facilities, drinking water, street lighting, sanitation, solid waste management, clean environment and so on in the county, is to work through gram panchayats and strengthen their capacities. Except Kerala and to a lesser extent West Bengal, most states have failed to appreciate this. In Kerala, more than 70â•¯per cent of the total plan funds of PRIs and nearly 62â•¯per cent of the total plan funds of all local governments are accounted for by the gram panchayats, while in Karnataka, widely known for its progress in decentralization, only 5â•¯per cent of the total PRIs’ expenditures is accounted by the gram panchayats. This is anomalous. Gram panchayats at the cutting-edge level is the key instrument to ensure horizontal equity in local level expenditures. When states like Karnataka (Karnataka gives every gram panchayat a lump sum grant of `5 lakhs) give the same amount to all gram panchayats, they virtually violate the canon of equity. As we have already mentioned, the most important fiscal instrument mandated to put the state sub-state level fiscal relations on an efficient and equitable footing is the institution of SFC. Even so, the most disquieting situation in the post-amendment regime 291

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has been the poor performance of the SFCs. As the Twelfth Finance Commission puts it: We find that most states are yet to appreciate the importance of this institution in terms of its potential to carry the process of democratic decentralization further and evolve competencies at the cutting edge level by strengthening the PRIs and the municipalities. The delays in the constitution of the SFCs, their constitution in phases, frequent reconstitution, the qualification of the persons chosen, delayed submission of reports and tabling of the action taken report (ATR) in the legislature have defeated the very purpose of this institution. This cannot, but, be a matter of concern for the central finance commission, which has to adopt their reports as the basis for its recommendation. (Government of India, 2005: 150)

Unless and until the SFCs are meaningfully streamlined and the quality of their recommendations improved, the issue of ushering in a regime of progressive fiscal system will continue to remain postponed. A progressive fiscal policy can be built only on a progressive tax structure. In a multi-level tax system the real question to be asked is: Who should tax what and where? The answers to these questions have to be sought with reference to at least two basic canons of taxation viz., equity in distribution of the money burden of taxation, and efficiency in the collection and management of tax administration. The Indian Constitution, which borrowed a substantial part of its financial provisions from the Government of India Act, 1935, failed to raise this question. Even in the context of the 73rd/74th Amendments which offered another opportunity to ask this question de novo (at least in the state sub-state levels) failed once again. The number of taxes at the panchayat level ranges from three in Tamil Nadu to 18 in Gujarat as per the conformity legislations of India. But the most productive taxes at the municipality and gram panchayat levels are property tax, profession tax and entertainment tax. Surely, it is possible to introduce progressivity in the property taxes if the states want such a tax structure. In view of the fact that in almost all the states for both 292

Towards a Rational and Progressive Fiscal Policy

rural and urban local bodies, property tax forms the major source of tax revenue, it is possible to introduce tax progressivity at the third tier through a progressive rate schedule and exemption scheme. A related issue to be mentioned while discussing progressive fiscal policy is the need for building a strong Own Source Revenue (OSR) base for the rural local bodies.6 In view of the fact that the OSR of PRIs as a proportion of the total revenue in 2002–03 (based on TFC data) works out only to 6.8â•¯per cent (6.7â•¯per cent in terms of total expenditure), the need for improving their OSR is loud and clear. Without a strong OSR and a flow of untied funds through intergovernmental transfers, autonomy and the goal of ushering in responsive and responsible local government will be very difficult. The table given in Appendix 11A.1 shows that the per capita OSR ranges from `0.85 in Bihar to over `94 in Kerala with wide interstate disparities as elaborated in the graph (Figure 11A.1). The table highlights the fiscal disabilities and surely the poor revenue efforts of the PRIs. I wish to reiterate that the UFC and the SFCs, as well as the fiscal policy makers in the country will have to think in terms of designing an intergovernmental transfer system that will incentivize tax and non-tax revenue efforts, and take care of the revenue disabilities as well as the physical cost disadvantages. The transfer system should be such that every citizen irrespective of the choice of his/her residential location is assured a minimum set of public services that will enhance their capabilities. The burden of meeting high equalization transfers (both by the UFC and SFCs) will be progressively reduced as the minimum needs of localities are increasingly provided. To conclude, the traditional theories of federal finance do not accord an important role for local governments although there are conspicuous exceptions. The 73rd/74th Amendments by mandating the union and state governments to create a third

6 The situation of urban local bodies which generally contribute more than 50â•¯per cent of their expenditure is relatively better and hence not discussed.

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stratum of self-governments at the local level have inaugurated a new fiscal regime. This has tremendous potential for ushering in better territorial equity in the provision of minimum needs for all citizens irrespective of the choice of their residence. This brief note has attempted to raise certain issues in this regard which should engage the attention of academics as well as policy makers in the country. Appendix 11A Table 11A.1:â•… State-wise Distribution of Per Capita Own Revenue of PRIs 2002–03 Sl No.

Name of the state

Per capita own revenue

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Andhra Pradesh Assam Bihar Gujarat Haryana Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal All states

30.05 3.17 0.85 21.10 49.43 16.47 94.07 37.55 80.65 1.71 59.08 8.23 18.34 4.57 5.17 21.19

Source: See Oommen (2008: 65).

294

Source: See Oommen (2008: 65).

Figure 11A.1:â•… State-wise Distribution of Per Capita Own Revenue of PRIs 2002–03

M. A. Oommen

References Chandra, Garg Subhash. 2006. ‘Transformation of Central Grants to States: Growing Conditionality and Bypassing State Budgets’, Economic and Political Weekly, XLI (48) December 2: 4977–84. Government of India. 2005. Report of the Twelfth Finance Commission 2005–10, Ministry of Finance. New Delhi: Government of India. Oommen, M. A. 2008. Fiscal Decentralisation to Local Government in India. Newcastle, UK: Cambridge Scholars Publishing. Rawls, John. 1971. Theory of Social Justice. New Delhi: Oxford University Press. Sen, Amartya. 1999. Development as Freedom. New Delhi: Oxford University Press. Shah, Anwar. 2008. ‘Fiscal Decentralization and Macro Economic Management’ in M. A. Oommen (ed.), Fiscal Decentralization to Local Governments in India, pp. 12–47. Newcastle, UK: Cambridge Scholars Publishing. Tiebout, Charles. 1956. ‘A Pure Theory of Local Expenditure’, Journal of Political Economy, 64 (5) October: 416–24.

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Section

III

Public Policies and Institutions towards Addressing the Development Deficits

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12 Unbalanced Growth, Tertiarization of the Indian Economy and Implications for Mass Living Standards Utsa Patnaik

Nearly two decades have passed since the inception of neoliberal economic reforms and trade liberalization from 1991. There have been more rapid structural shifts in the Indian economy than during any previous period of comparable length since Independence. The most notable features are acceleration in the growth rate of the overall economy as measured by Gross Domestic Product (GDP) growth, characterized by a rapid decline in the share of the primary sector in contributing to the nation’s income, stagnation in the share of the secondary sector and rapid rise in the share of services which has risen from about one-third to more than half. A decline in agriculture’s contribution to GDP and a rise in nonagriculture’s contribution have been traditionally regarded as representing ‘industrialization’ and ‘progress’. We know that today’s advanced capitalist countries went through a phase of sharp reduction in the importance of agriculture and a corresponding rise in the contribution of non-agricultural activities, particularly of manufacturing, to the nation’s income generation as they industrialized. This classical path of industrialization was then followed in the post-World War II period by a rise in the share of the services 299

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sector as these economies moved to a phase of mature capitalism. Simon Kuznets (1966), on the basis of historical time series has established these trends systematically. However the process we observe in India during the reform period is clearly not one of classical ‘industrialization’ but can be rather described more accurately as ‘tertiarization’ of the economy. This is because the decline in agriculture’s contribution or that of the primary sector generally, is not accompanied by any rise in the share of industry, which after rising a little up to 1997–78 has been stagnating at a relatively low level of about 23 per cent to 24 per cent of GDP for the last decade (Table 12.1 and Figure 12.1). Table 12.1:â•… Per cent Contribution (Three-year Averages Centred on Specified Years) of the Economic Sectors to GDP in India, from Output Values in 1999–2000 Prices 3-year average centred on 1982–83 1985–86 1988–89 1991–92 1994–95 1997–98 2000–01 2003–04 2006–07

Primary

Secondary

Tertiary

39.03 37.10 34.75 33.46 31.44 28.97 26.54 26.33 21.08

22.11 22.23 22.74 22.87 23.45 24.19 23.11 23.64 24.51

38.86 40.67 42.51 43.66 45.11 46.84 50.34 50.03 54.41

Source: RBI (2008). Note: Annual data at 1999–2000 prices of output value at factor cost, summarized as three-year averages centred on the specified year and expressed as per cent to three-year GDP averages.

This was not always the case. We know that at Independence, India inherited a legacy of deindustrialization induced under two centuries of colonialism, namely, destruction of a segment of artisanal manufacturing with the unrestricted inflow of manufactured textiles, and that the colonial government’s stores purchase policies meant that even the simplest manufactured goods continued to be imported from Britain. Limited growth of a few industries like iron and steel, cement, sugar manufacture and 300

Indian Economy and Implications for Mass Living Standards Figure 12.1:â•… Per cent Contribution of the Economic Sectors to GDP in India, from Output Values in 1999–2000 Prices

Primary

Secondary

Tertiary

Source: Data computed from information in Table 12.1

engineering goods started only as late as the inter-War period. The dominant trend between 1881 and 1931 was tertiarization, namely, a more rapid growth of transport, communication and services than of any other sector. After Independence, as planned, industrialization was undertaken, and the share of the secondary sector in GDP did register, while fluctuating, a slow rise as a trend from its initially low level. India’s current share of the secondary sector in GDP is substantially lower than that of China which is over one-third. The decline in primary sector’s share in India is entirely on account of the meteoric rise in the share of services which from less than two-fifths in the late 1980s, accounted for nearly 55 per cent of GDP by the triennium ending in 2006–07 as Table 12.2 and Figure 12.2 show. The sectoral shares in total employment are often used to supplement the output shares data and establish the trend or otherwise towards industrialization. While the primary sector’s share in GDP has declined rapidly, its share in employment has declined much 301

Utsa Patnaik Table 12.2:â•… Data for Figure 12.2: Three-year Averages Centred on Specified Years (Values in 1999–2000 Prices at Factor Cost)

1982–83 1985–86 1988–89 1991–92 1994–95 1997–98 2000–01 2003–04 2006–07

Primary

Secondary

Tertiary

GDP

3,851.10 3,949.08 4,088.29 4,293.76 4,463.08 4,700.27 4,817.13 5,382.70 5,116.50

2,181.78 2,366.71 2,674.76 2,935.27 3,328.59 3,924.08 4,194.47 4,832.25 5,950.75

3,834.32 4,328.50 5,000.05 5,602.92 6,403.55 7,597.75 9,136.11 10,227.74 13,206.74

9,867.20 10,644.29 11,763.10 12,831.95 14,195.23 16,222.10 18,147.71 20,442.68 24,274.00

Source: RBI (2008). Note: The output of sectors is per head of total population, so sector values sum to GDP per head. Figure 12.2:â•… Sectoral Output Per Head and Gdp Per Head, 1981–82 to 2005–06, (` in Constant 1999–2000 Prices)

Primary

Secondary

Tertiary

Source: Data computed from information in Table 12.2.

less, implying a widening adverse gap between agricultural output per worker and productivity in the remaining sectors (Figure 12.3). 302

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Table 12.3 shows that the relative output per worker (GDP share divided by employment share) in agriculture has declined from 0.57 to 0.36 from the early 1970s to date. Figure 12.4 shows the absolute values of real output per worker in agriculture which became completely stagnant between 1993–94 and 1999–2000 and rose little after that to 2004–05, a period when employment became stagnant. Table 12.3:â•… Share of Agriculture in GDP and Employment and Per Worker Relative Output During 1983 to 2004–05 (in Percentage) Indicators

1983

1993–94

1999–2000

2004–05

AG./GDP AG./Empl. Ratio

36.76 68.27 0.54

30.01 63.88 0.47

24.99 60.24 0.41

20.22 56.47 0.36

Source: RBI, 2008 for Output data, NSS Reports for Employment. Figure 12.3:â•… Share of Agriculture in GDP and Employment, 1983 to 2004–05

Source: Data computed from information in Table 12.3.

While incomes in agriculture have stagnated at the other pole, the tertiary sector has registered a rapid rise in productivity with income per head of total population at `13,207, exceeding the combined per head income from the primary and secondary sectors by 2006–07 (Table 12.4). 303

Utsa Patnaik Table 12.4:â•…Number of Workers (All-India Rural, in Million), and Real Output per Worker (in `100 and in 1999–2000 Prices at Factor Cost) Year 1983 1993–94 1999–2000 2004–05

Output per worker ( ` 100)

UPSS workers (in million)

117.775 140.437 170.507 170.492

206.68 239.35 240.26 258.77

Source: Output from RBI (2008), employment from NSS Reports. Figure 12.4:â•… All-India Rural, Number of Workers, Million and Real Output Per Worker (in `100 and in 1999–2000 Prices at Factor Cost)

Source: Data computed from information in Table 12.4.

The relative stagnation of the material productive sectors, especially agriculture during the economic reforms period is not accidental but has been engineered by following policies which are strongly public expenditure-deflating. Such macroeconomic contraction forms the core of the policy regime of neoliberalism. Of course, there is no objective economic rationale from the point of view of the welfare of the masses, for following such policies. They do subserve the long-term interests of advanced capitalist countries which want both unhindered access to the productive capacity of

304

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tropical lands and to developing markets, as well as mass demand deflation to contain the domestic demand of the developing country populations for the products of non-renewable and increasingly scarce resources like land and fossil fuels. On the other hand, in a liberalized world economy corporations increasingly outsource their simple manufactures as well as ITenabled services to large developing countries, where both unskilled and skilled labour costs are a fraction of those in the metropolitan countries. This has provided the opportunity to India to increase the inflow of invisible incomes on account of services. The tertiary sector thus mainly accounts for the impressive growth of the overall Indian economy, and its weight in GDP appears to be rising every year. The tertiary sector contains a highly heterogeneous set of activities with the majority of those deriving their income from services, being petty small-scale retailers, processed food vendors or wage-paid manual workers in trade and transport, all with low per capita incomes near or below the national average. However, the major part of fast rising incomes in the tertiary sector is being generated on account of the small minority of persons engaged in highly paid financial services, IT-enabled services and partly in the hospitality sector. The phenomenal growth of the tertiary sector and inequality of income generation within it has so far attracted inadequate attention and analysis, apart from the IT-enabled services on which some literature exists. Part of the massive injection in purchasing power into the Indian economy over the last 15 years has been coming from the rapid growth of exports of IT-enabled services and of worker remittances from abroad. The economy has always registered a fairly substantial deficit on merchandise trade which has been largely offset by such increasing invisible earnings to produce in most years a small current account deficit, which had briefly turned into a small surplus for a year or two recently as the growth of the material productive sectors decelerated. A major source of injection of liquidity into the economy, however, has been the annual inflow of foreign capital, which in the last decade and particularly

305

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in the four years preceding the onset of recession from 2008 has far exceeded the magnitudes which could be justified by the small current account deficit. Capital inflow had been made an objective in itself under neoliberal reforms regardless of the state of the current account balance, and the interest rate regime as well as the regulatory regime has been increasingly liberalized to subserve the aim of attracting foreign capital inflow. In effect, imbalance in the balance of payments has been deliberately engineered under the dogmas of neoliberal thinking which puts rising capital inflow as an absolutely privileged objective for developing countries. Inflow of capital far in excess of the current account deficit raises the problem of how to deal with the resulting external imbalance and effects on the exchange rate, particularly since the internal macroeconomic policies under the same neoliberal regime have been public expenditure-deflating and any big spurt in planned material production with rapid rise in the import bill is thereby prevented. As is well known, this capital inflow has created its own problems of increased rupee demand and upward pressure on the exchange rate, which was dealt with by the Reserve Bank of India (RBI) through ‘sterilizing’ the effects of dollar inflow. Every $100 of inflow increases the foreign currency assets of the RBI, which at the prevailing exchange rate releases `5,000 into circulation, of which a part is spent by recipients and a part is deposited in banks, which at the given cash reserve ratio can then create additional credit provided the demand for credit is expanding. The RBI has been mopping up part of this potential tsunami of liquidity by issuing bonds to the banks, but nevertheless there is a substantial net increase of incomes in the economy. Both tax evasion on a part of these incomes and a rapidly expanding base of black money have added to this. Such injection of liquidity on a scale which has been getting substantially larger over time means that vastly increased incomes have been going into the pockets of the wellto-do minority of Indians, further accentuating the already high inequality of income distribution. 306

Indian Economy and Implications for Mass Living Standards

While a high degree of asset and income concentration has always prevailed, this type of rapid growth of purchasing power in the hands of a small minority is new and indeed unprecedented for the Indian economy since disproportionately high incomes are flowing to people who have no connection with material production in any form. The gross and growing imbalance between the near-stagnating primary sector and low-growth secondary sector on the one hand, and fast burgeoning incomes in the service sector has attracted too little attention. While material output, especially in the primary sector, has been growing below the population growth rate, incomes in the hands of the corporate sector and the minority of well-to-do Indians have been booming. While we do not have income distribution data, judging from the inequality of asset distribution, the top 10 per cent of all Indians is now likely to command more than two-fifths of the nation’s income. Such unbalanced growth—low expansion of material output and fast rise in elite incomes—carries certain implications for the level and pattern of final demand for goods from the material productive sectors emanating from the different classes in the country. The main implication follows from the fast increasing inequality of access to consumption of goods and services by different classes of the population. The argument of this author is that where material production growth itself is decelerating—below the population growth rate in the case of the primary sector, so that per capita supply of primary necessities is falling—then the rapid increase in purchasing power with the minority is bound to result in absolute decline in market access to basic necessities on the part of the majority, the mechanism for this being the stagnation of real income for the poor majority and even decline for a substantial segment within this set of consumers. One viewpoint which is different from this author’s analysis, takes off from existing input-output tables and says that rapid growth of the economy being services dependent is no longer generating demand as before for primary sector raw materials and other 307

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inputs, showing up in falling coefficients over time with respect to the final demand on agriculture of a unit rise in income in the nonagricultural sector. This explains, according to this view, why the primary sector is lagging while the rest of the economy is growing fast. However, this viewpoint can be contested on a number of grounds, based on the fact that growth in a primary sector, which is large and supports two-thirds of the population, cannot be assumed to depend solely or even mainly on demand from nonagriculture and is rather strongly impacted by public investment and development spending policies. First and foremost, under the macroeconomic contraction typical of neoliberal reforms, direct cut-back in public investment and in public expenditures in India has been severe, and it clearly explains the observed deceleration both in agricultural output growth and in the incomes of the agriculture-dependent population, and not the falling demand on the part of the non-agricultural sector. Severe decline in the autonomous component of expenditure, in particular public development expenditure, all through the 1990s (shown in Figures 12.5.1 to 12.5.3) produced, through multiplier effects, rise in unemployment and decline in the growth rate of incomes. The central government’s development spending which was growing at over 6 per cent annually in the 1970s and 1980s, actually became negative (absolute decline) in the economic reforms decade of the 1990s (Figure 12.5.1). The spending on economic services by the states taken together, became stagnant with near-zero growth in the 1990s (Figure 12.5.2) compared to over 10 per cent growth in the 1970s, which decelerated just below 4 per cent in the 1980s. Rural development and infrastructure spending halved to 1.9 per cent of the Net National Product (NNP) by 2001 compared to nearly 4 percent in the pre-reforms period (Figure 12.5.3). The issue of why expenditure deflation always forms the core of neo-liberal reforms has been discussed in greater detail in Patnaik (2002 and 2003).

308

Indian Economy and Implications for Mass Living Standards Figure 12.5.1:â•… Decade-wise Annual Growth Rates of Central Development and Total Spending, 1970–71 to 1999–2000

Sources: Data from Planning Commission, Reserve Bank of India (2008). Growth rates by Ramakumar (2008).

Figures 12.6.1 and 12.6.2 show the substantial rise in the rural unemployment rate on every concept of unemployment as revealed by National Sample Survey (NSS) surveys. While urban unemployment rate has also risen, it is to a smaller extent than the rural rise (Figures 12.6.3 and 12.6.4). This contraction in jobs and incomes in turn reduced the induced investment on the part of the primary sector producers, further affecting the growth rate of agricultural output which not only came down in the 1990s but has also continued to decelerate up to 2007. It must be remembered that in an entirely wage-based producing sector the net output does not coincide with the income of the workers, which is the wage bill. The primary sector, however, is one where the majority of producers are petty small-scale producers, for whom their net output is the same as their income. A substantial

309

Utsa Patnaik Figure 12.5.2:â•… Decade-wise Annual Growth Rates of Spending on Economic and Social Services by State Governments, 1970–71 to 1999–2000

Sources: Data from Planning Commission, Reserve Bank of India (2008). Growth rates by Ramakumar (2008).

proportion of workers are wage earners, whose employment is bound to go down as output growth goes down since labourcoefficients (labour days per unit of output) are not rising to compensate, but if anything, are falling as the well-to-do farmers primarily using hired labour mechanize farm operations. Thus, we see simultaneous reduction of output growth on the one hand, and in the purchasing power on the other hand of both the petty producers and wage earners in the primary sector, following from declines in autonomous expenditures. Second, input-output tables are static while the pattern of demand changes over time as incomes grow rapidly. The very construction of the coefficients of the input-output tables will be faulty if there is no insight into the sources of demand as income changes,

310

Indian Economy and Implications for Mass Living Standards Figure 12.5.3:â•…Central Government Rural Development Expenditure and Infrastructure Expenditure as Per cent of NNP

Source: Budget Documents, various years (annual issues); Government of India.

for then these sources will not be incorporated in the tables. A universally held misconception in this country is that as consumer income rises the demand for a basic necessity like foodgrains, falls. It is argued that as incomes rise fast in the hands of the top deciles of the population, we cannot expect any rise in the demand for foodgrains, as these top groups are already ‘satiated’. These ideas are totally misconceived and arise from a failure to understand that grain demand has two components, direct demand as food (boiled rice, roti, bread, etc.) as well as indirect demand, and the latter rises fast in developing countries as income per head rises. Indirect demand in turn has several components. The main component of indirect grain demand is use as livestock feed, which converts grain into livestock products (milk, eggs, poultry, meat); a second component is industrial use of grain (starch, alcohol) and a third component assuming increasing importance, particularly in advanced countries, is the conversion of grain to ethanol. The total demand for grain is the sum of direct and indirect demand, as P. A. Yotopoluos argued long ago (Figure 12.7) and as numerous empirical studies including the United Nations Food and Agriculture’s (FAO) country-wise data (Food Balance Sheets)

311

Utsa Patnaik Figure 12.6.1:â•… Unemployment Rates for Female Workers (All-India Rural 1993–94 and 2004–05)

Source: NSS Reports on Employment and Unemployment, Report No. 515. Figure 12.6.2:â•… Unemployment Rates for Male Workers (All-India Rural 1993–94 and 2004–05)

Source: NSS Reports on Employment and Unemployment, Report No. 515.

have since corroborated (UNFAO website). Far from falling, the total demand for a basic necessity like grain rises quite fast as the country’s per capita income rises. This is because an increasing share of grain output goes into indirect demand which outstrips direct demand after a point. Poor developing countries in South Asia and Africa currently have a very low total grain demand per capita of 130 to 150 kg annually compared to 700 to 800 kg in the 312

Indian Economy and Implications for Mass Living Standards Figure 12.6.3:â•… Unemployment Rates for Female Workers (All-India Urban 1993–94 and 2004–05)

Source: NSS Reports on Employment and Unemployment, Report No. 515. Figure 12.6.4:â•… Unemployment Rates for Male Workers (All-India Urban 1993–94 and 2004–05)

Source: NSS Reports on Employment and Unemployment, Report No. 515.

industrialized European countries and nearly 900 kg in the United States. For the poor countries, indirect demand is one-fifth or less of their total grain demand whereas for the richest countries the converse holds, with direct demand being one-fifth or less of their total demand. Middle-income countries like Mexico with 375 to 400 kg annual per capita demand, approach a ratio of half and half for direct and indirect grain demand. 313

Utsa Patnaik Figure 12.7:â•… Direct and Indirect Demand for Grain with Rising Income

Source: Yotopoluos (1985).

India is no exception to the universal trend of a rising demand for grain-intensive animal products as per capita income rises. Far from being ‘satiated’, the very top fractiles of the Indian population have been showing a rapid rise in indirect consumption. Analyzing the NSS data on consumption expenditure and nutritional intake by comparing the 50th Round 1993–94 with the 61st Round 2004–05, we find that the tonnage of grain demanded as animal feed has quadrupled over the period from less than five million ton to nearly 20 million ton, and its share in grain output has gone up. In this context, the steep decline of per head grain availability in India, almost identical with per head total demand for grain, is abnormal and alarming. The argument that it is to be expected because people are ‘diversifying diets’ away from grains to animal products suffers from a fallacy as explained since such diversification should raise and not lower total grain demand over time (which is what the Indian availability graph in Figure 12.8 is measuring). It is like saying that a steep decline in per capita coal demand does not matter because people have ‘diversified’ away from coal to 314

Indian Economy and Implications for Mass Living Standards Table 12.5:â•… Data for Figure 12.8 Per Capita Foodgrains Net Output and Availability three-year average ending in Kg per annum net output 1991–92 1994–95 1997–98 2000–01 2003–04 2006–07

178.8 181.6 176.8 177.7 164.1 161.3

Kg per annum availability 177.0 174.3 174.2 163.2 153.0 157.8

Source: Author (computed as per the information given in the Economic Survey 2008–09, Government of India). Note: Foodgrains comprise cereals and pulses. Availability is defined as net output (gross output minus one-eighth on account of seed, feed and wastage) plus net imports and minus net addition to public stocks. Availability is almost the same as demand, only changes if any in privately held stocks are not factored in owing to lack of data. Figure 12.8:â•… Foodgrains Output and Availability, 1991–92 to 2006–07

Source: Figure updated to 2006–07 from Patnaik (2007). Note: Note that foodgrains comprise cereals and pulses. Availability is defined as net output (gross output minus one-eighth on account of seed, feed and wastage) plus net imports and minus net addition to public stocks. Availability is almost the same as demand, and only changes if any in privately held stocks are not factored in owing to lack of data.

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electricity—thus ignoring the fact that over 80 per cent of electricity is generated from coal. Since per capita income has been rising, we would expect the total grain demand per capita to rise provided income distribution is unchanged or has changed little. But per capita grain demand, far from rising, has been falling especially steeply after 1997–98, and this cannot reflect anything but a particular type of worsening of income distribution with actual stagnation and decline in demand emanating from substantial population segments which outweighs the fast rise in the income and demand of the tiny minority. Figure 12.8 shows that while there is a slight upturn in overall per head output and availability (demand) by the last triennium, both still remain very substantially below the early reform period level by 21 kg per head of population. If the per capita demand level of 181.6 kg in the triennium ending in 1994–95 had been maintained (as shown in Table 12.5) (and this level itself is low), total grain demand by 2009 should have been 217.9 million ton net and 249 million ton gross even without any shift in the composition of demand between direct and indirect.1 But the 2008–09 output is officially projected at a maximum of 228 million ton gross, giving below 200 million ton net output, while availability is likely to be below this level since net exports continue and stocks are again building up. Instead of rising, per head demand has been falling, and the reason lies in the fact that the rise in demand per head on the part of the minority which has been getter richer has been more than These figures take a 2009 population of 1,200 million as projected by demographers. The official population figures used for calculating per capita values; however, have always underestimated actual population for the first seven to eight years of each decade. The practice followed is adding the same constant number (1.6 crore every year from 1991 Census total in the 1990s, 1.9 crore every year to the 2001 Census total). The implicit population growth rate is lowered below the actual one since a constant is being added to an expanding base. Adjustment is made in the last two to three years by suddenly adding a much larger increment. 1

316

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outweighed by the fall in demand per head on the part of the majority which has been suffering real income stagnation or actual decline under macroeconomic contraction in the material production spheres.2 This inference is borne out by the changes in the pattern of consumption. The real expenditure per capita both on food and on cloth registers decline over the reform period in rural as well as urban India while the real expenditure on all items other than on food plus cloth registers a corresponding rise. Real expenditures on food and cloth in rural and urban areas are calculated using the overall Consumer Price Index for Agricultural Labourers (CPIAL) and the Consumer Price Index for Industrial Workers (CPIIW), respectively. But both food prices and cloth prices have risen more than the average commodity basket, so the actual real decline in consumption of food and cloth is likely to be larger than these estimates show. Table 12.6 and Figure 12.9 show the situation for rural India. The real Monthly Per Capita Expenditure (MPCE) has risen between 1993–94 and 2004–95 to only 10 per cent to 14 per cent in all expenditure classes, except for the top 5 per cent of persons who have registered a much higher 28 per cent rise. The concentration of spending with the top group has thus increased. The overall rise in real MPCE is only `39 or 14 per cent over the decade. Bhalla, Hazell and Kerr (1999), starting with 1993 base year figures for India and taking low feed grain /livestock output coefficients, had projected two estimates of total (food plus feed) net cereal demand for year 2020, namely, 375 and 296 million tons corresponding to 6 per cent and 3.7 per cent per capita income growth. The distribution of income was assumed to remain unchanged. The demand growth rate from the year 1993, inherent in these estimates, gives us by 2005, 198.5 million tons and 218.5 million tons demand respectively, whereas actual cereal availability/demand in 2005 was only 157 million ton, 41.5 million tons less than even the lower projection although the per capita real GDP growth rate was 4.6 per cent over the same period (from the data in Table 12.2 in this chapter). The large shortfall in actual demand is owing to the loss of mass purchasing power outweighing the rising demand on the part of the minority. 2

317

100.37 130.68 152.89 177.55 200.01 222.10 249.45 281.52 324.94 398.30 500.27 872.39 281.40

MPCE Class

I II III IV V VI VII VIII IX X XI XII All

114.41 145.53 170.09 196.33 222.32 247.74 276.12 311.50 361.47 444.38 573.36 1121.89 320.40

MPCE Total 2004–05 73.12 95.78 111.57 128.62 143.09 156.40 173.18 189.89 212.99 245.92 285.41 370.49 177.77

Food 1993–94 78.31 97.74 112.85 127.18 142.26 155.92 170.11 187.25 209.71 239.62 285.56 377.94 176.38

Food 2004–05 0.92 1.32 2.16 2.92 4.17 5.87 7.61 10.72 16.13 27.65 47.17 98.52 15.12

Clothing 1993–94

Source: Various rounds of NSS, Government of India. Note: The 2004–05 nominal values adjusted to 1993–94 prices using the CPIAL.

MPCE Total 1993–94

Real spending on food and cloth 1993–94 and 2004–05

1.36 2.16 3.27 4.62 6.15 7.73 10.05 12.53 16.67 25.53 36.35 78.23 14.52

Clothing 2004–05

73.8 74.3 74.4 74.1 73.6 73.1 72.5 71.3 70.5 68.7 66.5 53.8 68.5

Per cent F+C/T 1993–94

All India rural

Table 12.6:â•… Data for Figure 12.9 (First Two and Last Two Columns Used)

69.6 68.6 68.3 67.1 66.8 66.1 65.2 64.1 62.6 59.7 56.1 40.7 59.6

Per cent F+C/T 2004–05

`

Indian Economy and Implications for Mass Living Standards Figure 12.9:â•… Real Monthly Per Capita Expenditure and Per cent Spent on Food Plus Clothing, 1993–94 and 2004–05 (All-India Rural)

Source: Calculated from NSS Reports on Consumer Expenditure, Report No. 402, 405 for 50th Round and Nos 508, 513 for 61st Round.

With such meagre increment in spending, the absolute spending on the twin necessities food plus clothing has actually gone down for half the population, is stagnant for another one-tenth and shows a negligible rise of `0.25 to `5 per month for the remainder. The overall real spending on food plus clothing has declined from `192.9 to `190.9, the share of food plus clothing in total monthly spending has declined from 68.5 per cent to 59.6 per cent and the share of all other items other than food and clothing, comprising energy use, transport, health and education has risen from 31.5 per cent to 40.4 per cent. There has been a more rapid rise of food and clothing prices than in other prices over the 1990s, not fully captured in the use of the general CPIAL and CPIIW as deflators. Food prices even from the Public Distribution System (PDS) nearly doubled over the 1990s as issue prices were raised in a misguided attempt to cut the food subsidy. Cloth prices rose rapidly with vastly increased exports of raw cotton and yarn. More accurate commodity-specific deflators would show decline in real spending for the bottom half 319

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of the population as well. Part of the explanation for the declining absolute spending on basic necessities like food and cloth lies in this higher relative price rise and part lies on the trend towards market pricing of basic utilities as well as health care which, being costs essential for earning a living, has forced even the poorer consumers to cut back on necessities and devote a higher share of their meagre spending to these items. Existing price indices give a very low weight to prices of these items while the actual weight has been rising. Urban India has also fared badly. The data show absolute decline in the real expenditure on food for every expenditure class except the poorest 15 per cent, and most of even this set would show a decline if the food price index rather than CPIIW is used as deflator. The same remark applies to the real cloth expenditure which shows marginal rise only for the poorer 70 per cent of consumers and a large enough decline for the top 15 per cent for the overall average for urban India to decline. The overall average real food expenditure shows a sharp decline from `563 to `498 and real expenditure on clothing declines from `131 to `111.5 (Table 12.7 and Figure 12.10). The idea of maintenance of the standard of living is that incomes should rise in tandem with the cost of living. Instead, money incomes for the vast unorganized classes of workers, mainly the peasantry and labourers, are not rising sufficiently to enable them to maintain even their already low living standards. Unavoidably rising expenditure on non-food items as a result of increasing privatization and market-pricing of utilities like transport and power, and of medicine and health services, have been incurred only at the expense of reducing spending on the basic necessities, food and cloth. The higher non-food spending does not necessarily get the poorer consumers larger quantitative or real benefits, but simply reflects the higher cost of private services and poorer access to affordable public services. All this is reflected in the decline in per capita real cloth expenditure, decline of per capita calorie intake and decline in per capita protein intake. However, the per capita fat intake has registered a 320

458.04 132.84 175.52 210.80 247.51 286.84 331.57 380.72 447.58 543.46 698.33 923.38 1,643.06

MPCE Class

All I II III IV V VI VII VIII IX X XI XII

521.49 138.58 182.42 218.69 264.24 310.12 361.83 425.17 502.61 607.73 790.09 1,068.98 2,098.93

MPCE total 2004–05 250.32 94.37 123.49 146.59 167.81 189.62 212.98 236.22 265.99 303.20 364.84 443.38 563.01

Food 1993–94 221.71 89.89 115.12 131.30 151.41 171.64 189.51 211.28 234.25 270.05 317.42 380.82 497.52

Food 2004–05

Source: Various rounds of NSS, Government of India. Note: The 2004–05 nominal values adjusted to 1993–94 using the CPIIW.

MPCE total 1993–94 21.43 0.84 1.61 2.70 3.78 6.13 7.77 11.93 17.47 26.00 41.17 63.10 131.44

Cloth 1993–94

Table 12.7:â•… Data for Figure 12.10

20.86 1.70 2.73 5.56 7.09 7.53 12.25 14.96 18.89 23.78 36.59 49.07 111.50

Cloth 2004–05

59.33 71.67 71.27 70.82 69.33 68.24 66.58 65.18 63.33 60.57 58.14 54.85 42.27

Per cent 1993–94 F+C/T

46.51 66.09 64.60 63.50 59.98 57.77 55.76 53.21 50.37 48.35 44.81 40.21 29.02

Per cent 2004–05 F+C/T

Utsa Patnaik Figure 12.10:â•… Real Monthly Per Capita Expenditure and Per cent Spent on Food Plus Clothing, 1993–94 and 2004–05 (All-India Urban)

Source: Various rounds of NSS, Government of India.

small rise, including for the poorer spending classes, which is on account of a very slight rise of consumption of oil, so small that it has hardly made a dent in declining calories from foodgrains, whose per capita output has been declining as we have seen, while access to the public distribution system has been restricted by the arbitrary division of the population into below and above poverty line. Concluding Remarks

To argue that the non-agricultural sector’s demand for agricultural products is declining owing to the very nature of services-driven modern growth and therefore agriculture is lagging behind, is to miss the real macroeconomics underlying the current Indian growth process completely. What is lagging behind is not just agriculture but mass purchasing power in both rural and urban areas, owing to a massive squeeze on the incomes of both the peasantry and the working class via rising unemployment and stagnant mass real incomes. If we use calorie intake as a deflator—invariant price index derived from the money expenditure required at the two points of time, 1993–94 and 2004–05—to access a given nutrition norm,

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we find an actual decline in real spending on food for all spending classes except for only the top decile of persons (Patnaik, 2007). Mass purchasing power stagnation and decline has followed from public expenditure reducing policies, which in turn has impacted the inducement to invest. Further, the rapid rise in tertiary sector incomes and purchasing power concentrated in turn in the hands of a tiny minority—about 5 per cent of all persons in rural India and about 10 per cent in urban India—is not independent of the changing pattern of final demand for a necessity like food, but is impacting it strongly to the detriment of availability for the rest of the population. Part of the minority’s demand is spilling over into imports of what would have been considered luxury consumption items only a decade ago, but certain types of elite demands for durables and assets like spacious housing, golf courses and domestic tourist resorts cannot obviously be ever met through imports. This author had earlier discussed issues relating to the land question to some extent (Patnaik, 2008). Such demand for land for residential housing, recreational land and so on puts further pressure on maintaining the rate of agricultural output growth, while a rising demand for grain for increasing indirect consumption also emanates from this small minority enriching itself, which thereby draws away with its superior purchasing power, an increasingly larger share of the declining per capita grain output, to the detriment of the nutritional standards of the mass of the population. Despite the implementation of the National Rural Employment Guarantee Act, the problem of mass demand deflation is far from over since coverage and implementation is patchy at best, and the world depression from the last quarter of 2008 is impacting to increase unemployment and reduce investment again in both rural and urban India. In such a scenario the inadequate growth of output of basic necessities combined with stagnating mass purchasing power and burgeoning elite demand, is creating a serious imbalance which has to be recognized to be addressed.

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Reliance on the world market cannot solve the problem because the output per capita of a basic necessity like foodgrains is falling at a global level too. After an episode of rapid food price rise, the global recession has masked the supply-demand imbalance which already exists. With any revival of demand on a large scale, which is required to reverse the trend of mass decline in living standards, rapid food price inflation too will become a reality. The solution lies in the simultaneous revival of both the production of necessities and of mass purchasing power. References Bhalla, G. S., P. Hazell, and J. Kerr. 1999. Prospects for India’s Cereal Supply and Demand to 2020. Washington DC: International Food Policy Research Institute. Kuznets, S. 1966. Modern Economic Growth: Rate, Structure and Spread. New Haven and London: Yale University Press. National Sample Survey Organisation (NSSO). May 1996. Report No. 402, Level and Pattern of Consumer Expenditure 1993–94, India. ———. October 1996. Report No.405, Nutritional Intake in India 1993–94, India. ———. December 2006. Report No. 508, Level and Pattern of Consumer Expenditure 2004–05, India. ———. May 2007. Report No. 513, Nutritional Intake in India 2004–05, India. ———. September 2007. Report No. 515 Part I and II, Employment and Unemployment Situation in India 2004–05, India. ———. December 2003. Report No. 497, Income, Expenditure and Productive Assets of Farmer Households. Available online at www.mospi.nic.in. Patnaik, U. 2002. ‘Deflation and Déjà vu’, in V. K. Ramchandran and M. Swaminathan (eds), Agrarian Studies: Essays on Agrarian Relations in Less Developed Countries, Delhi: Tulika, pp. 111–43. ———. 2003. ‘Global Capitalism, Deflation and Agrarian Crisis in Developing Countries’, Social Policy and Development Programme, Paper Number 13, United Nations Research Institute for Social Development (UNRISD), October. Geneva, Switzerland. ———. 2007. ‘Neoliberalism and Rural Poverty in India’, Economic and Political Weekly, 42 (30) 28 Jul–3 Aug: 3132–50.

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Patnaik, U. 2008. The Republic of Hunger and Other Essays. Delhi: Three Essays Collective (Second Print). Ramakumar, R. 2008. ‘Levels and composition of public social and economic expenditures in India, 1950–51 to 2005–06’, Social Scientist, Sept–Oct, 36 (9–10). Reserve Bank of India. 2008. Handbook of Statistics on the Indian Economy, October. Mumbai: RBI. United Nations Food and Agriculture Organisation (UNFAO). Available online at www.faostat.org (accessed on 20 September 2010). Yotopoluos, P. A. 1985. ‘Middle-Income Classes and Food Crises: The “New” Food-Feed Competition’, Economic Development and Cultural Change, 33 (3): 463–83.

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13 From Outlays to Outcomes Some Missing Links N. C. Saxena

High Growth and Poor Social Outcomes

In the last decade and a half that India has successfully embraced economic reforms, a curious problem has haunted the country and vexed its policy makers: the disconnect between high economic growth and poor social indicators is unfortunately becoming sharper by the year, as more data on health, nutrition and poverty is becoming available. Internationally, India is shown to be suffering from alarming hunger, ranking 66th out of the 88 developing countries studied (Menon et al., 2008). India as part of the world community has pledged to achieve the Millennium Development Goals by 2015, but the trends so far indicate that this target is unlikely to be met in respect of health, nutrition, sanitation and gender goals. Despite GDP rising by 8 per cent to 9 per cent every year, the National Family Health Survey-3 (NFHS-3) data shows that malnutrition in the age group of zero to three years has declined only by one percentage point in the last eight years. The progress on immunization has been equally dismal, as it has improved only by one percentage point from 43 per cent to 44 per cent in the last eight 326

From Outlays to Outcomes

years. Rural health care in most states is marked by absenteeism of doctors/health providers, low levels of skills, shortage of medicines, inadequate supervision/monitoring and callous attitudes. There are neither rewards for good service providers nor punishments for defaulters. It is a matter of concern that India’s pace of improving social indicators seems to be much slower than countries poorer than India, such as Bangladesh, Vietnam, Myanmar and Bhutan as shown in Table 13.1. Table 13.1:â•…India’s Social Indicators Compared with Other Developing Countries India Bangladesh Myanmar Vietnam Bhutan GNI per capita (US $) Infant mortality rate 1990 2007 Underweight children under five Immunized against measles Rural population with adequate sanitation Attendance ratio of girls to boys in primary school (net) (%)

950 83

470 105

220 91

790 40

1,770 91

54 43 67 22

47 41 88 32

74 32 81 81

13 20 83 56

56 14 95 50

96

106

102

100

91

Source: SOWC (2009).

Outlays

Though Government of India (GoI) allocations for education, health and other social sectors have increased significantly over the past one decade, part of this increase is illusory because the Pay Commission Award has added to the salary burden. Thus, the budget increase on its own may not have resulted in a corresponding increase in the number of teachers or doctors. Second, 70 per cent to 80 per cent of the total expenditure on the social sector is borne by the states, but they have not been able to arrest the decline in social expenditure. As a result, the combined social sector expenditure by central and state governments as percentage of GDP 327

N. C. Saxena

has remained stagnant at around 6 per cent for past several years, which is largely explained by the stagnant or declining share of Health and Education in total expenditure by the states, as shown in Table 13.2. Table 13.2:â•… Share of Expenditure on Education and Health as a Percentage of Total Expenditure by the States Year 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 (RE) 2008–09 (BE)

Education

Health

17.4 16.2 15.1 12.6 12.7 14.2 14.0 14.0 14.2

4.6 4.4 4.0 3.4 3.4 3.9 3.9 4.0 4.1

Source: RBI (2009).

India has the lowest share of GDP as public expenditure on health among the major countries of the world. India also has the most privatized health sector in the world. Our government (Centre and states combined) spends only 1 per cent of GDP on health, and the public sector share is less than 20 per cent of the total expenditure on health. In contrast, in most developed countries the share of government expenditure on health exceeds 5 per cent of the GDP and is more than 60 per cent of the total expenditure on health. Shift from Input Controls to Monitoring of Outcomes

Outlays should not be considered as an end in itself. Delivery of social services requires increasing financial resources, but more importantly the quality of public expenditures in these areas. This in turn requires improving the governance, productivity and accountability of government machinery. On the other hand, over the last two decades, there has been a sharp decline in the quality of services being provided by government to its citizens, especially 328

From Outlays to Outcomes

the poor. This is due to a large number of factors related to governance. We discuss these, and suggest some feasible solutions. Information Management

Officials at all levels spend a great deal of time in collecting and submitting information, but these are used neither for taking corrective and remedial action nor for analysis; they are used only for forwarding to a higher level, or for answering Parliament/Assembly Questions. Often data on performance reaches late, or is not available district-wise, with the result that accountability cannot be enforced. For instance, we do not have district-wise figures on Infant Mortality Rate (IMR), Maternal Mortality Ratio (MMR) and poverty. Had this data been available every year and for each district, it would have been easier to fix responsibility and improve performance. On the other hand, state governments do not discourage reporting of inflated figures from the districts, which again renders monitoring ineffective. As data is often not verified or collected through independent sources, no action is taken against officers indulging in bogus reporting. For instance, in Uttar Pradesh, the number of fully immunized children that is being reported by the state government is almost cent per cent. However, the Rapid Household Survey, conducted in 2007–08 put the figure of fully immunized children in Uttar Pradesh at just 30 per cent, which has shown no increase in the last 10 years. The practice is so widely prevalent in all the states, presumably with the connivance of senior officers, that the overall percentage of malnourished children, in case of zero to three years according to the data reaching GoI from the districts is only 8 per cent (with only 1 per cent children severely malnourished), as against 43 per cent reported by NFHS-3. The field officials are thus able to escape from any sense of accountability towards reducing malnutrition. A study was done in 2008 of 162 Nirmal Gram Puraskar (NGP) awarded Gram Panchayats (GPs) which included all the 37 NGPawarded GPs of 2004–05 and 125 NGP awarded GPs from 329

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2005–06 across six states, that is, Andhra Pradesh, Chhattisgarh, Maharashtra, Tamil Nadu, Uttar Pradesh and West Bengal. It was startling to find that only in six GPs out of 162 was there no open defecation, though these GPs were given the President’s award for claiming fully defecation-free status. What was more shocking was the fact that in around 20 per cent cases there was no construction of household toilets to begin with, which means that the certificate given by the state government was incorrect. In about 40 per cent cases, toilets existed but were not being used. Among the reasons for not using the toilets were poor or unfinished installation, blockage of pans and pipes, lack of behaviour change and no super structure. Such cases of flagrant over-reporting should not go unpunished, otherwise honest reporting would be discouraged. All Flagship programmes have monitoring mechanisms built in as an integral part of these programmes. Elaborate formats have been developed for collection of data from the primary reporting units such as Sub-Primary Health Centre (Sub-PHC) in case of National Rural Health Mission (NRHM)/Reproductive and Child Health Programme (RCH), schools in case of Sarva Shiksha Abhiyan (SSA), etc. These routine monitoring systems have several shortcomings and do not meet most of the requirements of a good monitoring system. The major shortcomings are listed as follows: 1. Lengthy and cumbersome formats of reporting—errors in compilation. 2. Data on delivery of services doctored at the primary unit units (at times at higher levels) to reflect higher performance. 3. Incomplete coverage. 4. Data flows upward—no questions asked on inconsistencies; no feedback provided. 5. Lack of analysis. 6. Lack of scrutiny and supervision. 7. No ownership and accountability of data at any level. 8. Too much data, not enough information. 9. Total lack of quality and, therefore, unusable. 330

From Outlays to Outcomes

10. Inappropriate system design of computerization. 11. Delay in receipt of information at all levels, which defeats the purpose of monitoring. It is not enough that the central government departments and the state governments use professional and academic organizations to undertake impact studies from time to time. Their findings must be publicized and discussed with key stakeholders so that improvements in design and delivery can be effected at the earliest. Governments should also put on their web sites findings of the impact studies, and distribute these in the workshops they organize. Dissemination of results is critical for use. Assess Quality

There are unfortunately no indicators for assessing the quality of programme outcomes. GoI and civil society may like to fill this void and produce reports that assess the quality of outcomes. For instance, one would like to know how many newly constructed toilets are being used, and what impact have they had on peoples’ health and hygiene. According to the Sector Reforms report by the United Nations Children’s Fund (Unicef) on Orissa, less than half of those who avail subsidy are actually using the toilets, either fully or partially. The district administration is not held responsible for poor utilization, because information is collected on construction, but not on usage. Pratham, a voluntary organization, has evolved a simple test in education which judges the extent of learning in primary schools. Their finding shows that the actual learning levels of students are abysmally low. Such studies should be organized repeatedly in a frequent manner, and for each district. Set Service Standards and Inform Public about It

The government should inform the people for each village/locality the standards of service they can expect in due course. For instance, 331

N. C. Saxena

the government should announce that although drinking water is available for ‘X’ hours a day today, it will be ‘Y’ hours after six months or after a year. Government’s failure to provide quality services is forcing common people to opt and pay for private provision, often only a shade better than what government provides. Measure Satisfaction

The system of information flow in the government does not report on satisfaction. The data on drinking water reports the number of taps and villages covered, but not the quantity, the quality or the availability of water distributed. If the objective is to increase public satisfaction, one must begin by measuring it over a period of time. Even when people have physical access to a service (school, PHC), they are largely dissatisfied with its quality. In Bangalore, where the satisfaction from public hospitals was being annually monitored, it improved from 25 per cent to 34 per cent between 1994 and 1999, but jumped to 78 per cent in 2003. This highlights the importance of regular information flows. Measure Absenteeism

While satisfaction may be subjective, and with economic progress people’s aspirations for high-quality services may have increased, quantitative data on absenteeism of both service providers and service receivers (students in classrooms, or women turning up for institutional deliveries) throws a great deal of light on the quality of service. For instance, a study of Rajasthan indicated that 45 per cent of doctors were absent from PHCs, and that sub-centres were closed 56 per cent of the time. Worse, the patterns of absences and facility closures were essentially unpredictable, so people could not plan their visits. With one in four government primary school teachers being absent on a given day, and only one in two actually teaching, India

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is wasting a considerable share of its education budget, and missing an opportunity to educate its children. The overall salary of teachers has little effect on their absence, since teachers cannot be fired and attendance rates do not affect their emoluments. However, better infrastructure does provide a stronger incentive to attend school on a particular day. Similarly, improving monitoring increases the marginal cost of teacher absence. Social Audit

Governments should introduce social audit by assessing the experience of the people service providers are intended to serve. With community participation, the evidence should be collected from stakeholders, so as to promote accountability, equity, effectiveness and value for money. Such an audit will supplement the conventional audit and will often provide leads to it. Financial audit aims at making organizations accountable to the government and to the legislature. Social audit makes them accountable to their stakeholders, especially in relation to the social objectives. Simplify Procedures

GoI had issued instructions for increasing Integrated Child Development Services (ICDS) centres in 2004, but the states took several years to complete formalities. Nine chief secretaries had to appear personally before the Supreme Court in March 2007 because the proposed centres were not made operational till then. The state governments could expedite the process and cut down on possible delays by undertaking activities concurrently rather than sequentially. For instance, they can complete several steps (creation of posts, recruitment, selection of villages and sites, advance budget provision) simultaneously rather than do one activity at a time, so that much of the delay can be reduced.

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Budget

Release of budget is neither certain nor timely. The budget cycle is too short for full utilization of funds for capital works. Expenditure budget should be valid for two years, so that capital expenditure can be completed without surrender of funds. Similarly, for Centrally Sponsored Schemes, approval of the state legislature should not be necessary for using central funds that are transferred to the state consolidated fund. Funds allocated to the departments in the state budgets are not released during the year in an orderly manner and far too many references have to be made to the Finance Department (FD) for prior approval for release of funds on ways and means considerations. Large funds are released at the end of the financial year resulting in many irregularities in booking the expenditure. The trouble arises because the precepts of financial discipline have not been internalized in the administrative departments and have to be imposed externally from outside by FD. It is high time this system is changed. The state governments should adopt, for this purpose, a system of Financial Advisors (FAs) obtaining in the GoI. Under this system, the FA is responsible to the main finance only on certain broad budgetary matters. In all the others, he works under the control of the administrative secretary. Selecting NGOs

Several programmes such as Information, Education and Communication (IEC) for sanitation are run by the Non-Governmental Organizations (NGOs). However, there is a great deal of wastage, as the procedure to screen out undesirable NGOs is often not in place. GoI may assist state governments in framing new Guidelines which would help the districts in identifying good NGOs in an objective manner, so that assistance is extended only to those NGOs who have a good track record and proven competence in (a) community mobilization, (b) implementation of development 334

From Outlays to Outcomes

projects through people’s participation, including expenditure through people’s committees and those (c) who have worked for the empowerment of the socio-economically disadvantaged people. It is of utmost importance that the process of selection of NGOs is completely transparent. Recruitment, Postings and Promotions

All states will recruit a large number of teachers, Anganwadi Workers (AWWs), Auxiliary Nurse Midwives (ANMs) and other medical staff in the coming years. Procedure for doing so varies from state to state, and some states are able to complete recruitment with minimum complaints or litigation because they follow a fair and transparent procedure. If the appointment is for a particular post (and not to the cadre), posting to remote and difficult places does not pose a problem. The centralized process of recruitment for a cadre affects backward areas adversely, as teachers selected through this process often resist appointments to schools in remote areas. One of the reasons for better attendance of AWWs is the fact that their post is not transferable. The state governments should also construct residential quarters for its block and village level staff if it wants to improve attendance. GoI should provide matching funds. A beginning can be made with tribal blocks for which the Ministry of Tribal Affairs and Backward Regions Grant Fund (BRGF) can be asked to contribute. In almost all states, there is frequent transfer of teachers from rural to urban areas at their request, thereby interrupting teaching and learning, particularly when the transfer takes effect in the middle of the school year. The transfer of teachers, and to some extent educational administrators, is considered to be one of the most politically sensitive areas. Teachers are a large community and transfer is seen as a politician’s tool for obliging, reprimanding or exhibiting their influence in the government. For all these reasons, politicians are opposed to a statutory policy on transfers.

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At the same time, it must be recognized that some posts are more attractive for the employees than others. This may be due to better location where good schools or cheap government housing is available, more challenges, the pull of private practice for doctors or simply more opportunities to make money. Except for the Indian Foreign Service, no other service categorizes posts according to its demand so as to ensure that everyone gets a fair chance to serve on both important and difficult (such as in remote and tribal areas) assignments. One should categorize posts in each department according to the nature of duties and geographical location into ‘A’, ‘B’ and ‘C’ posts, and chart out the kind of mix that should dictate the average officer’s span of career. At least for Group ‘A’ officers, one should be able to know through web sites that total transparency is being observed and whether some ‘well connected’ officials have not been able to get ‘plum’ postings and avoid difficult areas. Government positions in social sector should have an adequate representation of women. In some states, such as Rajasthan, the cadre of Child Development Project Officers (CDPOs) is not reserved exclusively for women, with the result that 88 per cent of the serving CDPOs are males. They are often on deputation from other departments, which reduces their sense of ownership with the ICDS. In most states, avenues for promotion for AWWs and supervisors are limited, and stagnation sets in their mid-career. It would be better if all supervisors are selected from eligible AWWs, whereas supervisors can be promoted as ACDPOs. A study of inter-state variation in these personnel issues will not only be welcomed by the states, but will show the way to healthy practices in recruitment, postings and promotions. There is also a great deal of variation in promotions of para-teachers to regular posts. In some states, such as Bihar and Orissa, salary disbursement to contractual staff is delayed by several months leading to demoralization and demotivation amongst the staff. This again can be avoided through more innovative procedures.

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Link Performance with Fiscal Transfers

Very little of GoI’s annual transfers to the states (roughly `350,000 crore, not including subsidies, such as on food, kerosene and fertilizers) is linked with performance and good delivery. Often, incentives work in the other direction. For instance, the Finance Commission (FC) gives gap-filling grants so that revenue deficit of the states at the end of the period of five years becomes zero. Thus, if a state has been irresponsible and has ended up with a huge revenue deficit, it is likely to get a larger gap-filling grant. In other words, FC rewards profligacy. The concept of good governance needs to be translated into a quantifiable annual index on the basis of certain agreed indicators such as infant mortality rate, extent of immunisation, literacy rate for women, child sex ratio, feeding programmes for children, availability of safe drinking water supply, electrification of rural households, rural and urban unemployment, percentage of girls married below 18 years, percentage of villages not connected by all weather roads, number of grade ‘A’ government officials prosecuted and convicted for corruption, and so on. Central transfers should be linked to such an index. Summing Up

To sum up, India requires is a significant increase of targeted investments in nutrition programs, clinics, disease control, irrigation, rural electrification, rural roads and other basic investments, especially in rural India, where the current budgetary allocations are inadequate. Higher public investments in these areas need to be accompanied by systemic reforms that will overhaul the present system of service delivery, including issues of control and oversight (Bajpai et al., 2005). Outlays should not be considered as an end in itself. Delivery of social sector schemes requires increasing financial resources, but more importantly the quality of public expenditures

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in these areas. This in turn requires improving the governance, productivity and accountability of government machinery. Development is an outcome of efficient institutions rather than the other way around. Focus, therefore, must be shifted from maximizing the quantity of development funding to maximizing of development outcomes and effectiveness of public service delivery. Concerted policy action is needed to improve the social indicators of the 300 million poor, increasingly concentrated in the poorer states. This requires additional resources for the social sector, as well as better policies and sound delivery mechanisms. Unless teachers attend schools and teach, doctors attend health centres and provide health care and incentives for them to do so are not perverse, a mere increase in the social sector expenditure would only result in further leakages and swelling of the already non-functional parasitic bureaucracy. References Bajpai, Nirupam, Jeffrey D. Sachs and Nicole Volavka. 2005. ‘India’s Challenge to Meet the Millennium Development Goals’, CGSD Working Paper No. 24, April, Working Papers Series Centre on Globalization and Sustainable Development, The Earth Institute at Columbia University, Columbia. Available online at www.earth.columbia.edu (accessed on 31 January 2009). Menon, Purnima, Anil Deolalikar and Anjor Bhaskar. 2008. ‘The India State Hunger Index: Comparisons of Hunger across States’, IFPRI Occasional Papers, October 14, New Delhi. Reserve Bank of India (RBI). 2009. State Finances: A Study of Budgets of 2008–09. Mumbai: Reserve Bank of India. SOWC. 2009. The State of the World’s Children 2009. Report submitted by Unicef, New York.

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14 Social Sector Expenditures An Analysis for All India and States, 1980–81 to 2007–08 S. Mahendra Dev and N. Sreedevi

I. Introduction

There has been significant progress in the social sector in India since independence. Indicators of human development such as literacy and education, and maternal and infant mortality rates show steady improvement, but they also suggest that the progress is slow and we continue to lag behind several East and Southeast Asian countries. In the post-reform period, there was a ‘feel good factor’ in some indicators such as growth in services, IT and communication revolutions, balance of payments, foreign exchange reserves, booming stock market, etc. On the other hand, the performance has not been satisfactory in social sector. One of the important determinants of social sector performance is social sector expenditures. In this chapter, we analyze patterns in social sector expenditures in the pre-reform and reform years covering the period 1980–81 339

S. Mahendra Dev and N. Sreedevi

to 2007–08.1 The focus of the chapter is on the Centre as well as the states, as these two layers of government have responsibilities separately laid down in the Constitution. While health and most of the rural development issues are the purview of the states, education, welfare and employment issues come under the concurrent list—common domain of both the Centre and the states. Hence, the states have much more responsibility than the Centre as far as social sector is concerned.2 In this chapter, the term or the concept ‘social sector’ is defined as the total of expenditure on ‘Social Services’ and ‘Rural Development’ as given in central and state budgets. The functional budgetary classification of ‘Social Services’ includes, among other things, education, health and family welfare, water supply and sanitation. The expenditure under the head ‘Rural Development’ (which is listed under ‘Economic Services’ in the budget classification) relates mostly to anti-poverty programmes. Thus, the objectives of social sector expenditure are (a) to achieve the social development by improving the social development indicators such as education, health and nutritional standards of the general population and (b) to alleviate poverty by implementing employment-oriented programmes. While the objective (a) attends to the social aspect of the society, the objective (b) focuses on the economic aspects. Apart from (wage and self-) employment programmes for the rural and urban poor, there are specific health and nutritional programmes for women and children which largely target the poorer segments of the population. This chapter has the following structure. In the second section, we analyze trends in social sector expenditures. The third section See Dev and Mooij (2002a, 2002b) for an earlier analysis on central and state budgets. 2 In actual practice, however, there is involvement of the Centre in all social sectors. Activities that come under ‘state’ are sometimes directly or indirectly funded by the Centre (as the states receive central assistance for their five-year plans as well as other financial support) and the Centre has a considerable influence on policy directions in the states. This influence is reinforced by the severe fiscal crisis many states are experiencing at present. 1

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briefly discusses some implementation issues, while the last section summarizes the main arguments and concludes the chapter.

II Trends in social sector expenditure

The trends of social sector expenditure are examined at three levels: (a) combined expenditure of Centre and states, (b) exclusively central expenditure and (c) expenditure of all states. The paper also attempts to discuss state-wise expenditures taking major states into account. The expenditures refer to both plan and non-plan. Combined Expenditure on Social Sector (Centre and States)

The combined social sector expenditure provides the best picture of India’s commitment towards the social sector. The expenditure has increased by 3.5 times from `385.6 billion in 1990–91 to `1,371.2 billion in 2000–01. The increase in social sector expenditure was more than double by 2006–07 RE at `3,031.5 billion as compared to that of 2000–01. States’ Share in Combined Social Sector Expenditure

The magnitude of states’ responsibilities, obviously, is reflected in its relative share in the combined expenditure. In 1990–91, the states’ share for the total social services was 84 per cent and that of rural development was 90 per cent (Table 14.1). Total social sector expenditure, combining social services and rural development, was around 85 per cent. The share of the states declined for most of the major heads during the 1990s. By 2000–01, the share of states in the social services declined by 1.4 percentage points while that of rural development declined drastically to 64.4 per cent and the net effect on social sector was decline by 4 percentage points. In 2006–07 (RE), the decline in these shares of the states 341

Education, sports, art and culture 173.8 Medical, public health, water 65.6 supply and sanitation Family welfare 9.3 Housing 7.7 Urban development 7.7 Labour and employment 7.3 Social security and welfare 38.7 23.9 Othersa Total social services 334.1 Rural development 51.5 Social sector expenditure 385.6 28.3 41.6 38.2 20.8 150.1 63.9 1,223.9 147.3 1,371.2

637.6 243.6 75.7 85.0 148.0 37.5 365.4 164.2 2,587.3 444.2 3,031.5

1,218.2 493.3 8.7 5.5 6.6 4.4 36.0 4.4 282.0 46.5 328.5

157.0 59.5 21.6 18.1 35.5 12.0 134.0 11.7 1,015.5 94.9 1,110.4

567.1 215.6 36.0 47.2 142.3 24.0 332.4 59.2 2,064.3 230.5 2,294.9

997.0 426.4

93.5 71.4 85.7 60.3 92.3 18.4 84.4 90.3 85.2

90.3 90.7

76.5 43.4 92.9 57.8 89.3 18.3 83.0 64.4 81.0

88.9 88.5

Source: Computed from the data available in Indian Public Finance Statistics, Ministry of Finance, GoI, 1995, 2002, 2007–08. Note: The information given in the table relates to actual expenditures for 1990–91 and revised expenditures for 2000–01. a Others include scientific services and research, broadcasting, information and publicity.

â•‡ 3 â•‡ 4 â•‡ 5 â•‡ 6 â•‡ 7 â•‡ 8 â•‡ 9 10 11

â•‡ 1 â•‡ 2

Sl No. Head of expenditure

47.6 55.5 96.2 63.8 91.0 36.0 79.8 51.9 75.7

81.8 86.4

Only states As percentage of total ( ` billion) share of states 2006–07 2006–07 2006–07 1990–91 2000–01 RE 1990–91 2000–01 RE 1990–91 2000–01 RE

Combined centre + states ( ` billion)

Table 14.1:â•…Combined Social Sector Expenditure: Share of States 1990–91, 2000–01 and 2006–07 (%)

Social Sector Expenditures

was considerable. The share of states in social sector expenditures declined from 85 per cent in 1990–91 to 81 per cent in 2000–01 to 76 per cent in 2006–07. The reasons for this consistent decline could be due to unrealistic budgeting of the state governments, unspent provisions either by the states or paucity of funds that are to be flowed from the Centre to the states. Increase in expenditures on Centrally Sponsored Schemes (CSSs) also could be responsible for the decline in share of states. Aggregate Picture of Combined Social Sector Expenditure

There are different ways of examining the trends in budget expenditures. One way is to look at social sector expenditures as a proportion of Gross Domestic Product (GDP) or Gross State Domestic Product (GSDP) in the case of the states. A second approach is to calculate social sector expenditure as percentage of aggregate budget expenditure. The third method is to look at the real per capita expenditures (at constant prices) for the social sector. All the three approaches are used to discuss aggregate social sector expenditure. At disaggregate level of expenditure, that is, major and minor heads, the analysis is restricted to proportion of GDP or GSDP. Table 14.2.1 does all these three angles for the period 1980–81 to 2007–08. India spent around 7 per cent of its GDP on the social sector during the 1980s ranging from 4.91 per cent in 1980–81 to 7.15 per cent in 1989–90, mainly because of the shift in the plan priorities in favour of social development. During the 1990s it was less than 7 per cent throughout the decade with a declining trend. In 1990–91, the share in GDP was 6.78 per cent and declined to 6.4 per cent in 1997–98 because of the financial crisis both at the central and state level and the moderation of expenditure in the context of reforms. Only in 1998–99 was a higher level reached. These ratios were lower than that of the highest value of the 1980s, which was 7.17 per cent. After two decades this percentage, however, reached to 7.31 per cent and 7.4 per cent during 2006–07 (RE) and 2007–08 (BE), respectively. 343

S. Mahendra Dev and N. Sreedevi Table 14.2.1: Social Sector Expenditure by Centre and States: 1980–81 to 2006–07 Social sector expenditure As % of GDP 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1980–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 1990–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2000–07

4.91 4.96 5.30 5.33 5.56 5.75 6.13 7.19 6.90 7.15 6.90 6.77 6.56 6.35 6.41 6.37 6.38 6.25 6.39 6.76 6.88 6.54 6.52 6.31 6.47 6.41 6.30 6.65 7.31 6.63

As % of agg. Pub. Exp. 20.17 20.90 21.10 21.29 20.78 21.18 21.06 25.29 25.22 25.19 25.49 24.85 24.28 24.06 24.58 25.01 25.95 26.46 26.18 26.54 25.96 25.66 24.83 23.42 24.01 23.15 24.07 25.50 26.97 24.78

Per capita exp. ( `) 1993–94 prices 269 298 336 363 388 419 471 573 584 612 516 611 600 591 622 634 672 732 791 901 978 748 950 958 1,016 1,053 1,096 1,256 1,509 1,142

Source: Computed from the data available in Indian Public Finance Statistics, Ministry of Finance, GoI, 1995, 2002, 2007–08.

Although there were signs of increase in the share of social sector in GDP, the averages show that the ratio was 6.6 per cent during 2000–07. This ratio is slightly higher than that of the 1990s (6.5 per cent) but lower than that of the 1980s (6.9 per cent). The 344

Social Sector Expenditures

decadal averages for the components show that (Table 14.2.2) these proportions were higher in the 1980s than in the 1990s, barring education, and again showed a marginal increase in the present decade. The net result is the decline in the social sector expenditure and also in the social services and rural development at disaggregated level from the 1980s to the 1990s and again marginally in the present decade. Similar is the trend of social sector expenditure ratios with respect to total expenditure. As proportion of aggregate expenditure, India spent between 20 per cent and 27 per cent on the social sector. During 1990–94, the share of social sector expenditure in the aggregate expenditure declined mainly because of the severe fiscal crisis. The percentage started to increase marginally in the middle of the 1990s. However, this increase cannot be interpreted as an increase because the expenditure proportion that declined in the earlier years has been restored or started increasing again. Since 1995–96, the percentage is higher than that in the 1980s. In other words, a higher percentage of government expenditure had gone to the social sector in the late-1990s than when the reforms started or during the last years preceding the reforms. However, it showed a fluctuated trend between 23 per cent and 26 per cent during first half of 2000s and increased in the last two years 2006–08—around the expenditure ratios of 1997–99. The decadal averages show that the ratio of social sector in total expenditure was the lowest during 2000–07 as compared to that of the 1980s and 1990s. In terms of per capita real expenditure, there is a continuous increase in every decade (Table 14.2.2). It started increasing from 1980–81 onwards, reflecting the normal course of increase along with the other increasing indicators. Per capita expenditure has increased from `611 in 1990–91 to `978 in 1999–2000, an increase of 60 per cent in a decade, mainly because of the lower growth rate of population during 1991–2001. It declined in the subsequent years mainly because of the declined social sector with respect to both GDP as well as aggregate expenditure. Increase in per capita expenditure in recent years is in the lines of other two variables mentioned above. There was significant increase in 345

104 143 217

5.13 4.93 4.72

10.39 11.38 10.68 210 332 493

1.39 1.25 1.26

2.82 2.90 2.86

Education

116 170 272

5.72 5.83 5.91

1.55 1.48 1.58

430 645 982

21.25 22.13 21.31

5.76 5.64 5.70

Total social services

86 103 160

4.24 3.52 3.47

1.15 0.90 0.93

Rural development

516 748 1,142

25.49 25.66 24.78

6.90 6.54 6.63

Social sector

Source: For the period 1980–85, www.indiastat.com; for the remaining years, various issues of Indian Public Finance Statistics, GoI.

As percentage of GDP at current prices (%) 1980–90 1990–2000 2000–08 As percentage of total expenditure (%) 1980–90 1990–2000 2000–08 Per capita real expenditure (`) 1980–90 1990–2000 2000–08

Period

Public health, family welfare and water Other social supply and sanitation services

Table 14.2.2:â•…Combined Government Expenditure on Social Sector

Social Sector Expenditures

per capita expenditure from `1,256 in 2005–06 to `1,509 in 2006–07. Comparisons with Other Countries and International Norms

A comparison of expenditures with other countries shows that public expenditures on education and health in India are lower than the other countries given in Table 14.3. The expenditure on education in India was 10.2 per cent of total government expenditure as compared to 12 per cent to 25 per cent in other countries in 2002–05. Public expenditure on health as percentage of GDP was only 0.9 per cent of GDP and this ratio is the lowest among all the other countries given in Table 14.3. In order to facilitate cross-country comparisons and monitoring of social sector expenditure over time, the United Nations Development Programme (UNDP) has proposed the following four ratios (UNDP, 1991): The Public Expenditure Ratio: The percentage of national income that goes into public expenditure. The recommendation is to keep this ratio around 25 per cent. l The Social Allocation Ratio: The percentage of public expenditure earmarked for social services. This ratio, according to the UNDP, should be more than 40 per cent. l The Social Priority Ratio: The percentage of social expenditure devoted to human priority concerns. This ratio has to be more than 50 per cent. l The Human Expenditure Ratio: The percentage of national income devoted to human priority concerns. This ratio is the product of the above three ratios and the UNDP recommends that it should be about 5 per cent. l

Table 14.4 gives these ratios for India in the late 1980s, the late 1990s and 2000s. It shows that public expenditure ratio is equal or more to the norm. But, social allocation ratio, social priority ratio 347

3.8 (4.1) 2.5 (2.5) 1.9 (2.1) – (3.7) (3.8) 6.2 (6.2) – (3.1) 4.2 (5.4) 7.4 (7.8) 5.2 (5.5) 5.9 (4.8) 5.4 (4.5)

10.7 (12.7) 14.2 (15.7) 13.0 (12.8) – 16.5 (17.4) 25.2 (26.7) – 25.0 (31.0) 12.9 (13.4) – (12.5) 15.3 (12.3) 12.1 (11.4)

2002–05 (1998–2000) 2002–05 (1998–2000)

As % of total govt. exp. 0.9 (0.9) 0.9 (1.5) 1.8 (2.0) 2.2 (1.8) 2.9 (2.6) 2.2 (1.8) 2.0 (1.4) 2.3 (2.1) 7.7 (6.2) 6.8 (6.5) 6.9 (5.8) 7.0 (5.9)

2004 (2000) 4.1 (4.0) 2.2 (2.6) 2.9 (3.4) 3.7 (2.3) 2.7 (3.3) 1.6 (1.6) 2.3 (1.7) 1.2 (1.6) 1.4 (1.8) 3.0 (2.5) 8.5 (7.3) 1.1 (1.4)

2004 (2000)

Private exp. as % of GDP

Health public exp. as % of GDP

Source: UNDP (2003, 2007–2008). Note: Figures in the brackets are from the UNDP, Human Development Report 2003.

India Bangladesh China Egypt Korea Malaysia Sri Lanka Thailand Sweden Canada United States United Kingdom

Countries

as % of GNP

Education

Table 14.3:â•…Public Expenditure on Education and Health: International Comparisons

128 (127) 140 (139) 81 (104) 112 (120) 26 (30) 63 (58) 99 (99) 78 (74) 6 (3) 4 (8) 12 (7) 16 (13)

HDI rank 2008 (2003)

Social Sector Expenditures Table 14.4:â•… Social Sector Ratios

Public expenditure ratio Social allocation ratio Social priority ratio Human expenditure ratio

UNDP Norm 25.00 40.00 50.00 5.00

Late-1980s – 20.00 34.00 2.50

1998–99 25.00 27.00 40.00 2.80

2000–08 26.74 24.80 – –

Sources: (i) UNDP (1991), 40–41 (see for figures under columns UNDP Norm and Late 1980s). (ii) Authors (remaining values were estimated using the data source as given in Table 14.1). Note: Social priority ratio was taken as the share of social sector allocation to elementary education, water and sanitation, public health, maternal and child health and child nutrition.

and human expenditure ratios are lower than the norms prescribed by UNDP. It is clear that there has been some progress in the 1990s, but the ratios are still far removed from the UNDP norms. Trends in Central Government Expenditures

Tables 14.5 and 14.6 give an overview of central government expenditure for pre- (1980–81 to 1989–90) and post-reform periods, 1992–93 to 1999–2000 and 2001–02 to 2008–09. As a proportion of GDP, central government expenditure towards the social sector was not even 1 per cent in the early 1980s, which has increased to around 1.62 per cent in 1987–88. This increase was mainly attributed to the shift in the plan priorities in favour of social development. But these proportions have declined in the last two years of the 1980s and continued in the first three years of the reform period, mainly because of the fiscal crisis, and again increased afterwards to about 1.6 per cent, which is a normal course. These fluctuations repeated in 2000–08 as well. In the last three years (2005–06 to 2007–08), the ratio increased and reached 2â•¯per cent of GDP. As a proportion of aggregate expenditure too, social sector expenditure increased from 4.43 per cent in 1980–81 to 8.11 per cent 349

0.34 0.42 0.55 1.84 2.62 3.58 25 47 99

0.30 0.32 0.50 1.67 2.01 3.23 23 36 89

Education

24 34 55

1.77 1.88 1.98

0.32 0.30 0.31

71 117 243

5.28 6.52 8.79

0.95 1.03 1.36

25 46 68

1.86 2.57 2.45

0.34 0.40 0.38

96 163 311

7.14 9.09 11.24

1.29 1.43 1.74

Social sector

Source: For the period 1980–83, Explanatory Memorandum on the Budget of the central government for 1986–87; for the remaining years, Volume I, Expenditure Budget, GoI.

As percentage of GDP at current prices (%) 1980–90 1990–2000 2000–08 As percentage of total expenditure (%) 1980–90 1990–2000 2000–08 Per capita real expenditure (`) 1980–90 1990–2000 2000–08

Period

Public health, family welfare and water supply Other social Total social Rural and sanitation services services development

Table 14.5:â•…Central Government Expenditure on Social Sector

Social Sector Expenditures

in 1989–90 and reached 10 per cent in the year 1995–96. It again showed a decline thereafter till 2002–03. But in the last three years, it reached 12 per cent to 14 per cent of GDP. In terms of per capita real expenditure, social sector spending increased from `38 in 1980–81 to `132 in 1989–90, to `235 in 2002–03. Though these indicators showed an increase with fluctuations, the trend growth rate is lower in the 1990s than in the 1980s, and these indicators showed an increase in the 2000s. However, in terms of GDP and per capita, they are lower than that of the 1980s while in terms of aggregate expenditure there is only a moderate increase. With regard to all these three indicators, it is clear that the trend growth rate per annum was much higher in the pre-reform period than in the reform period (Table 14.6). So, although social sector expenditure continued to increase in the 1990s (as per cent of GDP, as per cent of aggregate expenditure and in terms of per capita expenditure), it was at a much lower pace than in the 1980s and the increase in the present decade also reiterates the same. In the last few years, however, there is some turn around in the ratios in the last few years. Either the fluctuations or the declining trend of social sector expenditure ratios showed a negative impact on the social development. The increase in these ratios, after registering a decline for some period, cannot be considered as an increase; instead, one can say that it is either restored or recovered. In general, the share of social sector expenditure, either in total expenditure or in the state income, shows its importance in the priorities of government finances/objectives. The inconsistent trend of these ratios— decline in one period and increase in another period and again fall in the subsequent period—may not help either in achieving the set objectives of social development or in strengthening the claims of the government on human development. The decadal averages, however, show that the averages of social sector expenditure as per cent of GDP and as per cent of total expenditures are higher in the period 2000–08 as compared to the decades of the 1990s and 1980s. These percentages increased steadily over the three periods (Tables 14.5 and 14.6). 351

S. Mahendra Dev and N. Sreedevi Table 14.6:â•… Social Sector Expenditure (Social Services + Rural Development) by Centre As percentage of Year 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 Annual growth rate (1980–90) 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 Annual growth rate (1992–2000) 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 RE 2009–10 BE Annual trend growth rate (2000–08)

GDP 0.69 0.73 0.79 1.03 1.20 1.20 1.49 1.63 1.47 1.54 10.74 1.28 1.48 1.48 1.53 1.36 1.41 1.46 1.46 0.74 1.41 1.52 1.68 1.62 1.54 1.82 1.73 2.11

4.44

Source: Budget Documents, GoI.

352

Agg. exp. 4.43 4.92 4.90 6.46 6.86 6.43 7.47 8.48 7.90 8.11 7.46 7.84 9.04 9.35 10.23 9.32 9.26 9.17 9.59 1.63 9.11 9.58 10.00 9.46 9.76 12.92 12.31 13.94 17.74 16.62 6.17

Per capita 93–94 prices 38 44 50 70 84 88 115 129 125 132 16.22 119 144 147 161 159 174 195 208 7.33 205 231 264 266 269 345 357 464

10.91

Social Sector Expenditures

Intra-sectoral Allocations in Education, Health and Rural Development

Table 14.7 provides intra-sectoral allocations for education, health and family welfare and rural development for the post-reform period. It shows that there have been significant shifts over the 1990s within these sectors. 1. In education, there has been a sharp increase in the share of elementary education, particularly since 1995–96. This share increased continuously and consistently from about 18 per cent in 1992–93 to 40 per cent in 1995–96 and to 48 per cent in 1997–98. During 1998–2003, however, the share has declined and again started increasing constituting nearly 70â•¯per cent by 2006–07. However, it showed a decline in the last two years. A further disaggregation showed that this shift in favour of elementary education was due to the introduction of nutrition programmes, Sarva Shiksha Abhiyan (SSA) and District Primary Education Programme (DPEP). The shift towards elementary education led to a decline in the shares of secondary, university and higher, technical and adult education. 2. The intra-allocations for health and family welfare show that there was a sharp increase in the share of reproduction and child health from around 5 per cent in 1992–93 to 15 per cent in the late 1990s and further increased to 20 per cent in mid-2000s and later on started declining as the shift was towards medical education and public health. 3. In the case of rural development, the share of rural wage employment programmes declined drastically since the mid1990s. In 2002–03, however, the share increased considerably again mainly because of the introduction of Food for Work programme initiated as drought relief and to get rid of the huge food stocks held by the Government of India. The share for rural housing and other programmes increased in

353

Education Education sector 100 100 100 100 100 100 100 100 100 100 100 100 100 Elementary 18.6 20.2 20.5 39.6 42.0 48.1 42.9 39.0 37.7 44.3 41.7 50.7 54.6 Secondary 25.0 25.6 24.1 19.9 19.0 15.0 15.5 14.4 14.3 15.3 13.6 13.6 10.3 University and higher 28.0 24.9 25.6 19.9 19.5 20.2 25.1 29.6 31.0 20.5 19.3 17.0 15.1 Adult 6.3 7.8 8.5 4.7 3.1 1.8 1.3 1.1 1.3 2.2 2.3 2.3 1.8 Technical 18.7 18.3 18.6 14.0 14.5 13.0 13.6 14.1 13.5 15.4 15.0 14.2 10.9 Others 3.4 3.2 2.7 1.9 1.9 1.9 1.6 1.8 2.1 2.3 8.0 2.1 7.3 Health and family welfare Health and family welfare 100 100 100 100 100 100 100 100 100 100 100 100 100 Public health 16.6 16.6 18.0 17.7 19.7 18.9 16.4 14.1 14.4 12.6 11.5 10.6 12.9 Medical education 13.6 12.4 12.3 12.2 12.3 13.1 15.2 13.1 13.6 12.5 11.6 11.1 12.1 Rural family welfare 17.2 15.8 13.2 13.7 12.4 13.9 15.3 21.4 15.8 15.5 25.0 20.9 19.8 Maternal and child health 5.4 6.0 6.3 11.0 11.9 13.6 15.3 13.6 15.5 16.6 14.6 16.7 17.9 Other services and 21.1 26.2 28.5 23.1 19.5 17.6 16.5 17.9 19.7 20.3 12.2 14.9 13.2 supplies Others 26.1 23.0 21.7 22.3 24.2 22.9 21.3 19.7 21.0 22.4 25.1 25.9 24.0

100 100 69.7 68.6 7.7 8.9 11.6 12.5 1.0 0.9 7.2 6.8 2.9 2.4

100 57.5 11.6 15.2 0.6 11.2 3.9

46.5

50.3 51.35

52.1

100 100 100 100 15.0 15.8 14.6 14.9 13.0 11.4 9.8 11.5 12.5 8.4 13.0 12.1 9.92 10.9 9.02 7.4 3.0 3.3 2.3 2.1

100 66.8 8.9 12.4 1.6 7.7 2.6

2008– 1992– 1993– 1994– 1995– 1996– 1997– 1998– 1999– 2000– 2001– 2002– 2003– 2004– 2005– 2006– 2007– 09 93 94 95 96 97 98 99 2000 01 02 03 04 05 06 07 08 (RE)

Table 14.7:â•…Central Government Intra-sectoral Allocation: In Education, Health and Rural Development: 1992–93 to 2008–09 (%)

14.5 – 68.9

1.0

0.2 1.8

13.8 – 70.5

1.0

0.1 1.3

0.3 1.6

1.2

12.9 – 70.8

5.9 1.4

4.0

10.7 6.6 57.3

15.2 1.6

6.4

10.6 7.0 44.5

13.6 1.7

5.8

10.4 5.8 46.0

16.2 1.6

5.3

9.6 6.8 42.8

17.7 1.6

1.9

12.1 7.6 39.8

12.6 8.2

23.2

9.9 6.2 23.7

13.4 6.7

20.3

9.8 4.9 31.1

8.4 6.6

13.6

8.7 0.0 51.6

8.9 6.9

12.6

8.7 0.0 50.1

14.3 9.5

9.0 9.4

14.1 15.2

10.7 8.34 0.0 0.0 35.1 42.5

100 100 100 100 100 100 100 100 100 100 100 100 100 100 13.3 13.6 13.2 14.1 14.7 16.7 17.7 19.3 16.0 13.9 11.0 12.9 16.3 15.6

8.5 9.0

9.7 9.0

17.6 17.2

8.1 8.1 0.0 0.0 41.5 38.0

100 100 15.4 17.9

11.8 5.0

11.4

5.8 0.0 54.7

100 11.4

Source: GoI, Vol. II, budget papers. Notes: 1. All the data in this table refer to revised estimates (RE). 2. Others in health and family welfare refer to central government health schemes, hospitals and dispensaries and urban family welfare. Maternal and child heath was replaced by reproductive and child health in 1998–99. 3. Special programmes for rural development refer to IRDP, TRYSEM, DPEP, Desert Area development programme, etc. Rural wage employment programmes are JRY and EAS. Other rural development programmes refer to DWCRA, rural roads, million wells scheme and training.

Rural development Rural development Water supply and sanitation Special programmes Social security and welfare Rural wage improvement programme Other rural development programmes* Housing Others

S. Mahendra Dev and N. Sreedevi

the 1990s. In the case of the latter, there was a twelve-fold increase between 1999–2000 and 2000–01, as a result of the introduction of the rural roads scheme which is included in the item ‘Others’, known as the Prime Minister’s Gram Samrudhi Yojana (PMGSY). Due to higher expenditure on National Rural Employment Guarantee Scheme (NREGS), the share of rural wage employment programmes increased in 2008–09. Trends in Expenditure by States

As mentioned above, the main responsibility for social sector expenditure lies with the states. Earlier studies by Prabhu (1997), UNDP (1997) and Chelliah and Sudarshan (1999) have shown that social sector expenditure, either taken as a proportion of GSDP or as a proportion of aggregate expenditure, started to decline for the majority of the states since the mid-1980s and that this trend continued in the early 1990s. Our study confirms this trend for the entire decade of the 1990s and also in the present decade. Table 14.8 shows trend growth rates per annum of the average level of social sector expenditure for all states during the pre- and post-reform period. It shows that the trend growth of real per capita expenditure for social sector declined from around 9 per cent in the 1980s to around 6 per cent in the 1990s. It further declined to 4.6 per cent in the present decade too. The same trends can be seen for the growth rates of social sector expenditures–total expenditure ratios (barring 2000–08) and also in the ratios with respect to social sector–GDP ratios. As mentioned earlier, higher growth rates during the 1980s either for social services or for social sector was mainly due to reprioritization of plan during the sixth-plan period and the decline in the 1990s was attributed mainly to severe fiscal crisis. The declining trend continued during the present decade too. At the disaggregated level, the trend growth rate turned negative, particularly in education, health and rural development. The type of trends will not contribute to achieve the better indices of human development. The only items that did relatively well 356

Health and family welfare

Water supply and sanitation

6.95 7.22 4.31 2.13 1.34 –0.82 0.28 1.12 –0.45

6.09 7.53 9.71 1.31 1.63 4.32 –0.52 1.41 4.71

Social services 5

Total others 4

Source: Calculated from the data given in Appendix Tables 14A.1 to 14A.3.

1 2 3 Per capita real expenditure (at 1993–94 prices) on social sector 1980–81 to 1989–90 7.65 0.18 7.27 1992–93 to 1999–2000 7.72 5.28 6.92 2000–01 to 2007–08 1.70 2.37 6.03 Expenditure (revenue + capital) on social sector as % of GDP 1980–81 to 1989–90 2.80 –4.34 2.10 1992–93 to 1999–2000 1.81 –0.50 1.05 2000–01 to 2007–08 –3.30 –2.66 0.82 Expenditure (revenue + capital) on social sector as % of total expenditure 1980–81 to 1989–90 0.94 –6.07 1.82 1992–93 to 1999–2000 1.59 –0.71 0.83 2000–01 to 2007–08 –2.93 –2.30 1.20

Education, sports, art and culture, etc.

–6.26 –5.33 2.31

–6.01 –5.12 1.93

–1.25 0.39 7.20

6

2.46 0.30 –0.16

4.34 0.51 –0.54

9.27 6.35 4.60

7

Social sector Rural (Services and development RD)

Table 14.8:â•…Trend Growth Rates of Social Sector Expenditure of All States (Per cent Per Annum)

5.41 2.06 6.17

8.93 2.88 4.44

14.12 8.52 10.25

8

Social sector centre

S. Mahendra Dev and N. Sreedevi

in the 1992–2002 period come under the ‘total others’ category, and include housing and urban development, labour and employment, welfare and welfare of Scheduled Castes (SCs)/Scheduled Tribes (STs). In the present decade, there has been revival in the rural development expenditures. If we compare Columns 7 and 8, we see declining growth rates both at the central and state level while the performance of the states is worse in all the periods. While the reasons for the nonperformance of the states with respect to social sector need a separate exercise altogether, certain reasons are explained in the subsequent discussions. There are very few states that have been able to increase their social sector expenditure as percentage of GSDP. In terms of real per capita expenditure, however, the expenditure has often increased in the 1990s and also in the 2000s. Table 14.9 shows the inter-state differences in per capita expenditure on the social sector. The per capita expenditure is very low in Uttar Pradesh, Bihar and Orissa and relatively high in Goa, Gujarat, Maharashtra, Kerala and Tamil Nadu. However, in almost all states, the per capita expenditure on social sector has increased irrespective of the income category. Table 14.10 shows the trends in the 1990s and 2005–06. In this table, the states are clustered according to their per capita State Domestic Product (SDP), and are divided into three categories: rich, middle and poor. The per capita index shows that there has been increase in social sector expenditures in all groups of states over time. A comparison of 1990–91 with 2005–06 shows that the increase was the highest in low income group of states. This is partly due to low base in these states. The low-income group states such as Bihar, Uttar Pradesh and Madhya Pradesh have increased in respect of education social services and social sector. The rich states did slightly better in education. The middle-income states performed better in health, and the poorer states did best in rural development. The intra-group variation is, however, considerable, which makes it difficult to draw group-wise conclusions. Uttar Pradesh, for instance, has done much worse in education, health and social services than other poor states. In the 358

Andhra Pradesh 440 Bihar incl. Jharkhand 315 Goa 1,696 Gujarat 549 Haryana 551 Karnataka 469 Kerala 612 Madhya Pradesh incl. 404 Chhattisgarh Maharashtra 543 Orissa 379 Punjab 607 Rajasthan 498 Tamil Nadu 617 Uttar Pradesh incl. 344 Uttarakhand West Bengal 471 All states 455

Source: RBI Bulletins.

Rural development

Social service and rural development

694 535 2,410 952 810 777 933 723 825 771 795 742 886 377 730 695

547 324 1,677 582 742 563 643 461

630 455 610 585 637 308

379 487

595 783

1,010 621 760 778 972 542

780 735 3,149 922 951 897 928 932

73 78

86 84 18 72 79 93

97 52 62 89 57 76 59 82

63 61

117 47 17 57 46 43

67 42 37 63 24 56 53 103

64 81

43 97 13 48 62 82

98 151 62 78 40 59 189 89

72 108

118 67 18 94 94 91

127 193 159 72 60 70 206 189

545 533

629 462 625 571 696 437

537 368 1,758 639 608 545 671 486

442 549

747 502 626 642 683 351

614 366 1,715 645 766 619 696 564

795 776

868 868 809 790 949 459

791 686 2,472 1,031 850 836 1,122 812

667 891

1,128 688 777 872 1,066 633

907 928 3,308 994 1,011 967 1,134 1,120

1990–91 1995–96 1999–2000 2005–06 1990–91 1995–96 1999–2000 2005–06 1990–91 1995–96 1999–2000 2005–06

Total social services

Table 14.9:â•… State-wise Per Capita Real Expenditure on Social Services and Rural Development (1993–94 Prices)

99 113 107 117 97 111 96 119 106 99 80 98 101

111

115 111 89

101 103

100 100 100 100 100 100 100 100 100 100 100 100 100

100

100 100 100

100 100

150 157

187 152 116

175

153 157 155 177 151 165 148 165 155 157 159 156 178

164 155

152 147 141

191

155 131 157 172 128 153 164 181 145 131 119 143 211

100 100

100 100 100

100

100 100 100 100 100 100 100 100 100 100 100 100 100

105 101

106 119 87

108

90 102 103 100 85 98 104 115 109 106 77 99 126

126 136

137 138 85

172

119 159 137 118 140 133 159 172 150 143 125 146 165

162 141

101 121 146

203

143 118 140 124 119 123 153 137 149 136 102 131 240

1990– 1995– 1999– 2005– 91 96 2000 06

1990– 1995– 1999– 2005– 91 96 2000 06

Source: Estimates based on data from RBI bulletins.

Goa Gujarat Haryana Maharashtra Punjab Sub-total Andhra Pradesh Karnataka Kerala Tamil Nadu West Bengal Sub-total Bihar incl. Jharkhand Madhya Pradesh incl. Chhattisgarh Orissa Rajasthan Uttar Pradesh incl. Uttarakhand Sub-total All states

Health and family welfare

Education, sport, art and culture

Rural development

100 100

100 100 100

100

100 100 100 100 100 100 100 100 100 100 100 100 100

104 107

120 117 90

114

99 106 135 116 100 113 124 120 105 103 80 105 103

149 153

204 149 110

179

142 173 147 152 131 153 158 166 152 144 155 154 170

183 172

164 156 158

230

186 168 172 186 125 171 177 191 152 158 126 158 233

100 100

100 100 100

100

100 100 100 100 100 100 100 100 100 100 100 100 100

70 79

56 79 46

126

60 71 42 137 95 107 70 74 90 58 86 73 81

121 104

116 67 88

109

99 88 71 50 76 65 101 78 322 79 88 107 289

156 139

80 130 98

230

255 81 106 138 101 118 132 92 351 119 98 131 370

1990– 1995– 1999– 2005– 1990– 1995– 1999– 2005– 91 96 2000 06 91 96 2000 06

Total social services

Table 14.10:â•… Index of Per Capita Real Expenditure on Social Services and Rural Development (1993–94 Prices)

Social Sector Expenditures

case of rural development, all states except one in 1995–96 and five states in 1999–00 recorded a decline in the index as compared to that of 1990–91.

III Effectiveness of social sector expenditures

The discussion above on social sector expenditure suggests that expenditures are too meagre and should be stepped up. This, no doubt, is true. But apart from that, there are major problems of concern. Important among them are (a) unrealistic budgeting, (b) unspent provisions and (c) rush of expenditure in the last quarter or last month of the fiscal year. Among others are misappropriation or reappropriation of allocations, non-reconciliation of funds, etc., unnecessary supplementary grants or insufficient allocations, etc. It indicates improper/inefficient/ineffective implementation of government policies. Effective and efficient public expenditure relays on proper planning and design of programmes. According to Rule 53 of the General Financial Rules, ministries/ departments are required to prepare their estimates keeping in view the trends of disbursements during the previous years and other relevant factors such as economy instructions issued by the ministry of finance. Scrutiny of the appropriation accounts by the Comptroller and Auditor General (CAG) revealed that under various sub-heads, provisions remained unutilized in the fiscal year and were reappropriated to other heads, defeating the original purpose for which the budget provisions were passed by the parliament (CAG Audit Report, 2006–07). Unspent provisions range between `1–2 crores to more than `100 crores. Unspent provisions of more than `100 crores were in the areas of social sector (also in other sectors), particularly food and public distribution, family welfare, health, education and rural development departments for several years either persistently or in the alternate years shows the fiscal marksmanship of the government. For example, in the Department of Food and Public 361

S. Mahendra Dev and N. Sreedevi

Distribution the unspent provision (under revenue account), continuously for four years, starting from 2003–04 was `2,733 crores, `293 crores, `3,299 crores and `205 crores. Similarly, in the Department of Family Welfare the unspent provision for the same period was `791 crores, `1,159 crores, `1,067 crores and `2,275 crores. Likewise, the other departments show unspent provisions if not to this extent. These unspent provisions were attributed by the ministries/departments to some of the schemes failing to take off. The unspent provisions in a grant or appropriation indicate either poor budgeting or shortfall in performance or both. While audit reports of CAG of India point out the irregularities existing in the executive government, the studies also show that under-spending hardly occurs in non-plan expenditure, but it does occur in most years in most sectors in the Plan. Labour and employment is a big under-spending sector, but also the other sectors under-spend most of the years (Dev and Mooij, 2002a: Table 14). Another irregularity is rush of expenditure in the last quarter of the fiscal year, particularly in the month of March. This rush of expenditure in the last month of the fiscal year ranges between 20â•¯per cent and 100 per cent across various heads of expenditure. For example, the Department of Elementary Education and Literacy spent nearly 44 per cent of its expenditure in the last month during 2003–04 and 45 per cent in 2004–05 and almost 71 per cent of the expenditure was spent in the month of March in the year 2005–06. Similarly, in the years 2003–04 and 2004–05, 42 per cent and 44 per cent of the expenditure were incurred only in the month of March. In the subsequent two years, that is, in 2005–06 and 2006–07, this proportion was 23 per cent and 20 per cent, respectively. Department of Family Welfare spent 81 per cent of the expenditure in the month of March for the financial year 2005–06. During 2004–05 to 2006–07, the rush of expenditure in the month of March ranged 45 per cent to 74 per cent. The list of these irregularities mentioned here are not exhaustive. CAG felt that the replies and reasons for rush of expenditure given by various central government ministries at the time of auditing are not 362

Social Sector Expenditures

tenable as delays in filing of claims, issue of sanctions, settlement of claims, etc. could have been avoided had appropriate action been initiated well in advance and flow of expenditure monitored closely at the end of each month/quarter (CAG Audit reports, 2003–04, 2004–05, 2005–06, 2006–07). The problem is even worse when one looks at mid-year utilization rates. This has been done in a study by Rajaraman (2001a, 2001b). The study focuses on some major schemes of the Ministry of Rural Development for the year 2000–2001. The utilization rates of these funds, for most of the schemes, were less than 50 per cent of the funds allocated for the first six months. In other words, in the first six months, less than 25 per cent of the annual allocation was used. Underutilization of funds seems to be more in the poorer states. So, although these schemes are meant to alleviate poverty, the poor states make less efficient use of them than the better-off states. The result of all this was that social development was not achieved to the required levels, and instead one witnesses the social deterioration. Underutilization of resources often points to inefficiency in resource management—a technical as well as an economic issue. It would be difficult to achieve the targets if the existing irregularities are not rectified and existing checks over public finance are not effectively implemented (Sreedevi, 2004, 2005). Current economic scenario indicates the pressure on the government, from the economic slowdown on one hand and inclusive growth which is the main objective of the Eleventh Five-Year Plan on the other, and makes the government inevitable and inescapable from its social development activities. Hence the government should concentrate, in order to minimize wasteful expenditure, on effective checks and balances in political and budgetary process. Experiences of Some States

Kerala is often mentioned as an example of a state that has been able to achieve spectacular improvements in terms of basic needs and standards of living. The differences in success rates between Kerala and other states seem to lie more in the quality of educational and 363

S. Mahendra Dev and N. Sreedevi

health facilities and the efficiency with which they are used than in a substantially higher allocation of resources. Another positive example is Tamil Nadu, which has been a pioneer in the implementation of nutrition schemes and protective social security measures. There are two important state-sponsored special nutrition programmes in Tamil Nadu, namely, the Chief Minister’s Nutrition Meal Programme (CMNMP) and the Tamil Nadu Integration Nutrition Project (TNINP). The first programme, which is considered as the largest feeding programme in the world, has increased the nutritional intake of many school-going children. The TNIP experience has showed that a limited package of health linked nutrition interventions can be successful and that it does not need to be very costly. Apart from Kerala and Tamil Nadu, some other states have also taken important initiatives. We can refer to the Employment Guarantee Scheme in Maharashtra, primary education in Himachal Pradesh and Madhya Pradesh, public distribution in Andhra Pradesh and land reform in West Bengal. By contrast, the less developed states like Bihar or Uttar Pradesh seem to be characterized by apathy rather than by concerted public action. This may well be related to rather extreme forms of social inequality. As Dreze and Gazdar (1997: p. 106) remark in the context of Uttar Pradesh, ‘the high concentration of power and privileges deriving from the combined effects of inequalities based on class, caste, and gender has made for an environment that is extremely hostile to change and broad based political participation.’ Inclusive Governance for Effective Implementation

With social mobilization, right to information and decentralization, governance can be made more inclusive for better implementation of public services. In social sectors like health and education, insufficient allocations, especially in the post-reform period, poor quality of services, inadequate access for the poorer sections and lack of accountability of the systems to the community have emerged as major problem areas. In particular, it is necessary to 364

Social Sector Expenditures

ensure the expansion of public services for the poor at a low cost, effective public regulation of private services like health care and accountability of these systems, public as well as private, to the local communities. Improvement in health and education in backward regions would improve economic growth and human development. There should be devolution of more powers to Panchayati Raj Institutions (PRIs). There has been increased focus on social sectors now than before. Past experience shows that programmes in health and education, and many types of rural development initiatives including the national rural employment guarantee programme, rural housing, rural drinking water, watershed management, etc. are most effective when there is active involvement of local community. To undertake these activities, sufficient funds have to be given. Only Kerala and West Bengal provide large proportion of their plan expenditure to PRIs. Other states should also give more funds to panchayats. Constitutionally mandated District Planning committees should be established. Strengthening the gram sabha is another important step to be undertaken. Taking government closer to the people, we have to ensure that the gram sabha serves as the empowered and proximate forum for local democracy. There is a great need for capacity building at the PRI level to ensure that plans evolved at the ground level are technically viable. There is a need to earmark some funds for capacity building. Active involvement of NGOs assisting the PRIs has proved to be very effective in many cases in capacity building. Devolution of funds to panchayats must be accompanied by greater accountability. Social mobilization of people and community involvement at ground level is important.

IV Summary and Conclusions

This chapter examines patterns in social sector expenditures at all India level and at the level of states for the period 1980–81 365

S. Mahendra Dev and N. Sreedevi

to 2007–08. It also discusses some issues relating to effective utilization of funds. The summary and conclusions of the paper are given as follows. Our analysis on Centre and states together shows that as a proportion of GDP, social sector expenditure has not increased in most of the years in the post-reform period. The percentage in the last three years (2005–06 to 2007–08) seems to be catching up with the levels of the late 1980s and the late 1990s. As a proportion of total public expenditure, social sector expenditure has been higher since the mid-1990s than in the late 1980s. However, it was lower during 2001–05 before increasing again in 2005–08. In terms of per capita real expenditure, social sector expenditure has also been more since the mid-1990s than what it was in the late 1980s. Regarding central government expenditures, since 1993–94, the share of GDP devoted to the social sector was higher than that in the base year 1990–91, although not very different from the shares in the late 1980s. As a proportion of public expenditure and in terms of real per capita expenditure, there has been a significant increase in social sector spending since the mid-1990s. However, the trend growth rates per annum for the pre- and post-reform period show that the pace of growth was much lower in the 1990s than in the 1980s. This is true for all the three measures of social expenditure development. During the present decade, these trend growth rates have increased but not reached the earlier pace, barring total expenditure. There seems some turnaround in central government expenditures on social sector in the last few years. The state-level analysis throws interesting results. Taken as a proportion of aggregate expenditure, social sector spending has come down in the 25 combined states. As proportion of GDP, the increase has been marginal. In terms of per capita real expenditure, there has been some increase only in the second half of the 1990s. In this decade also, per capita expenditure on social sector increased. Again, the pace of growth was much lower in the post-reform period than in the pre-reform period. Whatever increase the social sector has experienced, is not enough. 366

Social Sector Expenditures

The expenditures on health sector indicate that there has not been much increase in the post-reform period. Neither the Centre nor the states increased its/their health expenditures considerably. The first half of the 1990s was especially bleak. In the second half of the 1990s, the per capita real expenditure on health by the states increased (but there was no increase in terms of proportion of GDP or GSDP). It further declined in the present decade. Intra-sectoral allocations show that there has been a shift towards maternal and child health. With regard to education, expenditure from all the departments declined from around 4.1 per cent of GDP in 1990–91 to 3.8 per cent in 1998–99. This is mainly due to a decline at the state level. The Centre increased its expenditure after 1995–96. This increase is almost completely due to increases in spending on elementary education, and to a large extent (but not completely) related to the introduction and expansion of the Mid-Day Meal programme. In short, the shifts within education and health are towards social priority areas. In most states, social sector expenditure has not increased and with the fluctuations in the present decade. It was lower in the first half of the 1990s, but in the second half there has been an increase, that is, in terms of per capita real expenditure. The rich and middle income states have done better than the poor states, but there are huge variations within the groups of rich, middle and poor states. Within the group of rich states, social sector spending is highest in Goa. Within the group of middle income states, West Bengal is an outlier, in the sense that its social spending has increased much less than that of the other middle-income states, while the absolute level is also not very high. Within the group of poor states, the performance (in terms of spending) of Madhya Pradesh, Orissa and Rajasthan has increased considerably, especially after the mid-1990s, while Bihar and Uttar Pradesh did much less well. During 2005–06, per capita expenditure of total social services and rural development increased. The per capita index increased faster for the group of poor states as compared to other groups. But, as proportion of GSDP and total expenditures, the performance of states is not satisfactory. What is clear is that the pace of growth 367

S. Mahendra Dev and N. Sreedevi

in social sector expenditure has slowed down in the post-reform period, and that this is true with regard to all three indicators. The states have done much worse than the Centre. The present global financial crisis has impact on Indian economy. Economic growth is going to be less in this year and next year. It would affect the tax/GDP ratio and the social sector expenditures. The analysis in the paper shows that there is an urgent need for stepping up social sector expenditure. It is true that there was an attempt in the last three years to increase social sector expenditure. A substantial increase in the allocation for the social sector is only likely to happen when something changes in the budget-making process. In that respect, movements towards decentralized planning and increasing awareness among the public about budgets are to be welcomed. Finally, there is an obvious need for effective utilization of funds and better deliveries of public services through inclusive governance. This is important for better implementation of social-sectoral policies and poverty alleviation programmes. Social mobilization, community participation and decentralized approach are needed. It may, however, be noted that governance has to be contextualized in relation to socio-economic environment. Appropriate institutions are needed for better implementation of policies and programmes. Similarly, people-centric programmes and institutions are needed for poverty alleviation. Many people are of the opinion that the government cannot deliver services to the poor because of lack of accountability and resources. However, this should not be made an excuse by the government in undertaking investments in health and education and other services. Also, government responsibility is not limited to allocation of resources. It is the duty of governments to implement the programmes effectively. Political will is important for improving the effective implementation of policies. Many lessons can be learnt from within India on best practices in several states.

368

1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1980–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96

2.17 2.13 2.30 2.28 2.37 2.46 2.50 2.55 2.62 2.84 2.50 2.78 2.65 2.60 2.53 2.51 2.46

1 1.11 1.14 1.22 1.28 1.28 1.00 0.87 0.91 0.87 0.85 1.00 0.85 0.81 0.79 0.80 0.76 0.74

2 0.00 0.00 0.00 0.00 0.00 0.31 0.48 0.48 0.42 0.37 0.27 0.35 0.36 0.35 0.36 0.38 0.34

3

Water supply sanitation 1.06 1.02 1.20 1.15 1.18 1.25 1.29 1.31 1.20 1.11 1.19 1.16 1.18 1.08 1.02 1.00 1.17

4

Total others 4.34 4.30 4.72 4.70 4.82 5.02 5.14 5.25 5.11 5.16 4.96 5.13 5.00 4.81 4.71 4.65 4.72

5

Social services

4.34 4.30 4.72 4.70 4.82 5.81 6.06 6.16 5.99 5.77 5.49 5.97 5.84 5.68 5.57 5.35 5.29

7

Social sector

(Table 14A.1: continued)

0.00 0.00 0.00 0.00 0.00 0.79 0.92 0.92 0.88 0.60 0.53 0.84 0.84 0.87 0.86 0.70 0.57

6

Rural development

Table 14A.1:â•…All States’ Social Sector Expenditures as Per cent of GDP

Education, sports, art and culture, Health and etc. family welfare

Appendix 14A

1 2.43 2.47 2.64 2.89 2.60 2.87 2.67 2.57 2.40 2.29 2.23 2.22 2.34 2.40

2 0.71 0.74 0.76 0.77 0.76 0.77 0.73 0.70 0.66 0.62 0.62 0.61 0.67 0.66

3 0.34 0.37 0.40 0.37 0.36 0.41 0.36 0.37 0.37 0.38 0.38 0.37 0.43 0.39

Water supply sanitation

Source: RBI Bulletin on state finances for various years.

1996–97 1997–98 1998–99 1999–2000 1990–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2000–08

Education, sports, art and culture, Health and etc. family welfare

(Table 14A.1: continued)

4 1.10 1.12 1.12 1.12 1.11 1.20 1.23 1.22 1.27 1.28 1.32 1.43 1.73 1.38

Total others 5 4.59 4.70 4.92 5.15 4.84 5.24 4.98 4.85 4.70 4.58 4.54 4.63 5.17 4.83

Social services 6 0.58 0.57 0.62 0.57 0.66 0.54 0.55 0.57 0.58 0.59 0.60 0.60 0.62 0.59

Rural development

7 5.17 5.27 5.54 5.71 5.50 5.78 5.53 5.42 5.28 5.16 5.15 5.23 5.79 5.41

Social sector

Social Sector Expenditures Table 14A.2:â•…The Proportion of All States Social Sector Expenditure in the Total Expenditure (Revenue + Capital) Education, Health and Water sports, family supply Total Social Rural Social art and culture, etc. welfare sanitation others services development sector 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1980–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 1990–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 BE 2000–08

1

2

3

17.48 17.64 18.37 18.03 17.74 18.13 17.76 17.66 18.73 20.29 18.42 19.52 18.03 18.31 17.98 17.47 17.96 18.00 18.00 19.04 19.67 18.49 18.68 17.51 16.93 15.39 15.33 15.49 15.23 15.01 15.15 15.92

8.93 9.43 9.72 10.13 9.56 7.33 6.19 6.26 6.21 6.08 7.39 5.95 5.54 5.54 5.70 5.31 5.41 5.27 5.38 5.45 5.26 5.43 5.00 4.79 4.59 4.24 4.17 4.27 4.20 4.30 4.42 4.39

0.00 0.00 0.00 0.00 0.00 2.29 3.42 3.33 3.03 2.66 2.00 2.46 2.43 2.47 2.55 2.64 2.47 2.52 2.72 2.86 2.52 2.59 2.64 2.38 2.45 2.35 2.58 2.65 2.55 2.77 2.54 2.57

8.60 8.46 9.59 9.10 8.81 9.18 9.14 9.04 8.62 7.91 8.77 8.14 8.01 7.58 7.25 7.00 8.55 8.16 8.16 8.10 7.61 7.87 7.85 8.04 8.04 8.15 8.59 9.14 9.80 11.12 11.94 9.13

12

13

14

35.01 35.53 37.68 37.25 36.12 36.92 36.51 36.29 36.59 36.94 36.58 36.07 34.00 33.90 33.48 32.42 34.39 33.94 34.26 35.45 35.06 34.38 34.17 32.73 32.02 30.13 30.66 31.55 31.79 33.19 34.04 32.01

0.00 0.00 0.00 0.00 0.00 5.81 6.55 6.34 6.27 4.30 3.90 5.91 5.70 6.13 6.09 4.88 4.14 4.26 4.18 4.45 3.87 4.68 3.51 3.60 3.76 3.69 3.92 4.18 4.09 3.99 4.35 3.89

35.01 35.53 37.68 37.25 36.12 42.73 43.06 42.64 42.86 41.24 40.48 41.99 39.71 40.03 39.57 37.30 38.53 38.20 38.44 39.91 38.93 39.06 37.68 36.32 35.77 33.83 34.58 35.73 35.88 37.18 38.39 35.90

Source: RBI Bulletin on State Finances for various years.

371

S. Mahendra Dev and N. Sreedevi Table 14A.3:â•…All States Per Capita Real (1993–94 Prices) Social Sector Expenditure (`) Education, sports, art and culture, etc. 1 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1980–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 1990–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2000–08

126 130 147 154 165 181 190 200 221 251 188 254 240 242 245 248 260 278 294 334 386 291 380 362 358 351 353 369 398 449 382

Health and Water family supply Total Social Rural Social welfare sanitation others services development sector 2

3

4

5

64 70 78 86 89 73 66 71 73 75 75 77 74 73 78 75 78 81 88 96 103 85 102 99 97 97 96 102 110 128 105

0 0 0 0 0 23 37 38 36 33 20 32 32 33 35 37 36 39 44 50 50 41 54 49 52 54 59 63 67 83 62

62 63 77 78 82 92 98 102 102 98 89 106 107 100 99 99 124 126 133 142 149 124 160 166 170 186 198 218 256 332 219

252 263 301 318 335 369 391 410 432 456 373 469 454 447 456 460 497 525 559 622 688 541 695 677 676 687 707 752 830 992 768

Source: RBI Bulletin on State Finances for various years.

372

6 0 0 0 0 0 58 70 72 74 53 40 77 76 81 83 69 60 66 68 78 76 74 71 74 79 84 90 100 107 119 93

7 252 263 301 318 335 427 461 482 506 509 413 546 530 528 539 529 557 591 627 700 764 615 766 752 756 772 797 852 937 1,112 861

Social Sector Expenditures

References Chelliah, R. J. and R. Sudarshan. 1999. Income Poverty and Beyond: Human Development in India. New Delhi: Social Science Press. Dev, S. Mahendra and Jos Mooij. 2002a. ‘Social sector expenditures in the 1990s: An analysis of central and state budgets’, Economic and Political Weekly, 37 (9): 853–66. Dev, S. Mahendra and Jos Mooij. 2002b. Social sector expenditures and budgeting: An analysis of patterns and the budget making process in India in the 1990s’, Working Paper No. 43, Centre for Economic and Social Studies, Hyderabad. Dreze, Jean and Haris Gazdar. 1997. ‘Uttar Pradesh: The burden of inertia’, in Jean Dreze and Amartya Sen (eds), Indian Development: Selected Regional Perspectives, pp. 33–128. New Delhi: Oxford University Press. Government of India (GoI). 2005. Report of the Comptroller and Auditor General of India on Union Government Accounts 2003–04, Report 1, New Delhi. ———. 2006. Report of the Comptroller and Auditor General of India on Union Government Accounts 2004–05, Report 1, New Delhi. ———. 2007. Report of the Comptroller and Auditor General of India on Union Government Accounts 2005–06, Report 1, New Delhi. ———. 2007. Report of the Comptroller and Auditor General of India on Union Government Accounts 2006–07, Report 13, New Delhi. Prabhu, S. 1997. ‘Social sector expenditures in India: Trends and implications’, Background paper for UNDP, New Delhi. Rajaraman, Indira. 2001a. ‘Growth-accelerating fiscal devolution to the Third Tier’, paper presented at a Conference on Fiscal Policies to Accelerate Economic Growth, organized by the World Bank, New Delhi, 21–22 May. Rajaraman, Indira. 2001b. ‘Expenditure Reform’, The Economic Times, 10â•¯May, New Delhi. Sreedevi, N. 2004. ‘Control over public finance: A case of Andhra Pradesh’, Indian Journal of Public Administration, July–September, L (30): 840–51. Sreedevi, N. 2005. ‘Fiscal checks bypassed affect financial health’, The Hindu Business Line, 27 January. Available online at http://www.thehindu businessline.com/2005/01/27/stories/2005012700060800.htm. UNDP. 1991. UNDPs Human Development Report 1991. New York: Oxford University Press. ———. 1997. India: Road to Human Development, New Delhi Office, June. ———. 2003. Human Development Report. New York: United Nations. ———. 2007–08. Human Development Report. New York: United Nations.

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15 Centrally Sponsored Schemes Are They the Solution or the Problem? Praveen Jha, Subrat Das and Nilachala Acharya

Since the early 1990s, that is, in the era of economic liberalization in India, fiscal policies adopted by the successive governments at the Centre have been characterized by, first, a pronounced tendency towards conservatism with regard to the overall scope of government interventions for socio-economic development and, second, further accentuation of the powers of the Centre in the federal fiscal architecture of the country. The first feature is probably best reflected in the imposition of Fiscal Responsibility and Budget Management (FRBM) Acts, first on the Centre and subsequently on the state governments, which have put arbitrary constraints on public spending in the country, with adverse implications not only in the short term but more importantly in the long term. As regards the second feature flagged above, the relevant data clearly reveal that the fiscal policy space available to the states has shrunk vis-à-vis that of the Centre. The total tax revenue collected, as a proportion of GDP, had fallen from 16 per cent in 1989–90 to 13.8 per cent in 2001–02, before it started recovering gradually from 2002–03. The magnitude of tax revenue collected under the central 374

Centrally Sponsored Schemes

government tax system had fallen, again as a proportion of GDP, from 10.6 per cent in 1989–90 to 8.2 per cent in 2001–02. In the wake of the resource crunch faced by the Centre (which was a consequence of some of the liberalization policies), the magnitude of financial resources transferred from Centre to states had been compressed. The decline in transfer of resources from Centre to states, especially during the second half of the 1990s and the early years of the subsequent decade, had affected the fiscal health of the states adversely. Moreover, a rise in the administered interest rates in the country under the policies for financial sector liberalization meant that the interest payment burden of the states rose sharply during the second half of the 1990s and the early years of the subsequent decade. In addition, a huge increase in states’ outlay on salaries for government staff in the late 1990s (following the implementation of Fifth Pay Commission recommendations) added to the worsening fiscal health of the states. Furthermore, since 2002–03, while the growth of Centre’s tax revenue has shown a marked improvement, the growth in tax revenue collected by the state governments has been rather sluggish; this is largely because of the high dependence of states on sources (mainly indirect taxes) which are relatively inelastic in nature. A notable feature during the era of weakening fiscal health of the states in India has been the further proliferation of the central government’s development schemes (commonly referred to as Centrally Sponsored Schemes). As per the Union Budget 2009–10, there are as many as 1,258 central government schemes being implemented across the country. Given the crisis in their fiscal health, most states have become heavily dependent on the central schemes for financing new and targeted interventions for socio-economic development. However, there are serious concerns pertaining to the central government schemes, which range from problems in the design and implementation process of the schemes to the growing magnitude of central funds (allocated for states in many of the major central schemes) bypassing the state budgets. In this context, the changing roles and perspectives of institutions like the Finance 375

Praveen Jha, Subrat Das and Nilachala Acharya

Commission and the Planning Commission have also attracted a lot of scrutiny in the recent years. The present paper discusses some of the pertinent issues relating to the developments in Centre–State fiscal relations in general and the role of central government schemes in particular. In Section I, the chapter sketches a profile of the evolution of the federal fiscal architecture in India and highlights some of the major changes observed in the magnitude and composition of resource transfers from Centre to states over the last decade. Section II of the chapter examines the changes observed in the sphere of resource transfers from Centre to states, with reference to the changing roles of institutions like the Finance Commission and the Planning Commission. Section III highlights some of the major lacunae with the Centrally Sponsored Schemes vis-à-vis the objectives they attempt to fulfills; and Section IV concludes the chapter.

I Evolution of the federal fiscal architecture in india

The Constitution of India provides a clear division of the functions of the central government and the state governments, which has translated into a division of expenditure responsibilities and taxation powers between them. The Constitution specifies the exclusive functions of the Centre in the Union list and the exclusive functions of the states in the State list, while the Concurrent list captures those falling under the joint jurisdictions of both; all residual expenditure functions as well as residual powers of taxation have been allocated to the Centre. The different categories of taxes have been allocated exclusively to the Centre or to the states. For instance, the state governments have been vested with the exclusive powers to levy: stamp duty, land revenue, taxes on mineral rights, tax on intra-state sale of goods, duty on manufacture of alcohol, duty on entertainment and tax

376

Centrally Sponsored Schemes

on professions, among others. On the other hand, the central government has been vested with the exclusive powers to levy: taxes on income (other than agricultural income), corporation tax, customs duties, excise duties (excluding alcohol and narcotics), estate duty, wealth tax and inheritance tax, among others. We must note here that most of the broad-based taxes have been assigned to the Centre (among the taxes assigned to the states, only the tax on sale and purchase of goods has been significant for state revenues), and the Centre has also been assigned all residual tax powers. As a result, there is a vertical imbalance between the powers of the Centre and the states to raise revenue through taxes and duties. The powers of revenue mobilization vested with the states are insufficient to help them mobilize resources that would meet their total expenditure requirements. However, this kind of a vertical imbalance was built into the fiscal architecture of the country keeping in mind the need for central government’s interventions to address the horizontal imbalance, that is, the limited ability of some of the states to mobilize adequate resources from within their state economies. In order to address the imbalance between the states’ expenditure needs and their powers to raise revenue, the Constitution has provided for the sharing of the proceeds of certain centrally levied taxes with the states and making grants to the states from the Consolidated Fund of India. The Finance Commission, appointed by the President of India (once every five years or earlier as needed), determines the overall share of the states in the central taxes as well as its allocation among different states and recommends grants to states in need of assistance. In the fiscal architecture that has evolved in India, there are three main channels which govern the fiscal transfers from Centre to states. First, as mentioned above, the Finance Commission determines states’ share in central taxes and grants for states out of the Consolidated Fund of India. Second, the Planning Commission (which, unlike the Finance Commission, is not a constitutional

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Praveen Jha, Subrat Das and Nilachala Acharya

body) makes recommendations on the magnitude of grants and loans to be provided to states for financing their expenditure on targeted interventions for socio-economic development (commonly referred to as Plan expenditure). Third, there are Central Sector Schemes and Centrally Sponsored Schemes, designed by the various central government ministries in consultation with the Planning Commission, in which Centre’s funds are transferred to the states implementing the schemes. The schemes which are entirely funded by the Centre [e.g., the National Rural Employment Guarantee Scheme (NREGS), Integrated Child Development Services (ICDS), etc.] are called Central Sector Schemes, while the schemes which are partly funded by the Centre with the states contributing a matching share of funds [e.g., the Sarva Shiksha Abhiyan (SSA), the Total Sanitation Campaign (TSC), etc.] are called Centrally Sponsored Schemes. However, in the popular discourse relating to this area, both these kinds of schemes are often called as Centrally Sponsored Schemes, and in this chapter too, we refer to both as Centrally Sponsored Schemes (henceforth CSS). These different channels of fund flow are depicted in Figure 15.1. It would be worthwhile to note here that the last of the three channels mentioned earlier, that is, fund transfers to states through the CSSs designed by the various central ministries in consultation with the Planning Commission, has a marked difference from the other two in that these fund transfers to states are subject to the discretion of the central ministries and the Planning Commission. We shall discuss this aspect in detail later in this chapter. As was mentioned at the outset, in the wake of the resource crunch faced by the Centre during the late 1990s and the early years of the subsequent decade, the magnitude of financial resources transferred from Centre to states had been compressed. As shown in Table 15.1, Gross Devolution and Transfers (GDT) from the Centre to states (which include: states’ share in central taxes, all kinds of grants from the Centre, and gross loans from the Centre) had fallen, as a proportion of GDP, from 7.2 per cent in 1990–91 to 5.9 per cent in 1998–99; subsequently, it hovered around 5 per cent 378

Centrally Sponsored Schemes Figure 15.1:â•…Flow of Funds from Union Budget to a State

Source: Das (2007).

of the GDP during 1999–2000 to 2004–05.1 As a proportion of Total Expenditure from the Budgets of all states, GDT from the Centre to states had fallen from 45 per cent in 1990–91 to 39 per cent in 1998–99; subsequently, it had fallen from 31.1 per cent in 1999–2000 to 28 per cent in 2003–04. We find that the magnitude 1 We may note here that following the creation of the National Small Savings Fund in 1999–2000, there was a change in the system of accounting. Prior to 1999–2000, the states used to be given their shares in small savings collection as loans from the Centre. However, since 1999–2000, the states are being given their shares in small savings collection as loans from the National Small Savings Fund,

379

Praveen Jha, Subrat Das and Nilachala Acharya Table 15.1:â•… Gross Devolution and Transfers from Centre to States Year 1988–89 1989–90 1990–91 1998–99 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 (RE) 2008–09 (BE)

GDT from centre to statesa (in ` crore)

GDT as % of GDP

GDT as % of aggregate disbursements of states

30,333 32,862 40,859 102,268 95,652 106,730 119,213 128,657 143,785 160,750 178,871 220,462 284,063 331,525

7.2 6.8 7.2 5.9 4.9 5.1 5.2 5.2 5.2 5.1 5.0 4.7 5.2 5.5

45.2 42.8 44.9 39.1 31.1 31.4 32.3 31.4 28.0 29.0 31.8 33.5 36.1 37.1

Source: Authors (computed as per the data given in ‘State Finances: A Study of Budget 2008–09’, RBI, Mumbai; and GDP data is taken from Government of India [2008]). Note: a Gross Devolution and Transfers (GDT) include: (a) states’ share in central taxes, (b) grants from the Centre and (c) gross loans from the Centre.

of GDT from Centre to states shows a gradual improvement over the last five years, and it has gone up from 29 per cent of the aggregate disbursements of states (5.1â•¯per cent of the GDP) in 2004–05 to 37â•¯per cent of the aggregate disbursements of states (5.5 per cent of the GDP) in 2008–09 Budget Estimates (BE). However, we must note that the composition of the GDT from Centre to states shows two major changes over the last decade— first, the share of Grants in total GDT from Centre to states has gone up noticeably, and, second, the composition of total grants from Centre to states has been changing in a way that has reduced the share of the truly untied assistance available to the states. We shall discuss both these developments in detail in below. which is reported under internal debt in their state budgets. Hence, the magnitude of GDT from the Centre to states from 1999–2000 onwards is not comparable with the magnitude of the same during the years prior to 1999–2000.

380

Centrally Sponsored Schemes

II Role of the statutory and non-statutory bodies in fiscal transfers from centre to states

In order to assess the role and implications of the CSS at the current juncture, it would be necessary to first examine the changes observed in the sphere of resource transfers from Centre to states, with reference to the changing roles of institutions like the Finance Commission and the Planning Commission. In addition to this, the present section also tries to locate the role of central government ministries in the overall federal fiscal architecture prevailing in India. The Central Finance Commission

As mentioned earlier, the Finance Commission, a statutory body, recommends (at a regular interval of five years) to the central government for sharing the resources with the state governments out of its total divisible pool of resources. Resources are transferred from the central government’s budget to the states, as per the recommendations of the Finance Commission, in two forms: a share in central taxes and grants-in-aid, based on certain formula or principles which are transparent. However, over the years, the scope and nature of the recommendations made by the successive Finance Commissions have been influenced by the proliferation of the Terms of Reference (ToR) for the Finance Commission. It has been observed that starting with the Tenth Finance Commission (whose recommendations were applicable for five years from 1995–96 to 1999–2000), both the ToR for the successive Finance Commissions as well as their recommendations were biased towards promoting the conservative fiscal policy of the Centre and contributed towards the growing dominance of Centre in the federal fiscal architecture in India; the ToR given to the Thirteenth Finance Commission, which submitted its recommendations in 381

Praveen Jha, Subrat Das and Nilachala Acharya

December 2009 for the five fiscal years from 2010–11 to 2014–15, are no exception in this regard. If we observe the trends in the overall magnitude of resources transferred from Centre to states as per the Finance Commission recommendations since the late 1980s (Table 15.2), we find that as a proportion of the GDP this magnitude had registered a decline during the recommendation periods of the Tenth (1995–2000) and Eleventh Finance Commission (2000–05) in comparison to the recommendation period of the Ninth Finance Commission (1989–95). It shows a visible increase during the recommendation period of the Twelfth Finance Commission (2005–10). However, the earlier practice of central government giving loans (along with grants-in-aid) to states as Central Assistance for State Plans was discontinued in the recommendation period of the Twelfth Finance Commission (i.e., starting with 2005–06). As a result, the magnitude of GDT from Centre to states, as a proportion of the GDP, does not show any improvement during the recommendation period of the Twelfth Finance Commission (Table 15.1). Table 15.2:â•…Resources Transferred from Centre to States as per Finance Commission Recommendations Total Finance Commission transfers Annual average for the recommendation period ofâ•¯

States’ share in central taxes (as % of GDP)

Grants-in-aid Total Finance for states Commission transfers (as % of GDP) (as % of GDP)

VIII FC (1984–89) 2.58 0.32 IX FC (1989–95) 2.59 0.41 X FC (1995–2000) 2.54 0.27 XI FC (2000–05) 2.43 0.46 XII FC (2005–10) 2.94 0.60 For the years within XII FC recommendation period 2005–06 2.67 0.70 2006–07 2.96 0.69 2007–08 3.21 0.56 2008–09 (RE) 3.01 0.52 2009–10 (BE) 2.80 0.59

2.90 3.00 2.81 2.89 3.54 3.37 3.65 3.77 3.53 3.39

Source: Authors (computed as per the data given in Report of the Thirteenth Finance Commission [2010–15]; Ministry of Finance, GoI, December 2009).

382

Centrally Sponsored Schemes

Within the overall magnitude of resources transferred from Centre to states as per the Finance Commission recommendations, the proportion of States’ share in central taxes has declined steadily over the last five Finance Commission periods, which signifies that the approach of the Finance Commission has been shifted more towards a gap-filling approach in the form of recommending a significant quantum as grants-in-aid for the states based on their Non-plan expenditure commitments. The proportion of states’ share in central taxes had been around 92.3 per cent of the total amount recommended by the Seventh Finance Commission, while grants-in-aid constituted a meagre 7.7â•¯per cent of the total transfers. The share of grants-in-aid has increased visibly in the recommendation periods of the subsequent Finance Commissions, reaching almost 19 per cent in the Twelfth Finance Commission recommendations (Government of India, 2004). This kind of a development has raised the question of denial of states’ due share in central taxes, which give more flexibility to states in setting up their expenditure priorities unlike the Nonplan grants. The Planning Commission

Apart from the Constitution-mandated practice of accounting classification, that is, classifying the budget into ‘revenue’ and ‘other than revenue’ (or ‘capital’) accounts (which is also internationally prevalent), the Indian system of budgeting also categorizes the expenditure budget into two broad categories viz. Plan and Nonplan. The Indian Constitution does not mandate any such classification of expenditure; however, for the sake of administrative and functional ease, such a classification of expenditure has been adopted in India since the early 1950s. ‘Plan expenditure’ refers to all kinds of public expenditure incurred on the programmes/ schemes laid out in the ongoing Five Year Plan (FYP) (e.g., all kinds of expenditure incurred on SSA, Mid-Day Meal Scheme, ICDS, NREGS, etc.), whereas ‘Non-plan expenditure’ refers to all kinds 383

Praveen Jha, Subrat Das and Nilachala Acharya

of public expenditure that are outside the purview of the FYP (e.g., expenditure on defence services, interest payments, organs of the state, expenditure on the running of existing government institutions in different sectors, etc.). Plan expenditure arises out of schemes newly introduced in an ongoing FYP as well as the unfinished schemes from the previous FYPs; on the other hand, non-plan expenditure arises out of maintenance or running costs associated with the schemes from previous FYPs which have been completed as well as all kinds of expenditure in those sectors which are outside the purview of the Planning Commission. As regards the significance of this classification of expenditure in the context of the present paper, it would be worthwhile to note here that: within the total public expenditure in India in any year, non-plan expenditure accounts for a much higher share than Plan expenditure (for instance, in 2008–09 Budget Estimates, non-plan expenditure accounted for 67.6 per cent of Total Expenditure from the Union Budget and 65.2 per cent of Total Expenditure from the budgets of all states). l non-plan expenditure on ‘General Services’ (such as, defence, law and order, interest payments, pensions, running of organs of the state, etc.) is borne out of the Union Budget as well as state budgets. l non-plan expenditure on ‘Social Services’ (e.g., education, health, nutrition, water and sanitation, etc.) and ‘Economic Services’ (e.g., agriculture, irrigation, roads and transportation, industry and commerce, telecommunication, etc.) is borne mainly by the state budgets. l plan expenditure on ‘Social Services’ and ‘Economic Services’ is borne out of the Union Budget as well as state budgets. l within the total Plan expenditure on ‘Social Services’ and ‘Economic Services’ at present, the share of CSS is significantly higher than that of state plan schemes. l

384

Centrally Sponsored Schemes

The Planning Commission, which as mentioned earlier is a nonstatutory body, prepares FYPs for socio-economic development of the country covering mainly ‘Social Services’ and ‘Economic Services’. As regards the transfer of resources from Centre to states, the Planning Commission recommendations deal with mainly two channels viz. Central Assistance for State Plan and Plan schemes formulated by the central government ministries. With regard to the Union Budget in any year, the Gross Budgetary Support (GBS) for the Plan (which is recommended by the Planning Commission) comprises both these components, viz. Central Assistance for State Plan and funds for the CSS. The state governments, with the help of the State Planning Boards, work out their respective FYPs based on their assessment of resource availability during the Plan period (which includes the balance from current revenue, contributions from public sector enterprises, additional resource mobilization, market borrowings and other capital receipts, and a transfer from the Centre known as Central Assistance for state plan). The state plans too have to be approved by the Planning Commission. The magnitudes of Central Assistance for State Plan for different states are determined by a formula known as the Gadgil–Mukherjee formula, which takes into account a number of criteria (including population, per capita income, performance and special problems of the states). Thus, given that the magnitudes of the central assistance are formulabased, at the margin it is mainly the own revenue position of the states that determines the size of their state plans. We must note here that the practice of determination of the magnitudes of Central Assistance for State Plan by the Planning Commission has invited criticisms from several quarters, especially the state governments. The government-appointed ‘Sub-Group on Resources Other Than Tax Revenues of States for Eleventh Plan (2007–12)’ had observed that: the exercise of distribution of Central Assistance lacks transparency as the States do not have any information whether the database is regularly updated to arrive at fresh share of each State annually or for the Five Year Plan period;

l

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Praveen Jha, Subrat Das and Nilachala Acharya

the experience shows that the Central Assistance is allocated on an incremental basis; l the process of distribution of Central (Plan) Assistance should be transparent and the formula should be applied in a nondiscretionary manner; and that l the Planning Commission should follow the practice of the Finance Commission Reports, where all relevant information with regard to State’s share in Central taxes is included in the report of the Commission. l

Besides the Plan Assistance from central government to the states, Plan grants are given to states through CSS, which in some respects is the most controversial form of fund transfers. A close look into the transfer of resources from the central government budget to the states, as per the Planning Commission recommendations, reveals the following. It is observed that, as a proportion of GDP, the total GBS for Plan by Centre has been declining since 1985–86. The share of such expenditure was 7.1 per cent of GDP during 1985–86 and declined to 4.2 per cent at the end of Tenth FYP. However, during the first three years of the ongoing Eleventh FYP, the average share of total GBS for Plan by Centre registered a small increase compared to the previous FYP. A similar trend is also observed with regard to the share of Central Assistance for State (and UT) Plans from GDP. During 1985–86, the average share of Central Assistance for State Plan was 2.5 per cent of GDP which had fallen to 1.5 per cent of GDP by the end of Tenth FYP. A further decline is also observed during the first three years of Eleventh FYP. As shown in Table 15.3, the share of Central Assistance for State Plan in the GBS for Plan by Centre has declined significantly from around 36 per cent in 1985–86 to 26 per cent in 2009–10 (BE), while the share of budget support for Plan expenditure by Central Government Ministries in the GBS has increased steadily since the Eighth FYP. This changing composition of the GBS for Plan by the Centre implies the growing dominance of CSS in the domain 386

Centrally Sponsored Schemes Table 15.3:â•…Magnitude and Composition of GBS for Plan by the Centre (Which Comprises—Central Assistance for State and UT Plans and Plan Expenditure by Central Government Ministries) A

B

C

D

(B is one of the two components [C = (A – B) as of A) % of A] (B as % of A)

Year 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 Eighth FYP (annual average) Ninth FYP (annual average) Tenth FYP (annual average) First three years of Eleventh FYP (annual average) 2007–08 2008–09 RE 2009–10 BE

Central assistance for Total GBS for state and UT plan by centre as plans as % of GDP % of GDP

Budget support Central for plan expenditure assistance for by central govt state and UT ministries as % plans as % of total GBS of total GBS

7.1 7.3 6.8 6.1 5.6 5.0 4.7 4.5

2.5 2.5 2.7 2.3 1.9 1.9 2.1 2.0

64.4 65.2 59.7 62.9 65.6 61.7 55.2 55.2

35.6 34.8 40.3 37.1 34.4 38.3 44.8 44.8

4.0

1.7

56.5

43.5

4.2

1.5

65.7

34.3

5.1

1.4

72.0

28.0

4.5 5.3 5.6

1.3 1.5 1.5

70.7 72.1 73.8

29.3 27.9 26.2

Source: Computed from the data provided in Union Budget, GoI; various years.

of Plan expenditure in India. However, the overall magnitude of the GBS for Plan by the Centre registers a decline from 7.3 percent of GDP in 1986–87 to 5.6 percent of GDP in 2009–10 (BE), which has been rooted in the growing adherence by the Centre to fiscal conservatism. It would be worthwhile to note here that the composition of the total grants from the Centre to states (including both Finance 387

Praveen Jha, Subrat Das and Nilachala Acharya

Commission grants and Planning Commission recommended grants) has been changing since the early 1990s. Out of the different types of grants given by Centre to states, non-plan Grants (based on the recommendations of the Finance Commission) are untied or block grants for states, which they spend according to their own expenditure priorities. We must take into account the fact that almost two-third of the Total Expenditure from the state budgets is non-plan Expenditure (e.g., in 2008–09 BE, non-plan expenditure accounted for 65.2 per cent of Total Expenditure from the budgets of all states), and, furthermore, within the overall public expenditure in our country, non-plan expenditure on ‘Social Services’ and ‘Economic Services’ is borne mainly by the state budgets. Hence, there can be little doubt about the fact that almost all state governments expect a higher share of non-plan Grants within the total grants from the Centre to states. However, the share of non-plan Grants within the total grants from the Centre to states has fallen from around 35 per cent in 2000–01 to 26 per cent in 2008–09 (BE), as we can observe from the trends presented in Table 15.4. This decline would most likely be sharper if we extend the time period further and look at the composition of grants inâ•¯the 1990s. Over the last decade, within the total grants from the Centre to states, the share of Central Assistance for State Plan and grants under Plan Schemes of the central government ministries has shown a rise from around 65 per cent in 2000–01 to around 74 per cent in 2008–09 (BE). The grants under Plan Schemes of the central government ministries are well known as the tied or conditional grants for the states. However, what is worth discussing here is the fact that even the Central Assistance for State Plan cannot be viewed as an untied grant anymore. As per the Draft Annual Plan 2008–09 of the Government of Rajasthan: [O]f the Central Assistance (for State Plan) of Rs 325,000 crore, proposed in the Eleventh Plan (for the five years from 2007–08 to 2011–12), as much as Rs 182,000 crore—60 percent of assistance to the 388

37,784 43,082 45,683 51,348 56,857 76,750 94,451 124,638 143,030

42.9 45.1 43.4 49.8 52.6 37.5 42.6 44.3 46.6

3.0 2.9 3.8 2.6 2.3 2.9 2.2 5.0 4.6

19.0 19.4 19.0 19.3 18.4 17.3 18.4 19.8 19.0

Grants under Central assistance Grants under central centrally sponsored for state plan sector schemes schemes 0.3 0.5 0.5 0.6 0.5 0.4 0.3 0.7 0.7

Grants under NEC/special plan schemes

Source: Computed from the data provided in State Finances: A Study of Budgets, Reserve Bank of India, various years.

2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 (RE) 2008–09 (BE)

Year

Total grants from the centre to states (in ` crore)

34.8 32.0 33.4 27.7 26.2 41.9 36.4 28.1 26.1

Non-plan grants (as per finance commission recommendations)

Different types of grants as % of total grants from the centre to states

Table 15.4:â•… Composition of Total Grants from the Centre to States

Praveen Jha, Subrat Das and Nilachala Acharya

States—is meant for schemes which are actually Centrally Sponsored Schemes, but presented as Additional Central Assistance or Special Central Assistance. Examples of these are the Rashtriya Krishi Vikas Yojana (RKVY), Accelerated Irrigation Benefit Programme (AIBP), Accelerated Power Development & Reform Programme (APDRP), Jawaharlal Nehru National Urban Renewal Mission (JNNURM), Backward Regions Grant Fund (BRGF) and so on.2

In fact, in Union Budget 2009–10 (BE), in the Central Assistance for State Plans worth ` 80,066.7 crore the Normal Central Assistance (NCA) (which is the untied Central grant for supporting state plan expenditure determined by the Gadgil–Mukherjee formula) accounts for only ` 19,110.6 crore (i.e., roughly 24 per cent), while the rest of the amount is effectively tied to programmes like RKVY, JNNURM, AIBP, BRGF, etc. developed by the central government ministries. The Draft Annual Plan 2008–09 of the Government of Rajasthan adds that: [I]f the Additional Central Assistance (ACA), Special Central Assistance (SCA), Externally Aided Projects (EAPs), and Member of Parliament Local Area Development (MPLAD) scheme and Central Road Fund assistance are taken away, the actual untied central assistance to States Plans (proposed for the Eleventh FYP period) comes down to only Rs 111,000 crore, which is 8 percent of the Centre’s Gross Budgetary Support (proposed for the Eleventh FYP period). It is also pertinent to point out that Rs 111,000 crore is only 10 percent of the States’ own resources for the 11th Plan. This is the only and truly untied assistance available to the States.3

Thus, the composition of total grants from Centre to states has been changing in a way that has reduced the share of the truly untied assistance available to the states, while the share of assistance tied to programmes/schemes of the central government ministries has been expanding. The Planning Commission, under the leadership 2 3

Government of Rajasthan (2008). Ibid.

390

Centrally Sponsored Schemes

of D. R. Gadgil during the Fourth FYP period, had suggested that the bulk of the central assistance should go to the states as untied assistance, called NCA, and the National Development Council (NDC) had decided in the late 1960s that CSSs would not be more than one-sixth of the NCA. However, the situation prevailing at the current juncture seems the exact opposite of what was recommended by the NDC in the late 1960s. Moreover, as has already been discussed, even the process of determination of the NCA, following the Gadgil–Mukherjee formula, has been criticized for its lack of transparency. We should also note here that within the total amount of funds spent from the state budgets as state plan expenditure, a significant share of funds are spent on programmes/schemes of the central government ministries; as most CSSs, ACAs and SCAs require matching state government share. Thus, the actual flexibility available to state governments for setting up the priorities in Plan expenditure is limited further. The Central Government Ministries

As has been observed earlier, the fund transfers to states through the CSSs designed by the various central government ministries (in consultation with the Planning Commission) has a marked difference from the fund transfers based on the Finance Commission and the Planning Commission recommendations in that these fund transfers to states are subject to the discretion of the central government ministries (and the Planning Commission). Specific purpose grants and loans in the form of specific purpose schemes, though not termed as CSS before 1969, were a major area of discord between the Centre and the states ever since India’s independence. The states preferred untied or block assistance, whereas the central government was more inclined to provide specific purpose assistance. Until the Fourth FYP, central assistance to states for implementation of plan programmes within the states’ jurisdiction was given in the form of scheme-wise allocation 391

Praveen Jha, Subrat Das and Nilachala Acharya

of funds. This, however, resulted in rigidities in the system and inequitable distribution of central assistance. On many occasions, several state governments argued that if the Centre had additional resources, the same should be given to the states as part of the states’ share in taxes through the Finance Commission recommendations, or these should be given to them in the form of block assistance. The matter was raised in several meetings of NDC; and, on the basis of discussions held in the NDC, the concept of block/untied central assistance for state plans was introduced subsequently. It was decided in the NDC in 1969 that central assistance to the states for their Plans should be by and large in the form of block/unconditional assistance [termed NCA] so that states could formulate Plans according to their own priorities. This NCA to the state and UT governments, given in the form of grants or loans, was meant to provide funds for those programmes in the domain of states which are considered to be of national/regional priority. It was also decided that the Centre could provide scheme-based support (in the form of CSSs) but such support should not exceed one-sixth/one-seventh of the amount to be given as block/untied assistance (i.e., NCA). However, CSSs have figured prominently in successive FYPs of the central government as schemes formulated by various central government ministries with provision of funds in the Union Budget. The objectives, strategy and method of implementation are prescribed and funds are released to the states with due conditionalities. It had been recognized that CSSs are meant to provide the states with additional resources for expenditure which the central government considers important from the perspective of national/regional priority even though the functions/areas fall within the domain of states. These schemes, which were initially restricted to a few well defined areas, have subsequently proliferated fast. Central Assistance for State Plans was given almost entirely in the form of NCA for some years after 1969. However, over the last four decades, the number of CSSs has grown very fast and so has 392

Centrally Sponsored Schemes

the magnitude of funds provided in the Union Budget for these schemes. Central Assistance for State Plans, which was originally intended to be almost exclusively in the form of NCA, has also been partly linked to programmes/schemes of the central government ministries [e.g., Additional Central Assistance and Special Central Assistance]. Consequently, the NCA component has come down very sharply in total Central Assistance for State Plans. The total number of central schemes proposed in the Eleventh FYP was as high as 1,027, which included 798 Central Sector Schemes (in which Centre provides the total amount of funds and states only have to implement the schemes) and 129 Centrally Sponsored Schemes (in which Centre provides a part of the funds with states contributing a matching share of funds).4 As shown in Tableâ•¯15.5, the share of Central Assistance for State Plans in the total Plan Expenditure from the Union Budget had declined gradually from 44.5 per cent in 1997–98 (RE) to 39.9 per cent in 2004–05 (RE), while the share of Budget Support for central plan (which is the total amount of funds provided in the Union Budget for the CSSs) had increased during this phase from 55.5 per cent to 60.1 per cent. Since 2005–06, the recommendations of the Twelfth Finance Commission have been in force. These recommendations led to a major change in the composition of Central Assistance for State Plans—earlier (i.e., up to 2004–05), the non-special category states were given only 30 per cent of the Central Assistance for their State

4 We may note here that several of the CSSs are in the nature of umbrella programmes, each consisting of a number of sub-programmes or sub-schemes. For instance, National Rural Health Mission (NRHM) comprises several schemes like, Reproductive and Child Health programme, Routine Immunization, Pulse Polio Immunization, Rural Family Welfare Services, and so on. Hence, the actual number of schemes in operation could be higher than 1,027, which were listed in the Eleventh Plan. As mentioned earlier, the Union Budget 2009–10 states that there are 1,258 central government schemes being implemented in the country (Planning Commission, 2006).

393

404,013 114,089 45,870 68,219 40.2 59.8 11.4 16.9

235,245 60,630 27,001 33,629 44.5 55.5 11.5 14.3

2002–03 (RE)

16.3

10.8

60.1

82,529 39.9

54,858

137,387

505,791

2004–05 (RE)

Source: Compiled from data provided in the Union Budget, GoI, 1997–98 to 2009–10.

Total expenditure (Plan + Non-plan) from Union Budget (in ` crore) Total plan expenditure from the Union budget (in ` crore)—of which— Central assistance for state and UT plans (in ` crore) Budget support for central plan (in ` crore) Central assistance for state and UT plans as % of total plan exp. from the Union budget Budget support for central plan as % of total plan exp. from the union budget Central assistance for state and UT plans as % of total exp. (Plan + Non-plan) from the union budget Budget support for central plan as % of total exp. (Plan + Non-plan) from the union budget

1997–98 (RE)

21.1

7.2

74.6

107,253 25.4

36,538

143,791

508,705

2005–06 (RE)

Table 15.5:â•… Growing Share of the Union Budget for Plan Schemes of Central Government Ministries

23.5

8.4

73.8

239,840 26.2

85,309

325,149

1,020,838

2009–10 (BE)

Centrally Sponsored Schemes

Plans as grants while the remaining 70 per cent of the assistance used to be given as loans. This, according to the Twelfth Finance Commission, had increased the indebtedness of state governments, and several of them had asked for complete elimination of the loans component of the central assistance. Hence, starting from 2005–06, the Central Assistance for State Plans for most of the non-special category states is being given only as a grant. However, this change also led to a significant decline in the overall magnitude of the Central Assistance for State Plans, which fell from `54,858 crore in 2004–05 (RE) to `36,538 crore in 2005–06 (RE). As can be observed from Table 15.5, the share of Central Assistance for State Plans in the total Plan Expenditure from the Union Budget fell sharply to 25.4 per cent, which shows a small increase to 26.2 per cent by 2009–10 (BE). The share of Budget Support for central plan in total Plan Expenditure from the Union Budget had increased from 60.1 per cent in 2004–05 (RE) to 74.6 per cent in 2005–06 (RE), which stands at 73.8 per cent in 2009–10 (BE). The total amount of funds provided in the Union Budget for the CSSs (i.e., Budget Support for central plan) accounts for 23.5â•¯per cent of the total Union Budget outlay in 2009–10 (BE), which is significantly higher than its share of 14.3 per cent of the total Union Budget outlay in 1997–98 (RE). There are a number of major concerns relating to the CSSs, which are discussed in the following section.

III Key Concerns relating to Centrally Sponsored Schemes

It may be useful to state, very briefly, that some of the major arguments advanced in support of the growing number of CSSs in the country. First, lack of resources for socially relevant programmes, as well as absence of clear strategies to implement such programmes on part of the state governments is often highlighted as a major justification for the proliferation of CSSs. Inadequate commitment 395

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of financial and other resources on priority programmes, because of lack of political will at the sub-national levels and bottlenecks in fund flow (particularly time lags in fund transfer to the implementing agencies at the field level) are supposed to be major constraints in progressing towards important development goals. Second, it is also claimed that state governments are typically less efficient in utilization of resources and funds routed through the state budgets are often diverted towards other purposes, a point regularly made in the evaluation reports of the central government agencies. Third, an important reason for the increasing number of CSSs in the recent years is the availability of external funding for social sector programmes since the late 1990s, which have to be largely routed through the central government. However, there are a number of major problems with the CSSs, some of which are discussed below. Shrinking Flexibility of the State Governments

One of the major consequences of the proliferation of CSSs has been the shrinking flexibility available to the state governments for designing state-specific development schemes and providing resources for the same. The growing magnitude of funds for CSSs, first of all, implies that smaller amount funds would be available from the GBS (for Plan by the Centre) for being transferred to states as Central Assistance for State Plans and the state governments would also have to provide matching shares for the CSSs from their resources for state plan. Second, many of the CSSs imply conditionalities for the state governments (ranging from specific microlevel measures to larger policy prescriptions), which, however justified, take away the flexibility that state governments are entitled to. Also, it is well known that a uniform ‘one-size fits all’ approach often constrains the ability of state governments to address their locally felt development needs.

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Significant quantum of Central Government funds (for CSSs) bypassing the State Budgets

As shown in Table 15.6, during the last two years, almost 40 per cent of the total Union Budget outlay for CSSs has been directly transferred to the autonomous bank accounts of the state/districtlevel implementing agencies (for the schemes), bypassing the state budgets. This practice had been started mainly by the Central Ministry of Rural Development in the 1990s, which has been adopted by several central ministries for their major CSSs over the last decade. The typical argument cited in this context has been that in case of central government funds for CSSs being routed through the state budgets, there can be problems of diversion of funds or delay in flow of these funds to the field level implementing agencies. Table 15.6:â•…Funds for Central Government’s Plan Schemes Directly Transferred to State/District Level Implementing Agencies

Years 2006–07 REa 2007–08 RE 2008–09 RE 2009–10 BE

Funds directly Funds for central government’s plan schemes transferred as a Budget support for directly transferred to state/ proportion of budget district level implementing support for central central plan plan (in %) agencies (in ` crore) (in ` crore) 126,510 148,669 204,128 239,840

45,166 51,260 87,054 95,567

35.7 34.5 42.6 39.8

Source: Compiled from the data given in Union Budget, GoI, 1997–98 to 2009–10. Note: aUnion Budget documents of GoI started presenting information on the funds bypassing state budgets only from 2006–07.

However, there is no documented evidence to suggest that the actual flow of funds up to field level implementing agencies is faster in case of those CSSs where central government funds are bypassing the state budgets [e.g., SSA, NRHM, NREGS, National Child Labour Project (NCLP), TSC, etc.] as compared to others where

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such funds are routed through the state budgets (e.g., ICDS, Mid Day Meal scheme, etc.). On the other hand, it has been argued that there could be a lack of transparency and financial accountability in case of CSSs where central government funds are bypassing the state budgets, since the accounts for such funds (maintained by the state/district-level implementing agencies for the schemes) do not necessarily have to be audited by the Comptroller and Auditor General (CAG) of India. In fact, in 2008, the CAG had observed with regard to such funds that the central government cannot ascertain the actual magnitude of expenditure in several of its CSSs (where its funds are bypassing the state budgets) since disbursements of advances from one level to the next level of implementing agency were reported as expenditures in their accounts. More importantly, the practice of central government funds bypassing the state budgets clearly violates the spirit of fiscal federalism in the country. Numerous Problems in Implementation of CSSs

As regards the problems in implementation of CSSs, it may be worthwhile to highlight the findings emerging from some relevant studies, in particular, a detailed report from 1999 by the office of the CAG of India as follows: Uncontrolled and open-ended execution of schemes: CAG reports have been quite severe in their indictment of the inability of central ministries to control the execution of the schemes to ensure the attainment of the stated objectives in a cost effective manner, within a given time-frame; a frequent lament has been that the schemes were executed in uncontrolled and open-ended manner without quantitative and qualitative evaluation of delivery. l Lack of monitoring mechanisms to ensure effective utilization of funds: It has been observed that the central ministries confined their role to the provision of budget and release of the funds to the implementing agencies rather mechanically l

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l

l

l

l

l

without reference to the effective utilization of the funds released earlier in accordance with the guidelines and capacity of the respective agencies to actually spend the balance from the previous years and releases during the current year. No system of accountability for incorrect reporting: The central ministries were unable to ensure correctness of the data reported by the implementing agencies, since no system of accountability for incorrect reporting and verification of reported performance were in vogue. Delay in devolution of funds: The central ministries were more concerned with expenditure rather than the attainment of the stated objectives of the schemes. Large chunk of funds were released in the last quarter of the financial year, which raises a number of concerns with regard to the quality of fund utilization, and could not be expected to be spent by the respective implementing agencies during the given financial year. Besides, significant delay in flow of funds from the Centre and state governments had been observed in most of the development schemes which were being implemented. Indifferent attitude of the states: The state government’s attitude towards implementation of the programmes was generally indifferent; they laid emphasis on release of funds by the central ministry rather than ensuring quality of expenditure and realization of the objectives. Top-down approach and lack of flexibility: Most schemes followed a top-down approach, with little flexibility given to the implementing agencies. Any change in the scheme required approval from central government and the concerned ministry which was quite time consuming. Uniformity of the designs of schemes all over the country, without sufficient delegation to states to change the schemes to suit local conditions, led to a situation where the states became indifferent to their implementation. Failure to reflect and address state-specific problems: Designs of some of the schemes failed to address state-specific problems 399

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and, the states, while implementing the CSS, were rarely permitted to amend the norms/guidelines for expenditure. l Plethora of schemes: A huge number of CSSs were in operation with similar objectives targeting the same population. Most CSSs ignored the importance of the existing state plan schemes. Increasing outlays for CSSs not leading to improvements in outputs and outcomes

The concern with regard to how well do the budget outlays (i.e., financial allocations made in the budgets) translate into physical outputs/services (such as, schools, hospitals, teachers, doctors, textbooks, medicines, etc.) and ultimately lead to improvements in the development outcomes in the states (such as, improvement in children’s school enrolment ratios, reduction in children’s school dropout rates, reduction in Infant Mortality Rate, reduction in the proportion of underweight children, etc.) has been growing over the last few years. This concern has been highlighted by the Planning Commission and the Central Ministry of Finance about public spending in the country in general, and with regard to the CSSs in particular, as the Union Budget outlays for several of the CSSs have been increased visibly since 2004–05. The findings of a study by Centre for Budget and Governance Accountability (CBGA), ‘Constraints in Effective Utilization of Funds in the Social Sector’, (CBGA, 2010) throws light on a set of institutional and procedural constraints in the utilization of funds in the CSSs in the social sectors. This study analyzed the implementation of some of the major CSSs, like SSA, Mid Day Meal, Reproductive and Child Health (RCH) programme, Universal Immunization Programme, ICDS, NCLP and TSC at the district level in selected states. It highlights the following problems in utilization of funds in the selected CSSs. With regard to the selected CSSs, the study finds that a number of problems have been observed across various states, in particular the backward states, over the last few years, which are: 400

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1. low capacity of some of the states to increase spending, which is evident from the noticeable levels of unspent budget outlays left with some of the states and low levels of actual spending as compared to approved budgets for the schemes in many states; and 2. poor quality of spending/fund utilization in the schemes, since the fund utilization levels are skewed across the four quarters in a fiscal year (typically, a large share of spending getting crowded in the last two quarters), fund utilization levels are skewed across different components in a scheme (spending on those components increases quickly where it is easier to disburse money as compared to some other components which require greater efforts from the implementing agencies), and fund utilization levels are skewed across different regions. Some of the main reasons for such under-utilization of budget outlays by states in the CSSs can be traced to the institutional and procedural bottlenecks in the process of implementation and deficiencies in the planning process being followed at the district level. The said study by CBGA identifies a number of factors which could be the reasons for the above-mentioned problems in the levels and quality of fund utilization in CSSs, which can be broadly divided into the following categories: 1. The first set of factors pertains to the deficiencies in decentralized planning being carried out in most of the schemes, which is caused by shortage of staff to carry out planning activities, lack of emphasis on training and capacity building of staff and community leaders for decentralized planning and inadequate emphasis on community participation in the planning process. 2. The second set of factors pertains to bottlenecks in budgetary processes in the schemes, such as delay in flow of funds, delay in sending sanction orders for spending, decision-making 401

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being centralized within the states, low delegation of financial powers to district and sub-district level authorities, uniform norms of CSSs for all states, incomprehensibility of guidelines of some of the CSSs, very low unit costs which are unrealistic and weak monitoring and supervision of programme implementation activities. 3. The third set of factors relates to systemic weaknesses in the government apparatus in states, in particular the backward states. Shortage of trained, regular staff for various important roles (like, management, finance/accounts and frontline service provision) has weakened the capacity of government apparatus to implement Plan schemes. Weak infrastructural facilities with the government apparatus too have had an adverse impact. Moreover, there are too many Plan schemes being implemented in most of the states, without adequate convergence and integration across them. As regards the last set of factors mentioned above, that is, the systemic weaknesses in the government apparatus in the states, it can be argued that non-plan expenditure by the state plays an important role in improving the overall capacity of the government apparatus. Non-plan expenditure shapes up to a significant extent the strength of the state government apparatus, in terms of availability of regular qualified staff and adequacy of the government infrastructure, for implementing Plan schemes. However, over the last decade, nonplan expenditure in social services has been checked by many states due to the emphasis of the prevailing fiscal policy on reduction of deficits through curtailment of public expenditure. As a result, the overall capacity of the government apparatus to implement Plan schemes has been adversely affected. Thus, the country needs to have a fiscal policy that enables the state governments to increase non-plan spending in the development sectors. The institutional and procedural bottlenecks in planning, fund flow and fund utilization processes need to be removed through concerted efforts by both the Centre and states. Moreover, there is also a need for 402

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giving flexibility to the states vis-à-vis the norms, guidelines and units costs in the CSSs. CSSs not Rooted in Entitlements-based Approach

It is pertinent to note here that many of the CSSs are targeted interventions meant for addressing specific problems identified in the planning process, which are usually not accessible for all sections in the society, are supported only for a limited number of years and they often promote low-cost ad hoc interventions instead of entitlements for people. In this regard, the NREGS is perhaps the only exception among CSSs; it does provide a legal entitlement to the beneficiaries. However, most CSSs do not follow the approach of entitlements. For instance, SSA has an assured operation only up to 2011–12 for which the central government has made certain commitments to share the scheme’s funding with the states (which also has raised serious concerns since the Centre has shifted the fund sharing burden progressively on to states during the Eleventh Plan period). Given the uncertainty about the continuation of SSA beyond the Eleventh Plan period (i.e., beyond 2011–12) and the increasing burden on the states for its funding, it is not surprising that only contractual teachers or para-teachers have been recruited under this scheme at a large scale (except for a few of the southern states which insisted on recruiting only regular teachers even under SSA). However, most educationists have pointed out that large-scale recruitment of para-teachers, instead of qualified regular teachers, has put the future of India’s school education system at stake. Likewise, many of the interventions under SSA, such as, provision of free text books, are meant only for children belonging to certain communities, instead of making such basic provisions an entitlement for all children enrolled for elementary education. Many observers have contended that government interventions for development should promote entitlements for people, instead of piecemeal and short-term interventions, in order to effectively deal 403

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with the development deficits in our country. However, the steady increase in the number of CSSs and their share in total budgetary resources in various sectors, over the last few decades, have been antithetical to such an approach.

IV A Concluding Remark

Thus, there are a number of serious concerns relating to CSSs; however, such schemes have proliferated and their share in total outlay from the Union Budget has been growing steadily. One of the reasons for this could have been the fact that up to 2004–05, the nonspecial category states were given only 30 per cent of the Central Assistance for their State Plans as grants while the remaining 70 per cent of the assistance used to be given as loans. This had increased the indebtedness of state governments, a factor which may have discouraged many states from strongly advocating for a higher magnitude of Central Assistance for State Plans (from the Union Budget) instead of transfer of resources through CSSs. Moreover, it has also been argued that the central ministries have resisted the attempts from Planning Commission for shifting a major chunk of the CSSs to the states, as such a step would drastically reduce the Budgets available to these ministries. However, there exists a strong case for some drastic changes in the policy paradigm relating to public spending in the country, especially with regard to the CSSs. Government interventions for socio-economic development in the country should promote entitlements for people, instead of piecemeal and short-term interventions. Such an approach, however, would require the central and state governments to invest a much greater magnitude of budgetary resources for public provisioning in the social and economic sectors than what has prevailed until now and a lot more emphasis on fiscal decentralisation at all levels of governance. Instead of that, what we find is an increasing reliance on Plan schemes, and in particular 404

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CSSs riddled with rigidities, conditionalities and ad hoc measures, which are also not being implemented effectively. It is time that the central and state governments make a radical change in their approach towards public provisioning for socio-economic development in the country. References Centre for Budget and Governance Accountability. 2009. ‘How Did the UPA Spend Our Money?—An Assessment of Expenditure Priorities and Resource Mobilization Efforts of the UPA Government’. Available online at www. cbgaindia.org, New Delhi. ———. 2010. ‘Constraints in Effective Utilisation of Funds in the Social Sector?’ Unpublished report of a study supported by UNICEF, New Delhi. Das, S. 2007. ‘Let’s Talk about Budget’. New Delhi: Centre for Budget and Governance Accountability. Government of India. 2004. Report of the Twelfth Finance Commission, Ministry of Finance, Government of India. ———. 2008. Economic Survey, 2007–08, Ministry of Finance, Department of Economic Affairs, Economic Division, Government of India. ———. 1997–98 to 2009–10. Union Budget. Ministry of Finance, Government of India. Government of Rajasthan. 2008. ‘Draft Annual Plan 2008–09’, Planning Department, Government of Rajasthan. Planning Commission. 2006. Report of the Sub-Group on Resources Other Than Tax Revenues of States for 11th Plan (2007–2012). New Delhi: Planning Commission, Government of India. Reserve Bank of India. State Finances: A Study of Budgets; various years. Mumbai: RBI.

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16 Improving India’s Health The Significance of Public Financing Mita Choudhury and A. K. Shiva Kumar

India, a signatory to the Alma Ata Declaration of 1978, is far from realizing the goal of ensuring Health for All. Despite improvements since Independence in 1947, recent evidence points to large shortfalls in health achievements.1,2 Underlying the problems of health inequity, insufficient coverage, unequal access, poor quality and costly health-care services are serious deficiencies in the financing of health in India.3 Investments in health, however, are receiving greater priority now than before, especially because of the growing recognition of good health for accelerating and sustaining economic growth as well as the growing recognition of health as a human right. The National Rural Health Mission (NRHM) launched in 2005, for instance, seeks ‘to improve the availability of and access to quality health care by people, especially for those residing in rural areas, the poor, women and children’.4 Planning Commission (2005). Planning Commission (2008). 3 National Commission on Macroeconomics and Health (2005). 4 Government of India’s National Rural Health Mission (2005–12). 1 2

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Financing of health is an important factor that affects the efficiency and efficacy of health-care delivery in any country. India is no exception. Indeed, gaps in health spending and financing are largely responsible for India’s relatively poor health status. Well known, for example, is the fact that public spending at less than 1 per cent of India’s GDP is among the lowest in the world. Most Indians have little or no financial protection against ill-health. This chapter examines these and other characteristics of India’s health expenditure patterns and argues for adopting progressive fiscal measures to remedy the situation as a necessary, though not sufficient, condition for improving the health status of Indians. Data

Consolidated, regular and specialized data on health spending in India are difficult to obtain. The first comprehensive compilation of health expenditure data was provided by Government of India’s National Health Accounts (NHA) for the year 2001–02—last published in 2005.5 This Report admits to several limitations including sketchy household expenditure data, difficulties in estimating costs of inpatient and outpatient care and duplication of government expenditure data. According to the Report, there is need: [T]o reconcile the estimates based on demand side data with the estimates based on supply side data, i.e., survey of health care providers. In the present situation, obtaining data from private providers is difficult in India, especially where this sector is unregulated and also where there is no dependable estimate about the size of the private sector providers.

The National Commission on Macroeconomics and Health set up by Government of India in 2004 is the second source of information on health expenditures and financing in India. The Commission, using the National Health Accounts 2001–02 as the basis, 5

Ministry of Health and Family Welfare (2005).

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updated and revised the estimates. The Report of the Working Group on Health Care Financing including Health Insurance for the Eleventh Five-Year Plan released in October 2006 once again uses the estimates of the National Commission on Macroeconomics and Health as the basis for making recommendations. The second report on National Health Accounts India—2004–05 released in 2009 by the Ministry of Health and Family Welfare offers the most recent estimates.6 Six Features

Recapitulated below are six well-known features of health expenditures in India. One, India in 2004 spent around 5 per cent of GDP on health as against the global average of 6 per cent. India’s health spending as a percentage of GDP was higher than countries like Thailand, Singapore, Malaysia, Sri Lanka and China though India reports lower life expectancy and poorer health outcomes than all these outcomes (Figure 16.1). However, the picture changes when we analyze levels of per capita health expenditures. Levels of per capita health expenditure in 2004 varied from Purchasing Power Parity (PPP) $15 in Ethiopia to PPP $6,096 in the United States. India spent, on average, PPP $91 on health in 2004 as against the world average of PPP $743. Per capita spending on health in China and Thailand is, on average, more than three times that of India (Figure 16.2). And of the 37 countries that spent less than India (or PPP $91), only three (Comoros, Pakistan and Tajikistan) reported higher levels of life expectancy. What do Indians get for these levels of health spending? The vast majority of Indians do not have access to affordable quality care. The failure of the state to provide a credible public health National Health Accounts Cell and Ministry of Health and Family Welfare (2009). 6

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Improving India’s Health Figure 16.1:â•… Health Expenditure as a Percentage of GDP, Selected Countries, 2004

Source: Based on data from the Human Development Report, 2007–08. Figure 16.2:â•… Per Capita Health Expenditure, Selected Countries, 2004 (PPP US$)

Source: Based on data from the Human Development Report, 2007–08.

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care system has been responsible for the expansion of a large private sector. However, absence of effective regulations has resulted in the private sector being known for ‘quackery’ and ‘crookery’ that exploit the ignorance and vulnerability of the patient. Also, high-quality private medical care is well beyond the reach of most Indians. At the same time, quality health services in the public sector, often free or highly subsidized, are in serious short supply. The inability to enforce proper accountability in the public sector has led to serious inefficiencies in the public health system. Two, public spending on health is extremely low in India. As a proportion of GDP, India’s public expenditure on health was 0.9 per cent in 2004. There were only 11 countries in the world where public expenditure on health as a proportion of GDP was lower than India’s. The situation is no different when we analyze per capita public spending on health. In 2004, there were only 18 countries in the world with levels of per capita public spending lower than India’s. On a per capita basis, public spending on health in China is almost six times higher than in India, and it is 12 times higher than in India in Thailand. The huge deficiency in public spending on health becomes even more obvious when we examine state-level public expenditures on health. For example, Bihar, a relatively poor-health Indian state of 83 million people, spent in 2005–06, on average, an equivalent of US PPP $39 on health and Uttar Pradesh, another poor-health state of 166 million, spent US PPP $41. Three, as a proportion of GDP, public spending on health has been stagnating around one percent of GDP (Figure 16.3). One would have expected that the growing recognition of the importance of health, the acceleration in economic growth and the increase in per capita incomes and tax collections would have led to an increase in total spending on social sectors and more specifically on health. This unfortunately has not happened. Four, a consequence of the low levels of public health spending is the extremely high burden of out of pocket private expenditures on health in India (Figure 16.4). According to the National Health 410

Improving India’s Health Figure 16.3:â•…Trends in Public Expenditure on Health as a Percentage of GDP, India, 1970–71 to 2003–04

Source: Based on data from Central Bureau of Health Intelligence, Government of India, 2007. Figure 16.4:â•… Fund Flow to Health Sector by Sources, 2004–05 (Per cent)

Source: National Health Accounts, India, 2004–05.

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Accounts, 2004–05, out-of-pocket expenditures by households accounted for almost 70 per cent of total health expenditures, and government expenditure (including external assistance) accounted for 22 per cent of total health spending. Figure 16.5 shows the position of private out-of-pocket spending on health in India vis-à-vis other countries for the year 2004. India’s out-of-pocket expenses on health are among the highest in the world—much higher than what we find in rich countries where the proportion is often less than 20 per cent (as in Denmark and the United Kingdom). Five, there has been a steady rise in health-care costs over the past two decades. Table 16.1 shows that between 1986 and 2004, the average costs per hospitalization case have gone up almost three times in both government and private hospitals. Figure 16.5:â•… Share of Public and Private Health Spending, Selected Countries, 2004 (Per cent)

Source: Human Development Report, 2007–08.

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Improving India’s Health Table 16.1:â•… Comparative Average Total Expenditure per Hospitalized Case During Last 365 Days by Type of Hospital Adjusted by Consumer Price Index—Rural and Urban Government hospitals 42nd Round 1986–87 Rural Urban

1,120 1,348

Private hospitals

52nd Round 60th 1995–96 Round 2004 3,307 3,490

3,238 3,877

42nd 52nd Round Round 60th 1986–87 1995–96 Round 2004 2,566 4,221

5,091 6,234

7,408 11,553

Source: NSSO cited in Ministry of Health and Family Welfare (2007).

A consequence of the rising costs has been a reduction in the number of cases of hospitalization due to financial reasons. In 1986–87, lack of sufficient financial resources was cited by 15 per cent in rural areas and 10 per cent in urban areas as the reason for not treating ailments. By 2004, these proportions rose to 28 per cent in rural areas and 20 per cent in urban areas. At the same time, rising costs of health care, as well as the high out-of-pocket expenses continue to force many households to dispose off their assets or borrow. In 2004, for instance, nearly half (47 per cent) of the hospitalization cases in rural India and 31 per cent of the hospitalization cases in urban India were financed by loans and sale of assets.7 Six, India offers practically no financial protection to offset the costs incurred on in-patient and out-patient care. According to the National Family Health Survey 2005–06, only 10 per cent of households in India had at least one member covered by medical insurance. The health insurance base in India remains fairly small and fragmented.8,9,10 Consequently, insurance premiums have made an insignificant contribution to the financing of health expenditures in India. Expenditure on social insurance accounted for only 1.13 per cent of total health spending in 2004–05. The National Sample Survey Organisation (NSSO), (2006). Gupta and Trivedi (2006). 9 Acharya and Ranson (2005). 10 Ellis, Alam and Gupta (2000). 7 8

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absence of financial protection and the rising costs of treatment have been dissuading people from accessing much-needed health care. In 2004, 28 per cent of ailments in rural areas went untreated due to ‘financial reasons’—up from 15 per cent in 1995–96. Public Spending Matters

Figure 16.6 shows the relation between per capita public health expenditures and life expectancy at birth across countries. The graph illustrates not only a positive association, but also suggests that at low levels of per capita public health expenditures, even a small increase in public spending on health can bring about large improvements in longevity. Per capita public health expenditures, however, vary widely across the country. Though in 2005–06, the Indian government Figure 16.6:â•…Relationship between Per Capita Public Expenditure on Health (PPP US$) and Life Expectancy at Birth (Years) across Different Countries, 2004

Source: Data from 177 countries from Human Development Report, 2007–08.

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spent, on average, `234 per person on health, it varied from a low of `113 in Bihar to a high of `301 in Kerala (Figure 16.7). We find a strong correlation between public expenditure on health and health outcomes across Indian states. The higher the per capita levels of public spending on health, better is the health outcomes measured in terms of longevity. It is true that longevity is also positively correlated with per capita incomes. However, as our statistical analysis shows, per capita public health spending emerges as a significant variable affecting life expectancy at birth across Indian states; and the association between per capita Gross State Domestic Product (GSDP) and life expectancy at birth disappears with the inclusion of per capita public health spending. Figure 16.7:â•… Per Capita Public Spending (`) and Life Expectancy at Birth (Years) across Selected Indian States, 2005–06

Source: Authors. Note: Data on life expectancy at birth has been taken from Population Projections for India and States 2001–2026, Office of the Registrar General and Census Commissioner. Data on public expenditure has been taken from Finance Accounts of individual States, compiled by the Comptroller and Auditor General of India.

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The observation that health outcomes are positively associated with levels of public health spending needs to be qualified. Many factors other than mere levels of expenditures mediate to influence health outcomes. These could be factors directly associated with the health sector (such as the priority assigned to health, equitable provisioning and reach of health services, the quality of health care and the institutional milieu in which service delivery takes place), non-health related factors (such as several social determinants and factors influencing health-seeking behaviour) and complementary investments in sectors other than health (such as basic education, nutrition, sanitation and water). Empirical evidence suggests that public health expenditures, more so than incomes, are an important determinant of health outcomes. Anand and Ravallion in 1993, for instance, offer statistical evidence to establish the critical importance of public spending on health for health outcomes.11 Their inter-country statistical analysis shows that while life expectancy is positively correlated with Gross National Product (GNP) per capita, the relationship works mainly through the impact of GNP on the incomes of the poor and public expenditure on health care. In other words, public expenditure on health care and success in poverty reduction have a profound impact on life expectancy at birth—much more so than GNP per capita. The inclusion of these two variables in the statistical exercise makes the association between GNP per capita and life expectancy at birth disappear almost entirely. We tested the Anand–Ravallion hypothesis by using appropriate data from 14 Indian states for the year 2005–06. The results are presented as follows: log (80 − LE ) = 2.54 + 0.17 log(GSDP/capita ) − 0.02 log(PR ) − 0.92 log(PC CPHS) (2.65) (0.85) ( −0.10) ( −2.34 )

r2 = 0.62

Where, GSDP/capita = Gross State Domestic Product per capita, PR = Poverty Ratio defined as the proportion of population 11

Anand and Ravallion (1993).

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below the poverty line and PCPHS = Per capita public spending on health. The analysis reveals that per capita public health spending emerges as the most significant variable affecting life expectancy at birth across Indian states, and the association between per capita GSDP and life expectancy at birth disappears with the inclusion of per capita public spending on health and the poverty ratio. Progressive Measures

Recognizing the continued neglect of health, Government of India announced in 2005 that public spending on health will be stepped up from the current level of 1 per cent of GDP to 3 per cent over the next five–seven years. The Working Group on Health Care Financing including Health Insurance for the Eleventh Five Year Plan (October 2006), the Approach Paper to the Eleventh Five Year Plan (December 2006) as well as the Eleventh Five Year Plan document (2007–12) also endorse the target of 3 per cent.12,13 However, Government of India needs to take several progressive measures for this to happen. First, steps must be taken to ensure that India progressively moves towards the goal of allocating 3 per cent of GDP for public health. Our projections reveal that nominal per capita health expenditures will have to go up from `267 in 2005–06 to `2,430 by 2015.14 Planning Commission (2006). Planning Commission (2008). 14 Note that in the earlier discussion, we cite for 2005–06 the per capita pub-lic health expenditure figure as `234 for India whereas here it is `267. The figure in this table has been calculated by fixing the proportion of public health expenditure at 0.9 per cent of GDP and then computing the per capita figure by dividing the total public health expenditure by estimated population for 2005–06. The lower figure has been computed from expenditure statements of the various state governments. We believe that the higher figure may actually be more accurate given that the earlier estimate does not include expenditures on health incurred by various other departments like defence, railways and so on. 12 13

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Mita Choudhury and A. K. Shiva Kumar Table 16.2:â•… Projected Public Expenditures on Health

Year 2005–06 2009–10 2014–15

Public expenditure on Public expenditure Per capita public health as proportion on health in nominal expenditure on health of GDP terms ( ` million) ( `) 0.9% 1.5% 3.0%

294,810 832,502 3,047,466

267 707 2,430

Source: Authors.

Government of India must set up an appropriate tracking mechanism to ensure that the required resources are indeed allocated to health. Two, meeting these financial commitments will require a reexamination of the role of the central government in the provision and financing of health care. Radical changes are needed both in terms of the amount of central resources that are spent and in terms of how the Centre will allocate resources to different states. For instance, if the national goal is to provide quality primary health care services to all, then it might become necessary for the central government to cover capital and recurring expenditures of at least primary health-care centres. At the same time, existing arrangements for expenditure sharing between the central and state governments need to be reexamined. Under the National Rural Health Mission (NRHM), states are to provide a 15 per cent share of NRHM resources during the Eleventh Plan and 25 per cent there after, along with a minimum 10 per cent increase in the state’s expenditure on health every year. This arrangement needs to be carefully examined on a state-by-state basis as it may simply not be possible for many states to allocate sufficient funds for health given their fiscal deficits as well as their existing non-negotiable financial commitments. The central government will have to reassess the extent and criteria for extending financial support to state governments as they attempt to enhance public spending on health to reach the desired outcomes. Three, India must specify the source of financing of this additional health expenditures. We believe that taxation ought to 418

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remain the principal source of financing public health in India. In 2005–06, total public expenditures on health accounted for 4 per cent of total tax revenues. If India has to fulfil its financial commitment to meet the target of public spending rising to 3 per cent of GDP, then Government of India must progressively ear-mark additional taxes for health. As indicated in Table 16.3, this would mean increasing tax allocations to health so that by 2015, some 11 per cent of tax revenues are strictly earmarked for health. This is, of course, based on the assumptions made by the Planning Commission for the Eleventh Five Year Plan hold true till 2015. Should growth rates falter or inflation be higher, then the allocations to health will be correspondingly different. Table 16.3:â•…Taxation and Public Health Expenditures in India Year 2005–06 2009–10 2014–15

Public expenditure on health/GDP (%) 0.9 1.5 3.0

Public health expenditure/tax revenue (%) 3.9 6.3 10.9

Source: Authors.

Four, India must commit itself to offering universal medical insurance cover to all its citizens. Many new medical insurance programmes such as the Rashtriya Swasthya Bima Yojana (RSBY) have been announced by Government of India. Many state governments have introduced insurance schemes over the past decade. Yet the coverage remains low, largely because the institutional arrangements for extending coverage are not in place. It is important for India to make a strong commitment extend financial protection against medical expenditures to all families, not just the poor. Like China, India must commit itself to increasing medical insurance coverage to 90 per cent of the population over the next three years. Such a social medical insurance scheme for health care could be supported primarily by public financing complemented by other sources including mandatory private insurance for formal sector employers. This will call for rationalizing and unifying all existing insurance schemes under a single payer system that utilizes the 419

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services of both public and private providers of both allopathic and non-allopathic systems of medicine to ensure effective coverage. At the same time, steps ought to be taken to establish standards for payment, quality of care and ensure cash-free transactions. Concluding Comments

While endorsing India’s commitment to increasing public health expenditures and calling for the strict earmarking of tax revues for health, it would be naïve to even suggest that additional finances alone will solve the problem. Clearly, every effort must be made to improve cost effectiveness and efficiency of public spending as well as accountability. The many well-known deficiencies in public management of health-care delivery systems need to be addressed. More detailed analyzes of the levels of per capita public health spending and their composition can offer useful insights into provisioning of public sector health care in terms of adequacy of staff and facilities, reach and quality. At the same time, health outcomes will be affected not only by levels of expenditures in health but also by complementary investments in sectors other than health (such as basic education, nutrition, physical infrastructure, water and sanitation). Nevertheless, we believe that the under-funding of health in India has been a major factor responsible for the country’s poor health outcomes. To that extent, stepping up public investments in health is certainly a necessary condition for effective health sector reforms. And increasing financial allocations through the adoption of radical public financing mechanisms is urgently required to promote much needed health security in India. References Acharya, A. and K. Ranson. 2005. ‘Health Care Financing for the Poor: Community-based Health Insurance Schemes in Gujarat’, Economic and Political Weekly, September 17, Mumbai 40 (38): 4141–50.

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Anand, Sudhir, and Martin Ravallion. 1993. ‘Human Development in Poor Countries: On the Role of Private Incomes and Public Services’, Journal of Economic Perspectives, 7 (Winter): 133–50. Ellis, R. P., M. Alam, and I. Gupta. 2000. ‘Health insurance in India: Prognosis and prospects’, Economic and Political Weekly. January 22, 35 (4): 207–17. Gupta, I. and M. Trivedi. 2006. ‘Health insurance: Beyond a piecemeal approach’, Economic and Political Weekly. 41 (25) June 24, 2525–28. Ministry of Health and Family Welfare. 2005. Report of National Health Accounts, India 2001–02. Report submitted to Government of India, New Delhi. Available online at http://mohfw.nic.in/NHA%202001-02.pdf (accessed 27 September 2010). Ministry of Health and Family Welfare. 2005. Government of India’s National Rural Health Mission. Mission document available online at http://mohfw. nic.in/NRHM/Documents/Mission_Document.pdf (accessed 27â•¯September 2010). National Commission on Macroeconomics and Health. 2005. Report of the National Commission on Macroeconomics and Health. Report submitted to Government of India, New Delhi. National Health Accounts Cell and Ministry of Health and Family Welfare. 2009. National Health Accounts, India 2004–05. Report submitted to Government of India, New Delhi. National Sample Survey Organisation (NSSO). Report on Morbidity Health Care and Condition of the Aged (Report no. 507). Report submitted to 60th round Government of India, New Delhi. Planning Commission. 2005. ‘Mid-Term Appraisal of the Tenth Five Year Plan (2002–2007). Government of India’, New Delhi. Available online at http://planningcommission.nic.in/plans/mta/midterm/midtermapp.html (accessed on 27 September 2010). Planning Commission. 2006. Towards Faster and More Inclusive Growth—An Approach to the 11th Five Year Plan. Government of India. New Delhi. Planning Commission. 2008. ‘Health and Family Welfare and AYUSH,’ in Eleventh Five Year Plan 2007–2012, Volume II, pp. 57–127. Government of India. Planning Commission. 2008. Eleventh Five Year Plan 2007–2012, Volume II, pp. 57–71. Government of India.

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17 Financing the Right to Education Santosh Mehrotra*

India’s population of illiterates in the year 2001 was greater than the total population of the country at the time of independence (1947). The illiterate population of around 350 million was the outcome of policies and funding patterns that prevailed in India from the Second Plan onwards (1957–62). While the First Five Year Plan had taken serious note of the requirements of elementary education, very soon thereafter, higher and technical education began to take precedence over elementary education. The nation is still paying the price for this monumental lack of vision, and the poor in particular have remained excluded from the fruits of even elementary education. In an already highly socially stratified society, the exclusion from elementary education has been the underlying cause of the mass scale of chronic poverty in the country. It is not surprising that in 2004–05, the number of poor (as estimated by the Planning Commission) is not dissimilar from the number of illiterates in India—300 million. This is the context that gives urgency * I am grateful to Dr Anit Mukerjee, National Institute of Public Finance and Policy, Professor R. Govinda, Vice-Chancellor, National University for Educational Planning and Administration and Mr Muchkund Dubey, author of the Bihar Common School System report, for their comments and suggestions. The usual disclaimers apply.

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to the Right to Education (RTE), and in fact we are already half a century too late and behind the Constitutional directive. A ‘Right’ can be attained immediately and progressively. An example of the former is the Right to Information (RTI), where except for enacting the various provisions of the ‘Right’, and forming some institutions to implement the right, nothing much needs to be put in place. On the other hand, economic, social and cultural rights fall into the second category, where the state progressively puts in place structures to protect, promote and fulfil the social compact. At no place in the actual publication in The Gazette is the word ‘progressive’ utilized, which leads us to infer that RTE has to fall in the first category also. This puts an immediate financing burden on the duty-bearer (i.e., the state). This is the critical point in the debate—where will the money come from. One of main contributions of the chapter is to identify these channels, and to set them in the context of the immediate argument. In December 2002, the Indian Parliament passed the Constitution 86th Amendment Act which mandated the provision of free and compulsory education, by inserting Article 21A in the Fundamental Rights: ‘[T]he State shall provide free and compulsory education to all children of the age of 6–14 years in such a manner as the State may, by law, determine.’ Article 21A in the Fundamental Rights chapter replaced Article 45 in the Directive Principles of State Policy: ‘[T]he State shall endeavour to provide early child-hood care and education for all children until they complete the age of 6 years.’ But the 86th Constitutional Amendment stipulates that ‘[i]t shall come into force from such date as the central government may by notification in the Official Gazette, appoint’. Unfortunately, this notification has never been issued. Therefore, the 86th Constitutional Amendment has not yet come into force. It is for this reason that the need arose for the RTE bill.1 1 The Bill was introduced in Parliament in the last session before the 14th Lok Sabha came to an end in April 2009. The Bill was introduced in the Rajya Sabha, and hence it was taken up again when the 15th Lok Sabha met, and has since been passed and has become an Act of Parliament.

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Many arguments were made in the intervening period against the need for a RTE Act. For instance, it was suggested that resources have not been an obstacle for some states to provide free and compulsory education. States like Kerala, Himachal Pradesh, Mizoram and Tamil Nadu have already provided universal elementary schooling to a large extent even without legislation like the proposed one, and it was argued that other states can also do the same. However, this argument overlooked the large backlog of out-of-school children, especially in certain states, and the fact that a vast number of illiterates in India are geographically concentrated in very poor, northern and the eastern states, with a large population. In fact, Uttar Pradesh (undivided), Bihar (undivided), Madhya Pradesh (undivided) and Maharashtra together accounted for 49 per cent of the poor in India in 1993, but by 2004–05, the share of the same territory in the total poor of the country had increased to 58 per cent (Planning Commission, 2008). These states will need to give priority to elementary education in their own plans and allocations, but they will also need additional fiscal support from the central government to universalize elementary education. This is the key to the achievement of unusual elementary education in India, and is a subject we return to later in the chapter. Another argument against the RTE was that the Centre should not take over the responsibility for an ever-expanding list of key state subjects such as law and order, health and education. It was also suggested that if the Centre were to go on doing this, state governments would go on with their lopsided prioritizing of the populist programmes and not the priority programmes. While there is indeed a need for correcting the lopsidedness in state governments’ allocations, there is an equal need to incentivize the poorest state to prioritize elementary education and not penalize them for their erstwhile populism in economic and social policy. Such a system of incentivization should be the responsibility of both the Planning Commission as well as the Thirteenth Finance Commission (FC13). We will return to this issue later in the chapter. 424

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The real issue now is the following: Now that the RTE Bill has become law, will the central and state governments together be able to provide necessary funding to ensure the right of children to free and compulsory education up to Class VIII? The title of the Eleventh Five Year Plan is ‘Towards Faster and More Inclusive Growth’ (Planning Commission, 2008), and ensuring better access and retention of children at elementary level is an essential component of inclusive growth. But the fact remains that after five years of fiscal consolidation over 2002–03 to 2007–08, the global financial and economic crisis that began in the third quarter of the year 2008 has resulted in a very sharp deterioration in the fiscal balance of the central government, and to some extent in that of all the state governments as well. So much so, the total fiscal deficit to GDP ratio of central and state governments in 2008–09 is likely to have exceeded 10 per cent. Under the circumstances, the task of increasing financial allocations for elementary education, as mandated by the RTE, would remain a challenge, especially since allocations are required over and above the Sarva Shiksha Abhiyaan (SSA) allocations—a central government for elementary education being implemented by the states. This chapter focuses on the financing of the RTE over the next eight-year period or so, that is, until the end of the Twelfth Five Year Plan (2012–17). Section I of the chapter begins by outlining in brief some key provisions of the RTE, to set the context on cost and financing. Section II goes on to examine the financing of the RTE. In particular, a critical issue that will arise is that some 85â•¯per cent of the total elementary education expenditure by all levels of government is undertaken by state governments, and yet state governments will have to rely on central allocations to reach the targets required by the norms set in the RTE. In particular, the challenge facing the educationally backward states in the north and east of the country are especially daunting, and there is a special need for them to be enabled and supported to raise their per student elementary education expenditure up to the average level of national per student elementary education expenditure of government. 425

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I Provisions of the RTE

We will first discuss the norms and standards for a school laid down in the Act, and then lay out the provisions in the main Act. The schedule appended to the Act lays down the norms and standards for a government elementary school. These relate to pupilteacher (PT) ratio per school as well as to infrastructure. The current prevailing PT ratio at primary level is 40, but the RTE ambitiously pegs the target PT ratio at 30 for each primary school. In other words, the PT ratio of 30 is not applicable at a block or district level but at the level of each and every school, so that the phenomenon of single- or two-teacher school will practically disappear with the implementation of the RTE norms and PT ratio of 30. Second, at upper primary level (Classes VI to VIII), the PT ratio should be 35 with at least one teacher per class for Science and Maths, Social Studies and Languages. Third, in respect of infrastructure, there should be at least one classroom for every teacher, which implies that the age-old, though still current, phenomenon of two- or three-room schools has to disappear. The school building must also provide for separate toilets for boys and girls, which would bring about a revolutionary change from the position prevailing now. For example, in 2005–06, 45â•¯per cent of the primary schools and 15 per cent of upper primary schools did not have a toilet. The RTE Act also provides that the school must have safe drinking water facilities, which again would be a remarkable change from the current situation where 15 per cent of primary schools and 5 per cent of upper primary schools did not have drinking water. Thus, we have found that children in schools that do not have drinking water go home (in a village) to drink water and then do not return to school that day (Mehrotra et al., 2005). The RTE also provides a kitchen where the Mid Day Meal (MDM) is cooked in the school. In addition, it provides a playground and the need for the school building to have 426

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a boundary wall or fencing. All these provisions have very clear cost implications, which we will be discussing in Section II. It states that the minimum number of working days should be 200 for primary schools and 220 for upper primary schools. This again is a welcome change from the current prevailing situation where in most states the number of school working days rarely exceeds 180 (Mehrotra et al., 2005). In addition to the norms and standards mentioned above, we should also take note of some key provisions in the main draft bill of the RTE. First, the Bill provides that children between the ages of three–six years should have access to early childhood care and education and indicates that the ‘appropriate government may make necessary arrangements for providing free pre-school education’. This is perhaps one of the weakest clauses of the Bill, which clearly underestimates the importance of pre-school education, and does not even begin to estimate the costs of ensuring pre-school education to all children between three–six years. We will return to this issue later. Second, the Bill provides that private unaided schools will be required to admit in Class I, at least for 25 per cent of the strength of that class, children of weaker sections and disadvantaged groups in the neighbourhood, and offer them free elementary education till its completion. The school will be able to get reimbursement on the basis of per child expenditure from the state. This has been one of the most criticized clauses in the bill, as it has been seen to encourage private schooling, and to entrench the current segmentation in the school system between high-quality private and low-quality government schools. It is also seen as signifying the death knell of the idea of a ‘common school system’, as opposed to a segmented one, that has been advocated ever since the Kothari Commission (1964). Third, the Bill ensures that no school can be established without obtaining a certificate of recognition from the government. This is a welcome development from the hitherto situation of large numbers of unrecognized, unaided schools proliferating in the country in the private sector. 427

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Fourth, every school will be required to constitute a School Management Committee (SMC) formed by the elected representatives of local authorities, parents of children studying in such a school and teachers. The SMC would hopefully be able to ensure the decline teacher absences over time, an issue we will return to later. Fifth, to address the long standing complaint of teachers and guardians that their services are often used for non-educational purposes by the government, the Bill provides that their services will not be used for any purposes other than the decennial population census, disaster relief duties or duties relating to elections of the local authorities, state legislatures or parliament. Areas of Concern in the Bill

There are two broad types of concerns with the provisions of the RTE bill. First, there are concerns which do not necessarily have any financial implication. Second, there are those which have financial costs associated with them. We will discuss each in turn. One of the biggest reasons for the poor learning experience of children in government elementary schools is the very high level of teacher absenteeism. Kremer et al. (2004), in a seminal study for the World Bank, based on a representative sample in each of the 20 major states in India had concluded that teacher absenteeism on average amounted to 24 per cent of the total working days in a school calendar year. The most educationally backward states were characterized by even higher levels of absenteeism, with Jharkhand showing the maximum absentee rate of 38 per cent, while the southern states had rates usually below 20 per cent. What was worrying in that study was that even when teachers were present, there was not a great deal of teaching activity going on during classroom hours. Therefore, the real issue is whether the SMC to be instituted by the RTE will have the necessary clout to ensure improvement in this state of affairs. The SMC does not seem to be any different from the already existing village education committees found in every gram panchayat—which are captured 428

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by local elites and the teachers, if they function at all. It would be far better if the rules that will be formulated (by the central education ministry) after the passage of the RTE Bill in Parliament at least ensure that in future the SMC will be awarded the power to (a) sanction the leave of the teachers when they wish to be absent and (b) sanction the salary release, subject to attendance and performance. In other words, the rules should provide that the teacher should remain an employee of the district administration and will receive his/her salary from the administration, but neither leave nor salary will be granted until the SMC approves. This kind of measure has the potential of offsetting the power yielded by teacher unions in a state. The Bill also compromises further the possibility of improving teacher attendance by requirement of his services for such noneducational purposes as the census, Panchayati Raj Institutions (PRIs), state and parliament elections and disaster relief duties. In other words, what is proposed in the Bill is hardly different from the current situation in regard to the diversion of teachers’ time for non-teaching duties. Finally, the Bill pays scant attention to pre-school education. There is overwhelming research evidence on the efficacy of early childhood care and education, which has established that preschool-age children who undergo pre-school education not only perform better in school but also do better in life. This evidence holds even for children whose parents have had reasonably good education. Pre-school education becomes even more important for children of functionally illiterate parents, who constitute one-third of the total adult population of India. The children of illiterate parents are ill-prepared for entry into primary classes at Class I, and hence such poor children often tend to drop out from Classes I and II. Pre-school education has not been costed in the total cost of achieving universalization of elementary education. Even though the RTE refers to ages 6 to 14, the fact remains that the retention of children in primary and upper primary school critically depends on their successful preparation for primary school by undergoing pre-school education. While pre-school education in India has 429

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been seen as belonging to the domain of the Integrated Child Development Services (ICDS) Scheme (1.2 million ICDS centres exist throughout India), the fact remains that pre-school education is among the most neglected aspects of the ICDS. Therefore, to not cost what it would take to universalize pre-school education is tantamount to its near total neglect in the Indian school system. To that extent, the cost of achieving universalized elementary education has been underestimated.

II Financing the RTE

There are several issues which should be discussed before we can say with some degree of certainty that the additional cost requirements to universalize elementary education can be financed. First, on account of the global financial and economic crisis that began in late 2008, there is an increase in the fiscal deficit following the multiple stimuli the central government initiated to ensure that economic growth is sustained in 2009–10 and beyond. The current fiscal deficit to GDP ratio of the Centre and states taken together stands at over 10 per cent. This constitutes a significant deterioration in the fiscal situation from that prevailing in fiscal 2007–08. Partly on account of the rapid economic growth in the preceding five years of the Tenth Five Year Plan period, there was a sharp increase in tax and non-tax revenues, with the result that total rev-enues in 2007–08 stood at 20.5 per cent of GDP, for Centre and state together, which is quite unprecedented in India’ fiscal history. In addition, the discipline imposed on both Centre and states by the FRBM Act and their equivalent Acts in 20 states had also resulted in reduction in the fiscal deficit over time. But these two processes have been compromised by the global and financial crisis. The result will be that there will be fewer resources available to all levels of government just when there would be an increase in the requirements for elementary education on account of the RTE. 430

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There may be another constraint on fiscal resources, arising from the demands of higher levels of education. Thus, the Eleventh Plan had already increased allocation for secondary education by a factor of 12.8 in 2007 prices, and for higher education by a factor of five as compared to the Tenth plan period. This significant increase in commitments over the Eleventh plan for secondary and tertiary levels of education will naturally put a downward pressure on the requirements of elementary education in plan funding. In fact, over the last few years a strong case had been made in government circles for increasing public funding for secondary and tertiary education. Reference was often made to China, which has 20 per cent of its relevant age cohort in higher education. However, China’s secondary-level enrolment is 74 per cent as against 57 per cent in India. Its literacy rate is 91 per cent as against 64 per cent for India. Its PT ratio at primary level is 19: 1, as against 40: 1 in India. It will be difficult to attain 20 per cent enrolment in higher education in India if we cannot ensure full coverage of all children aged 6 to 14 in elementary schools, and simultaneously ensure an increase in the completion rate at elementary level—thus raising the transition rate to secondary education. As the RTE has become law, there will be no choice but to find the resources to meet the norms and standards laid down in the RTE Act. However, apart from the pressures arising from the national fiscal deficit, there is an additional issue: the Centre and the states will need to arrive at some agreement on the share of the increased fiscal burden between the federal government and the state governments. In addition, there will have to be some clarity within the Centre about the respective role of the Planning Commission and that of the Thirteenth Finance Commission (FC13). The simple answer to the question of the respective responsibilities of the Planning Commission and the Thirteenth Finance Commission is that non-plan expenditure would remain the responsibility of the Finance Commission, while the Planning Commission will ensure that plan funds to meet to the cost of civil works will be ensured. We return to this issue later. 431

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For good or for ill, we have a distinction in India’s classification of expenditure which is unique to our country—between plan and non-plan. Plan expenditure has been defined as that which focuses on new schemes/new projects/new extensions to currently running schemes. As the Eleventh Plan document notes, this distinction has become ‘dysfunctional’ and ‘illogical’, because of two reasons: one, it results in the neglect of maintenance of existing capacity and service levels, and two, it has created the perception that non-plan expenditure is wasteful and has to be minimized. This distinction has increasingly become untenable, since the ban on recruitment for non-plan posts, which are especially important for sectors like education and health, has caused irreparable damage to the quality of service delivery over the last few decades. Nevertheless, we shall sidestep this dysfunctionality of the distinction between plan and non-plan expenditure, for the purposes of this chapter—since the current system still recognizes it, and until it is abolished, ‘planning’ will have to continue on the basis of this distinction. This distinction is of relevance for the expenditure requirements of elementary education. Three-fourths of total plan expenditure on elementary education is accounted for by the central government, and the remaining one-fourth comes from state governments (Tilak, 2009).2 Most additional expenditure that we have referred to in the previous section on costs of RTE would fall under the Plan category. The issue that will then arise is: will the states meet those plan expenditures, or the Centre will? Given that three-fourths of the total plan expenditure on elementary education is met by the central government (as we noted above), the states’ expectation will be that the Centre will meet the additional expenditure mostly on its own, since the RTE is a central government legislation. 2 During the Tenth Plan, 65 per cent of states’ total plan resources were derived from states’ own resources (i.e., the balance from current revenues, resources of public sector enterprises and borrowings), and the remaining 35 per cent from central assistance for states’ plan spending (Planning Commission, 2008, Chap 3, vol. 1).

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That this will be a terrain full of contention between the Centre and the states can be anticipated from the contentious nature of the division of funding responsibility that SSA has proved to be in the recent past. During the Ninth Plan, the central state sharing arrangement for expenditure on elementary education was 85: 15, (i.e., for SSA), which changed to 75: 25 during the Tenth Plan, and after much debate it was agreed that over the Eleventh Plan the Centre’s share would taper down from 65: 35 to 50: 50 in the final year of the Plan (2011–12). Almost all (99 per cent, according to Tilak, 2009) of the nonplan expenditure on elementary education is undertaken by state governments. Most of this expenditure is, of course, on teacher salaries. It is unlikely that the 15 per cent additional costs on teacher salaries (see, Section I) for the RTE will have to be met by state governments from non-plan funds. It will almost certainly come from the central government under plan funds. However, the fact remains that even for plan funds for elementary education, we have seen that three-fourths of that is met by the central government. In fact, for plan and non-plan expenditure together, the share of the central government in elementary education increased from 11 per cent in 2001–02 to 27 per cent in 2007–08, while the share of the state governments fell accordingly (Tilak, 2009). Yet, there is no question that the absolute increase in both plan and non-plan expenditure as a result of the RTE will mean that the states will have to increase their expenditures under the non-plan head. In any case, states do have to meet one-fourth of plan expenditure, so that head of expenditure will also increase. The central government’s share of plan funding for elementary education has been increasing steadily. The central government’s funds for elementary education come from two sources: the education cess, which is an ear-marked ‘tax-on-income tax’, which goes straight into the Prarambhik Shiksha Kosh (PSK) and the Gross Budgetary Support, which is sourced from the general revenues of the central government. The contributions from the education cess have been increasing over the last few years (2006–07 to 2008–09), with the cess accounting for 53 per cent, 66 per cent and 59 per cent, 433

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respectively in the three years of central government’s allocation for the SSA (elementary education) (CPR Budget Briefs 2009–10).3 One will have to wait to see whether the central government decides to increase the cess to fund the PSK to meet the costs of RTE, or simply rely on an increase of general revenues. The biggest area of concern remains: How will the states, especially the educationally backward states, meet their obligations under the RTE? The difficulty arises from the fact that the Twelfth Finance Commission covering the period 2005–10, managed to disappoint the educationally backward states. A major reason for the poor educational performance of the northern and the eastern states has been the much lower per student expenditure at elementary level compared to the national average. The Finance Commission, which makes allocations to states in the form of grants as well as devolves tax revenues to them, could only ensure that over 2005–10 barely 10 per cent of the gap between per student elementary education expenditure of backward states and the national average was met from earmarked grants. It is absolutely critical, therefore, that at least in respect of non-plan spending this gap is completely filled by the recommendations of the Thirteenth Finance Commission (ThFC). That would mean that the earmarked grants for elementary education over the period 2010 to 2015 should increase significantly. A final issue relates to states’ capacity to absorb the resources. The problem can be illustrated by examining the relationship or ratio of expenditure to allocation for SSA, and the ratio of expenditure to releases for SSA. SSA is implemented by the State Implementation Society through its state and district level officers. There are major delays in the release of funds from the central and state governments to the implementing agency. For all states taken together, The SSA and the MDM given to school children at elementary level together account for 97 per cent of total elementary education expenditure. For MDM, the education cess contributed 45 per cent, 54 per cent and 36 per cent of total central funds, while the remainder of MDM funds came from gross budgetary support in those same years. 3

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the expenditure-allocation ratio in 2006–07 was 70 per cent, or 30 per cent of funds remained unspent. The expenditure-release ratio in 2007–08 was 78 per cent for all states, so 22 per cent of funds released to the societies were unspent. Table 17.1 shows that in 2007–08, for most of the educationally backward states, the expenditure-release ratio was much worse than 78 per cent. In other words, even if the financing was available, there will still be issues around the capacity of the weakest states, which account for most children out of school, to absorb the funds available. Government finance is not the only source of potential financing for the RTE. Since 1990, the Government of India has accepted external finance for elementary education. Given that the fiscal deficit of the Centre and the states has increased significantly after the global economic crisis (beginning 2008), India may well have to think hard about external sources of finance. Since 2008, India is no more a low-income country under the World Bank classification, and hence not eligible for the soft-loan window of the multilateral financial institutions. In other words, just as the needs of elementary education for increased funding have increased, two new constraints have emerged: the increased fiscal deficit which cannot be increased further without causing macroeconomic instability, and the closure of the soft-loan window for external finance. In fact, we know that during the Eleventh Five Year Plan, there was a sudden and sharp increase in expenditure on infrastructure and on rural development as part of the fiscal stimulus to increase domestic investment and consumption demand as well as to counteract the effects of the fall in external demand. The automatic squeeze effect of this fiscal stimulus has been felt, and will continue to be felt in the two big ticket items in the Eleventh Plan: health and education, since these are the two sectors that had witnessed the greatest increase in allocations at the beginning of the Plan period. Hence, India may well have to consider approaching the major bilateral donors for increased finance for elementary education, to partially address the financing gap. Data confirm the rapidly rising trend in the real value of aid for education throughout the 1990s, with some variation since 2002–03 435

2 Released

Assam 183.20 183.20 Bihar 443.99 443.99 Jharkhand 107.82 107.82 Madhya Pradesh 76.03 76.03 Orissa 53.49 53.46 Rajasthan 20.00 20.00 Uttar Pradesh 736.87 736.87 West Bengal 64.83 64.83 Total 1,686.23 1,653.79

1 Allotted

4 Released

200.60 200.60 486.17 486.17 118.06 59.03 83.25 83.25 58.57 58.57 20.00 20.00 806.87 806.87 70.99 35.50 1,844.51 1,749.99

3 Allotted

2006–07

Source: Compiled from by author from www.ssa.nic.in.

1 2 3 4 5 6 7 8

Sl No. States

2005–06

6 Released

8 Released (as on 29 7 Allotted Sept 2008)

2008–09

219.66 109.83 240.53 120.27 532.36 266.18 582.93 291.47 129.28 66.64 141.56 70.78 91.16 91.16 99.82 49.91 64.13 64.13 70.22 35.11 20.00 10.00 20.00 10.00 883.52 441.76 967.45 483.73 77.73 38.86 85.11 42.56 2,017.84 1,088.56 2,207.62 1,103.81

5 Allotted

2007–08

Table 17.1:â•… Utilization of SSA Funds by Educationally Backward States

10 Allotted 263.38 1,107.37 638.31 2,683.76 155.01 651.73 109.30 459.56 76.89 323.30 20.00 100.00 1,059.36 4,454.07 93.20 391.86 2,415.45 10,171.65

9 Allotted

Total 2009–10 (2005–10)

Financing the Right to Education

(Colclough and De, 2009).4 On the other hand, when expressed as a proportion of development expenditure in the sector, its role has been much more substantial, increasing from 5 per cent of central government plan expenditure on education in 1993–94 to 20 per cent in 2000–01 (Tilak, 2008). The proportion is considerably higher for elementary education, where aid was concentrated, increasing from 10 per cent to 35 per cent over those years. This implies that aid donors have been financing a very significant part of the development costs of elementary education expenditures in India over many years, as Colclough and De (2009) rightly note. It is now time for India to prepare to increase bilateral borrowing for elementary education. Servicing these loans will be relatively easy for India, given its large foreign exchange reserves, which have hardly been dented by the global crisis. Finally, there is now a new-found emphasis in the last few years on public–private partnership in the social sectors. If there is a resource constraint, government will need to find new ways to relax the financial constraint upon itself. There have so far not been many examples of public–private partnership in education, especially not in elementary education. However, we cannot continue to be ideologically opposed to public–private partnership in education, where it is feasible, and where the objective of equity is not undermined. The central Ministry of Human Resource Development (MHRD) has also suggested that the proposed National Education Finance Corporation (NFC) should finance school education as well as government local bodies to increase enrolment and improve infrastructure. An earlier proposal was for the corporation to finance only higher education, but the ministry has suggested that funding of the RTE (i.e., school education) should also be included in the 4 When compared to the total volume of public spending on education in India, foreign aid to the sector is very small. For example, in 2002–03 when external aid was roughly at its height, aid was equivalent to only 1.5 per cent of total education expenditure and to 3 per cent of expenditure on elementary education.

437

Santosh Mehrotra

mandate of the National Education Finance Corporation. The mandate of the corporation will be to directly finance educational institutions recognized under law and to finance any government or local body for increasing enrolment. The corporation could also grant loans to any scheduled public sector bank by way of refinance for establishment, development or promotion of educational institutions. An institute with 25 per cent project cost sourced from donations or contributions will get a loan at concessional rates. Also, it is proposed that for setting up educational institutes in backward areas, loans would be cheaper. Concluding Remarks

We have expressed a number of concerns about the content of the RTE Act itself in this chapter—even though we remain staunch supporters of the Act. Notwithstanding these concerns, there will still remain serious unresolved issues around the financing of the RTE. Just as the requirements of funding will increase for elementary education, thanks to the passage of the RTE Act, the resource constraints have tightened. If the FC 13 is unable to meet the gap between backward states and the national mean for per student elementary education expenditure, the objectives of the RTE will remain unrealized. In any case, the central government will need to think hard about the finding external resources for elementary education, in addition to exploring the possibilities for public-private partnership. Finally, the pressure to rethink the plan/non-plan distinction itself will become greater, as we indicated in this chapter, given that an overwhelming proportion of government expenditure on education is devoted to teacher salaries. References Banerji, R. and A. Mukherjee, 2008. ‘Achieving Universal Elementary Education in India: Future Strategies for Ensuring Access Quality and Finance’, Margin: The Journal of Applied Economic Research, 2 (2): 213–28.

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Budget Briefs. 2009. ‘Accountability Initiative Education Budget Brief 2008–09’. Available online on www.accountabilityindia.org (accessed on 22 October 2009). Colclough, Christopher and Anuradha De. 2009. ‘The Impact of Aid on Education Policy in India’, mimeo submitted to the Research Consortium on Educational Outcomes and Poverty, Cambridge, UK. Kremer, M., K. Muralidharan, N. Chaudhary, J. Hammer and H. Rogero. 2004. ‘Teacher Absence in India’. Available online at www.worldbank.org (accessed on 22 October 2009). Mehrotra, Santosh, P. R. Panchamukhi, Ranjana Srivastava and Ravi Srivastava. 2005. Universalising Elementary Education in India, Uncaging the Tiger Economy. New Delhi: Oxford University Press. Planning Commission. 2008. ‘Towards Faster and More Inclusive Growth, 11th Five Year 2007–12’. Report submitted to Government of India, New Delhi. Tilak, J. B. G. 2008. ‘Political Economy of external aid for education in India’, Journal of Asian Public Policy, 1 (1): 32–51. Tilak, J. B. G. 2009. ‘Inadequate funding for elementary education’, Combat Law, May–August, 8 (38.4).

439

About the Editor and Contributors

Editor

Praveen Jha is on the faculty of the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. He has been a visiting faculty at the University of Bremen, Germany since 1999. His major areas of research interest include economics of education, labour economics, agricultural economics and public finance with special focus on the developing countries. He has authored/edited a number of books and monographs, the most recent among which is Public Provisioning for Elementary Education in India (Sage, 2008), and has published several articles in journals published in India and abroad. He has been the honorary economic advisor to the Centre for Budget and Governance Accountability, New Delhi, since its inception. He was a member of the Task Force on Labour Laws, constituted by the National Commission for Enterprises in the Unorganised Sector (NCEUS) and a member of the Committee on State Agrarian Relations and the Unfinished Task in Land Reforms, Ministry of Rural Development, Government of India. He also works closely with people’s movements and labour organizations in India. Contributors

Nilachala Acharya is a research scholar pursuing a PhD in Economics from the Centre for Economic Studies and Planning at Jawaharlal Nehru University, New Delhi. He has also been 440

About the Editor and Contributors

associated with Centre for Budget and Governance Accountability, New Delhi. He has worked on public investments in agriculture and food security. Nirmal Kumar Chandra retired as a teacher from the Indian Institute of Management Calcutta. His areas of interest include economic development in India, the process of globalization and economic transformation in Russia, East Europe and China. Apart from journal articles, he has published two books, namely The Retarded Economies: Foreign Domination and Class Relations in India and Other Emerging Nations (1988) and Political Economy of India in the South Asian Context (1994). C. P. Chandrasekhar is a Professor at the Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University in New Delhi. Besides articles in journals published in India and abroad, he has authored and edited a number of books and monographs, of which most recent are After Crisis: Adjustment, Recovery and Fragility in East Asia and Financial Liberalization and the New Dynamics of Growth in India. He writes a regular column for the fortnightly national magazine, Frontline. Saumen Chattopadhyay is Associate Professor at the Zakir Husain Centre for Educational Studies, School of Social Sciences, Jawaharlal Nehru University, New Delhi. Earlier, he was associated with the National Institute of Public Finance and Policy (NIPFP) for the period 1995–2004. He works in the area of public finance and economics of education. He was involved in many projects in the area of public finance including a major project on compliance costs of income taxes in India while he was at the NIPFP. Mita Choudhury is a senior economist at the National Institute of Public Finance and Policy, New Delhi. She has been associated with various research projects related to financing human development in India and works specifically on the health sector. 441

Progressive Fiscal Policy in India

Her research interests include issues related to the social sector, human development and health financing. Subrat Das is currently Executive Director of the Centre for Budget and Governance Accountability in New Delhi. He has worked on India’s public policy towards natural disasters, financing of social sectors, responsiveness of government budgets to disadvantaged sections of population and budgetary processes in the country. He has authored a number of monographs and co-authored a book Public Provisioning for Elementary Education in India (2008). He holds an MPhil degree from the Centre for Economic Studies and Planning at Jawaharlal Nehru University, New Delhi. S. Mahendra Dev is currently Director of IGIDR, Mumbai. Earlier he was the Chairman of the Commission for Agricultural Costs and Prices. He was also Director, Centre for Economic and Social Studies, Hyderabad for nine years during 1999–2008. He holds his PhD from the Delhi School of Economics and his post-doctoral research at the Economic Growth Centre, Yale University and was faculty member at the Indira Gandhi Institute of Development Research, Mumbai for 11 years. He was Senior Fellow at Rajiv Gandhi Foundation during 1996–97 and Visiting Professor at University of Bonn, Germany in 1999. He has written extensively on agricultural development, poverty and public policy, food security, employment guarantee schemes, social security, farm and non-farm employment. He has more than 100 research publications in national and international journals. He has recently authored a book Inclusive Growth in India (2008). He has been a consultant and adviser to many international organizations like the UNDP, World Bank, International Food Policy Research Institute, ILO, FAO and ESCAP. He also did collaborative projects with IFPRI on food security and poverty. He has been a member of several government Committees including Prime Minister’s Task

442

About the Editor and Contributors

Force on Employment and Rangarajan Commission on Financial Inclusion. He was member of several working groups for Ninth, Tenth and Eleventh Five Year Plans. He has also received honours for eminence in public service. K. K. George is currently the Chairman at the Centre for Socioeconomic and Environmental Studies, Kochi, Kerala. Formerly Professor George was AICTE Emeritus Fellow and Director, School of Management Studies, Cochin University of Science and Technology, Kochi, Kerala. Jayati Ghosh is a Professor of Economics at the Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University in New Delhi, India. She is also the Executive Secretary of the International Development Economics Associates (IDEAS), a network of economists critical of the mainstream economic paradigm of neoliberalism and a Founding Trustee of the Economic Research Foundation. She contributes regularly to columns on economics and current affairs for Frontline magazine, and the newspapers Businessline, Ganashakti, Deccan Chronicle and Asian Age. She has been a member of the National Knowledge Commission and Chairperson of the Commission on Framers’ Welfare of the Andhra Pradesh government. She also works closely with many progressive organizations. Her recent books include The Market that Failed: Neoliberal Economic Reforms in India, After Crisis: Adjustment, Recovery and Fragility in East Asia and Never Done and Poorly Paid: Women’s Work in Globalising India. K. K. Krishnakumar, a BTech (Computer Science) and MBA, is on the faculty of the Centre for Socio-economic and Environmental Studies, Kochi, Kerala. Santosh Mehrotra is currently the Director-General of the Institute of Applied Manpower Research, New Delhi, with the rank of Secretary to the Government of India. He was earlier the Senior Advisor for Rural Development and Economic Advisor 443

Progressive Fiscal Policy in India

for the social sectors in the Planning Commission. Prior to joining the government, he worked with the United Nations for 15 years. He served as Regional Economic Advisor at UNDP’s Regional Centre for Asia, Chief Economist for UNDP’s global Human Development Report and he also led UNICEF’s research programme on developing countries at Innocenti Research Centre, Florence. His research interests span industry and trade issues, the impact of macroeconomic policy on health and education, the informal sector and the economics of health and education. His books include India and the Soviet Union: Trade and Technology Transfer (1990), Development with a Human Face: Experiences in Social Achievement and Economic Growth (1997 and 2000), Universalizing Elementary Education in India: Uncaging the Tiger Economy (2005), The Economics of Elementary Education in India (2006), Asian Informal Workers: Global Risks, Local Protection (London) and Eliminating Human Poverty: Macro-economic and Social Policies for Equitable Growth. M. A. Oommen, currently Chairman, Fourth State Finance Commission, Government of Kerala and Emeritus Professor, Institute of Social Sciences, New Delhi is an economist of repute with a rich collection of professional papers and more than 25 books to his credit. He has participated and presented papers in several national and international seminars and conferences. A post-doctoral scholar of the Rockefeller Foundation and a Visiting Fellow at the Yale University, he was also a senior Fulbright scholar. He has taught in the Universities of Kerala, Calicut and Botswana over a span of more than three decades and was Director, Institute of Management in Government, besides serving on important commissions and committees in India and abroad. Prabhat Patnaik retired recently from the Centre for Economic Studies and Planning, where he held the Sukhamoy Chakravarty Chair, at the School of Social Sciences of the Jawaharlal Nehru University in New Delhi. He is also the Vice-Chairman of the State 444

About the Editor and Contributors

Planning Board of Kerala. He specializes in macroeconomics and political economy, and is the editor of the journal Social Scientist. His books include Time, Inflation and Growth, Economics and Egalitarianism, Whatever Happened to Imperialism and Other Essays, The Retreat to Unfreedom, Accumulation and Stability Under Capitalism and The Value of Money. Utsa Patnaik recently retired as Professor of Economics from the Centre for Economic Studies and Planning, Jawaharlal Nehru University in New Delhi. She has written extensively on problems of agrarian transition in the process of industrialization, both in a historical context and in relation to contemporary developments. Her recent research has been in two main areas—the measurement of colonial transfers and their role in metropolitan industrialization, and the present day impact of imperialist globalization on food security and poverty in developing countries. Her recent publications include Republic of Hunger: And Other Essays and The Agrarian Question in Marx and His Successors. R. Ramakumar is an Associate Professor at the Centre for Development Studies, Tata Institute of Social Sciences, Mumbai, India. He is a PhD from the Indian Statistical Institute, Kolkata. He works on issues of Indian agriculture and agrarian relations. N. C. Saxena is presently serving as the advisor to UNICEF and as Commissioner of the Supreme Court to monitor the implementation of all orders relating to the Right to Food cases. He is a member on the editorial boards of International Forestry Review, Oxford, and Food Policy, Amsterdam. He is also a Member of the Royal Swedish Academy of Agriculture and Forestry, Stockholm, and Member, ADB Institute Advisory Council, Tokyo. He has served in the Government of India in various capacities. He was the Secretary, Planning Commission (1999–2002); Secretary, Rural Development (1997–99) and Director, LBS National Academy of Administration, Mussoorie (1993–96). 445

Progressive Fiscal Policy in India

Tapas K. Sen is a Professor at the National Institute of Public Finance and Policy, New Delhi. He has several research reports, books/monographs and papers to his credit in various areas of public finance. Besides working on topics at the national as well as sub-national levels within India, his international experience includes work on Canada, Ethiopia, Nigeria and Sri Lanka. His current research includes issues pertaining to fiscal federalism and state-level government finances, often focusing on resource requirements for human development. S. L. Shetty was the Director of Economic and Political Weekly Research Foundation (EPWRF) from its inception in March 1993, and continued in that capacity for 16 years, that is, until April 2009. Since then he has been associated with the institution as an adviser. Earlier, he served the Reserve Bank of India for about 24 years and retired as Adviser-in-Charge of its Department of Economic Analysis and Policy. He has authored the well-known publication, Structural Retrogression in the Indian Economy since the Mid-1960s (1978) and also a study on the ‘Performance of Banks since Nationalisation: Promise and Reality’. Based on his empirical studies and participation in policy debates, he has been nominated to serve on a few committees appointed by the RBI and the Government of India. A. K. Shiva Kumar is a development economist and Advisor to UNICEF India. He also teaches Economics and Public Policy at the Indian School of Business, Hyderabad and at the Harvard Kennedy School. He has focused his research on poverty and human development, social sector analysis and the impact of development policies on children and women. He has been a regular contributor to UNDP’s Human Development Reports and has undertaken evaluations of development programmes across a number of countries. He is the co-author of the Handbook of Human Development: Concepts, Measures and Policies. Shiva Kumar holds a PhD in Political Economy and Government from Harvard University. 446

About the Editor and Contributors

N. Sreedevi is a Professor at the Centre for Economic and Social Studies, Hyderabad, India. She is an expert in public finance. She has researched extensively on issues of state finances, particularly focusing on Andhra Pradesh. She has also looked into the issues of social sector expenditure and Centre–State financial relations. D. K. Srivastava is Director and Professor at the Madras School of Economics, Chennai. His research interests include Public Finance, Macroeconomics, Fiscal Federalism, and Applied Econometric Forecasting. He has held several important positions in the past. He was Member of the Twelfth Finance Commission in the rank of Minister of State of the Union Government. He has written extensively on fiscal policy issues in India. T. M. Thomas Isaac is currently the Finance Minister of Government of Kerala, India. He obtained his PhD in Economics from the Centre for Development Studies, Trivandrum. He has also served as a member of the Kerala State Planning Board and was in charge of the People’s Plan Campaign (PPC) in Kerala. He has published many books and articles in English and Malayalam. About CBGA Centre for Budget and Governance Accountability (CBGA) promotes transparent, accountable and participatory governance, and a peoplecentred perspective in the policies shaping up the government’s budgets. CBGA’s research on public policies and budgets, over the last eight years, has focused on the priorities underlying budgets, quality of government interventions in the social sector, responsiveness of budgets to disadvantaged sections of population and structural issues in India’s fiscal federalism. Research on these issues has laid the foundation for CBGA’s efforts pertaining to training and capacity building on budgets (mainly with the civil society organisations in the country) and policy advocacy with important stakeholders. Please visit the website www.cbgaindia.org to know more about the organisation. 447

Index

Above the poverty line (APL), 60 Absenteeism, measurement, 332–33 Accelerated Irrigation Benefit Programme (AIBP), 390 Accelerated Power Development & Reform Programme (APDRP), 390 Additional Central Assistance (ACA), 390, 391, 393 Additional Duty of Customs (CVD), 154, 230 Agriculture credit to, 65–77 growth rates in, 131 share in GDP and employment, 303 vs. non-agricultural GDP distribution, disparities in, 109 Allied activities sector, growth rates in, 131 All India Income Tax Statistics (AIITS), 160 American Depositary Receipts (ADRs), 29 Anganwadi Workers (AWWs), 335, 336 Asset Management Companies (AMC), 78 Audit, social, 333 Auxiliary Nurse Midwives (ANMs), 335

448

Awards, finance commission, 276–77 Backward Regions Grant Fund (BRGF), 390 Balance of Payments (BOP), 41, 42 Bank for International Settlement (BIS), 74 Below the Official Poverty Line (BPL), 60, 61 Bharatiya Janata Party (BJP), 38, 40, 46, 54, 55, 65 Bihar, Madhya Pradesh, Rajasthan, Uttar Pradesh (BIMARU), 92, 178 Bombay Stock Exchange (BSE), 42, 141, 142 Budget, 334 Budget Estimate (BE), 380, 384 Business Process Outsourcing (BPO), 36, 162, 274 Capital expenditure, 54, 55 Capital gains tax, absence of, 115–16 Capital receipts, 187–88 Cash balance surplus in states, xlvii, 179–90 capital receipts, 187–88 central transfers, 184–86 own revenue, 186 receipts, trends in, 184

Index

revenue expenditures, trends in, 188–90 Central budget 2009–10, 227 Central finance commission, 381–83 Central Goods and Services Tax (CGST), 230 Central government funds, bypassing state budgets, 397–98 ministries, 391–95 plan schemes, funds for, 397 revenue, states’ shares in, 269 rural development and infrastructure expenditures, 311 social sector expenditures, 349–56 intra-sectoral allocations in education, health and rural development, 353–56 Central Intelligence Agency (CIA), 78 Centrally sponsored schemes (CSSs), xlv, li, 216–19, 238, 270, 271, 274, 290, 291, 334, 374–405 federal fiscal architecture, evolution of, 376–80 fiscal transfers, statutory and nonstatutory bodies in, 381–95 central finance commission, 381–83 central government ministries, 391–95 planning commission, 383–91 key concerns relating to, 395–404 central government funds bypassing state budgets, 397–98 entitlement-based approach, 403–04 implementation problems, 398–400 outlays and outcomes, 400–03

shrinking flexibility to state governments, 396 per capita grants received under, 257 Central Pay Commission (CPC), xliii Central Plan Schemes (CPS), 257 per capita grants received under, 257 Central Sales Tax (CST), 230, 231 Central sector schemes, 378 Central Statistical Organisation (CSO), 107 Central taxes annual buoyancy of, 226 percentage composition of, 171 share in GDP, 157, 172 Central transfers, 184–86 Central Value Added Tax (CenVAT), 154, 155, 229 Centre excess funds, use of, 270–71 revenue collection, shortfall in, 272–74 Centre’s Gross Revenue Receipt (CGRR), 234 Centre for Budget and Governance Accountability (CBGA), xxx, xxxi, xliv, 400, 401 Centre for Monitoring the Indian Economy (CMIE), 42, 55 Chairman and Managing Director (CMD), 120 Chief Executive Officer (CEO), 117, 119 Chief Minister’s Nutrition Meal Programme (CMNMP), 364 Child Development Project Officers (CDPOs), 336 China, poor people proportion in, 94 Climate change, 231–34 Clothing, monthly per capita expenditure on, 318, 319, 321, 322

449

Progressive Fiscal Policy in India

Coarctation, definition of, 72 Combined social sector expenditures, 341–343 aggregate picture in, 343–47 states’ share in, 341–43 Commercial banks, 76 employees distribution, 138 number of offices of, 137 outstanding credit of, 133–34 Common Minimum Programme (CMP), 38, 40, 54, 56, 59, 60, 61, 66, 71, 72, 80 Communist Party of India (Marxist) (CPI (M)), 40 Companies Act, 116, 120 Company executives remuneration of, 118–20 top earners amongst, 117 Comptroller and Auditor General (CAG), 34, 156, 361, 362, 398 Confederation of Indian Industry (CII), 116 Constitutional identity of finance commission, 264–81 Constitutional parameters, 286–89 Consumer Price Index for Agricultural Labourers (CPIAL), 317, 319 Consumer Price Index for Industrial Workers (CPIIW), 317, 319, 320 Convergence, 248–49 Corporate income tax, 48, 49, 50, 151, 152, 153, 160–62, 165 profit-wise companies distribution, 161 Credit Rating Agencies (CRA), 45, 75, 80 Current Account Balance (CAB), 41, 42 Current Daily Status (CDS), 103 Data, on health spending, 407–08 Debts

450

management, 226–29 public, 45 relief, increasing conditionalities of, 274–76 Department of Food and Public Distribution (PDS), 319 Development Economics, xxxv Directive Principles of State Policy (DPSP), xll, 423 Direct taxes, 151–53 collection of, 156–58 District Planning Committee (DPC), 287, 365 District Primary Education Programme (DPEP), 353 Divergence, 248–49 Dropout rates, primary and secondary education, 100 Early Childhood Care and Education (ECCE), 98 Economic and Political Weekly Research Foundation (EPWRF), 76, 109, 116, 144 Economic crisis, and Thirteenth Finance Commission’s projections, 223–26 Economic structure, 122–23 Education. See also Right to education (RTE) central government social sector expenditures for, 353–56 intra-sectoral allocation, 354–55 primary, enrolment and dropout rates, 100 public expenditures on, 348 secondary, enrolment and dropout rates, 100 Effective Rates of Protection (ERP), 154 Effective Tax Rate (ETR), 36, 159–60, 168, 169, 171

Index

Employment and inequality, 103–06 share of agriculture in, 303 workers, distribution of, 105 Entitlement-based approach, 403–04 Environment, 231–34 Equalization, 250–51 finance commission, 257–61 as formal requirement, 251–52 institutions, 253–57 European Science Open Forums (ESOFs), 117 Executives, remuneration of, 116–21 tracing problems, 117–21 Expenditures. See also individual entries contraction, 190–202 pattern of state government, 188 revenue, trends in, 188–90 social sector. See Social sector expenditures Externally Aided Projects (EAPs), 390

debt relief and grants, increasing conditionalities of, 274–76 and equalization, 257–61 FC13, context of, 267–68 fetters on, 265–67 grants, states’ shares in, 243 role in resources transfer from centre to state, 382 vertical transfer issues, 268–70 ‘Finance demand for money’, 12 Finance Department (FD), 334 Financial Advisor (FA), 334 Financial architecture, 122–23 Financial exclusion, 122–40 economic structure and financial architecture, 122–123 informal sectors, credit for, 129–40 land holdings, marginalization of, 123–29 farmer households, 127–29 non-farm sector households and enterprises, 126–27 Financial markets, 140–45 forex market, exotic derivative contacts in, 144–45 Fiscal deficit, 226–29 of states, 195 Fiscal devolution in liberalization era, 206–21 grants problems, 216–21 recent patterns of, 210–16 Twelfth Finance Commission’s report, implications of, 207–08 Fiscal policy towards rational and progressive, 283–95 constitutional parameters, 286–89 framework, 289–94

Federal fiscal architecture, evolution of, 376–80 Federalism fiscal, emerging, 284–86 horizontal imbalance in. See Horizontal imbalance Finance capital, 3, 4, 9 Finance commission, 198–201, 232, 265 awards and state plans, 276–77 central, 381–83 centre excess funds, use of, 270–71 revenue collection, shortfall in, 272–74 constitutional identity of, 264–81

451

Progressive Fiscal Policy in India

third stratum and emerging fiscal federalism, 284–86 Fiscal policy, challenges to, 177–203 cash balance surplus in states, 179–90 capital receipts, 187–88 central transfers, 184–86 own revenue, 186 receipts, trends in, 184 revenue expenditures, trends in, 188–90 FRBM acts and expenditure contraction, 190–202 finance commissions, role of, 198–201 fiscal responsibility litigations, international experience with, 201–02 state finances, 190–93 Fiscal Responsibility and Budget Management (FRBM) Act, xl, 21, 44, 190–202, 374 finance commissions, role of, 198–201 fiscal responsibility litigations, international experience with, 201–02 state finances, 190–93 year of passing of, 197 Fiscal responsibility legislations (FRL), xl–xli, xlvii, 11 international experience with, 201–02 Fiscal transfers linking performance with, 337 statutory and non-statutory bodies in, 381–95 central finance commission, 381–83 central government ministries, 391–95 planning commission, 383–91

452

Five Year Plan (FYP), 383, 408, 417, 419, 422 Food, monthly per capita expenditure on, 318, 319, 321, 322 Food and Agriculture (FAO), 311 Foodgrains direct and indirect demand for, 314 output and availability, 315 Foreign direct investment (FDI), xxxix, 80 Foreign exchange reserves (FER), 41, 42, 43 Foreign institutional investments (FIIS), 40, 42 Foreign institutional investors (FIIS), 29 Forex market, exotic derivative contacts in, 144–45 Fringe Benefits Tax (FBT), 153 Gadgil–Mukherjee formula, 385 Global Depositary Receipts (GDRs), 29 ‘Golden Age of Capitalism’, xxxiv Goods and services tax (GST), 229, 230, 266 shift from value added tax to, 229–31 Government of India Act, 265, 292 Grains. See Foodgrains Gramm-Rudman-Hollings Act, 201 Gram panchayats (GPs), 291, 292, 329, 428 Grants increasing conditionalities of, 274–76 problems, 216–21 total, from centre to states, 389 Gross budgetary support (GBS), 270, 277, 385, 433 magnitude and composition of, 387

Index

Gross capital formation (GCF), 130 Gross devolution and transfers (GDT), 378, 380, 382 Gross domestic product (GDP), 11, 21, 38, 98, 148, 207, 299, 343 central taxes, share of, 157, 172 distribution between agricultural and non-agricultural sectors, 110 growth at 1999–2000, 225 share of agriculture in, 303 Gross fiscal deficit (GFD), xli, 41, 43, 44, 45 Gross National Product (GNP), 416 Gross State Domestic Product (GSDP), xliii, 111, 189, 343, 415

High Net Worth Individuals with Assets of at least $1 million (HNWI), 78–79 Horizontal imbalance, 246–62 convergence/divergence, 248–49 equalization, 250–51 finance commission, 257–61 as formal requirement, 251–52 institutions, 253–57 regional inequalities and, 246–48 resolving, 239–43 Inclusive governance, 364–65 Inclusive growth in neoliberal India, 38–83 budgetary expenditure, 53–56 credit to agriculture and SSI, 65–77 employment guarantee, 57–60 social security, 60–65 taxation, 46–53 wealth and income, concentration of, 77–79 Income(s) concentration of, 77–79 disparities, rural vs. urban, 107–09, 111–12 distribution of, 107 speculative and unearned, 140–45 Income tax classification, 113 corporate, 160–62 personal, 159–60 Income Tax Act, 153 Income-tax burden, 112–15 India health facilities per capital income in, 62 vs. neighbours, social indicators, 327

Harmonized System of Nomenclature (HSN), 230 Head count ratio (HCR), 90, 91 Health central government social sector expenditures for, 353–56 intra-sectoral allocation, 354–35 expenditures per capita, 409 expenditures of India, improving, 406–20 data, 407–08 progressive measures, 417–20 public spending matters, 414–17 six features, 408–14 public expenditures on, 348, 418 and life expectancy, relationship, 414, 415 taxation and, 419 trends in, 411 sector, fund flow to, 411 spending, public/private, 412 High growth and poor social outcomes, 326–27

453

Progressive Fiscal Policy in India

people below poverty line in, 91 poor people proportion in, 94 poverty ratio across major states, 92 vulnerability of, 41–46 Indian Administrative Service (IAS), 89 Indian Civil Service (ICS), 89 Indian economy, tertiarization of, 299 Indian Institute of Technology (IIT), 271 Indian Institutes of Engineering Science and Technology (IIESTs), 271 Indirect taxes, 48, 153–55 Inequality(ies), 86–145 employment and unemployment, 103–06 executives, remuneration of, 116–21 tracing problems, 117–21 financial exclusion, 122–40 economic structure and financial architecture, 122–23 informal sectors, credit for, 129–40 land holdings, marginalization of, 123–29 financial markets, 140–45 government system, failure to reform, 87–89 indicators of, 106–16 agricultural vs. non-agricultural GDP distribution, disparities in, 109 capital gains tax, absence of, 115–16 income-tax burden, 112–15 inter-state disparities, 109–11 rural–urban income disparities, 107–09, 111–12

454

Millennium Development Goals, 102 Naxalite challenge, 90 poor, social composition of, 96 poverty, distribution, 90–95 inter-state and inter-regional disparities, 92–93 slipping into poverty, 93 World Bank’s estimates, 93–95 regional, and horizontal imbalance, 246–48 social deprivation, 96–102 social sector development, 97–102 Infant mortality rate (IMR), 98, 329, 400 Informal sectors, credit for, 129–40 Information, Education and Communication (IEC), 334 Information and Communication Technology (ICT), 150 Information management, 329–31 Information technology (IT), 51, 114, 158 Input tax credit (ITC), 155, 230 Integrated Child Development Services (ICDS), 333, 336, 378, 383, 400, 430 Intensive rural development programme (IRDP), 107 Interest payments, 54, 55 Intermediate treasury bills investment outstanding of state governments, 181, 183 International Monetary Fund (IMF), 41, 79, 177 International poverty lines poor people proportion as per, 94 Inter-state and inter-regional disparities, 92–93, 109–11

Index

Millennium Development Goals (MDGs), 98, 102, 326 progress towards achieving, 101 Minimum Alternate Tax (MAT), 35, 36, 153 Ministries, central government, 391–95 Monthly Per Capita Expenditure (MPCE), 317, 319, 322

IT-enabled Services (ITeS), 43, 274, 305 Jawaharlal Nehru National Urban Renewal Mission (JNNURM), 217, 390 Juvenile Justice Act, 280 Land holdings, marginalization of, 123–29 non-farm sector households and enterprises, 126–27 farmer households, 127–29

National and Housing and Urban Development Corporation (HUDCO), 253 National Child Labour Project (NCLP), 397, 400 National Commission for Enterprises in the Unorganized Sector (NCEUS), 58, 59, 60, 61, 64, 66, 73, 74, 75, 82, 127 National Common Minimum Programme (NCMP), 98 National Co-operative Development Corporation (NCD), 253 National Council of Applied Economic Research (NCAER), 107 National Democratic Alliance (NDA), 12 National Development Council (NDC), 22, 391, 392 National Employment Guarantee Act, 38 National Family Health Survey (NFHS), 326, 413 National Police Commission (NPC), 88 National Rural Employment Guarantee Act (NREGA), 57, 58, 59, 60, 323 National Rural Employment Guarantee Scheme (NREGS), 356, 378, 383, 397, 403 National Rural Health Mission (NRHM), 330, 393, 406, 418

Liberalization, 21–37 era, fiscal devolution in. See Fiscal devolution in liberalization era exit debate, 31–34 resources mobilization, 23–31, 34–37 Life expectancy, and public health expenditures, relationship, 414, 415 Litigations fiscal responsibility, international experience with, 201–02 Manufacturing Stage Value Added Tax (MANVAT), 154 Mass living standards, implications for, 299 Maternal Mortality Ratio (MMR), 98, 100, 329 Member of Parliament Local Area Development (MPLAD), 390 Memorandum of Understandings (MOUs), 169, 286 Mergers and Acquisition (M&A), 52 Micro, Small and Medium Enterprises Act, 72 Mid Day Meal (MDM), 383, 398, 400, 426

455

Progressive Fiscal Policy in India

National Sample Survey (NSS), 69, 77, 78, 127, 309, 314 National Sample Survey Organisation (NSSO), 123, 126 National Small Savings Fund (NSSF), xlii, 182, 215 National Stock Exchange (NSE), 142 business growth of futures and options segment of, 143 Naxalite, 90 Net Domestic Product (NDP), 107, 109, 163, 165 distribution between rural–urban areas, 108 Net National Product (NNP), 163, 308, 311 Net State Domestic Product (NSDP), 247 Nirmal Gram Puraskar (NGP), 329 Non-agricultural GDP (NA-GDP), 47, 48, 109 Nongovernmental organizations (NGOs), selecting, 334–35 Non-performing Assets (NPA), 74, 75 Non-resident Indian (NRI), 29 Normal Central Assistance (NCA), 270, 390–91, 392–93 Open Market Borrowing (OMB), xlii Operating Surplus (OS), 49–50 Operational holdings, 123–26 characteristics of, 124 size distribution changes, 125 Organisation for Economic Cooperation and Development (OECD), 54, 61 Organized sector employment, growth in, 105 Other Backward Classes (OBC), 55

456

Outcomes, monitoring. See Outlays and outcomes Outlays and outcomes, 326 absenteeism measurement, 332–33 budget, 334 centrally sponsored schemes, 400–03 fiscal transfers, linking performance with, 337 high growth and poor social outcomes, 326–27 information management, 329–31 NGOs, selecting, 334–35 procedures, simplification of, 333 quality assessment, 331 recruitment, postings and promotions, 335–36 satisfaction measurement, 332 service standards, 331–32 social audit, 333 Outstanding liabilities of states, 194 Overdraft (OD), 179 Own revenue, 186 Own Source Revenue (OSR), 293 Panchayati Raj Institutions (PRIs), 89, 285, 365, 429 state-wise distribution of per capita own revenue of, 294, 295 Per Capita Public Spending on Health (PCPHS), 417 Performance, linking with fiscal transfers, 337 Permanent Account Number (PAN), 153, 158, 170 Personal income tax (PIT), 48, 49, 159–60 Plan expenditure, 378 definition of, 432 Planning commission, 383–91

Index

Postings, 335–36 Poverty, distribution, 90–95 inter-state and inter-regional disparities, 92–93 slipping into, 93 World Bank’s estimates, 93–95 Poverty line people below, in India, 91 Poverty ratio (PR), 97 definition of, 416–17 across major states, 92 Power Finance Corporation (PFC), 253 Prarambhik Shiksha Kosh (PSK), 433, 434 Primary education, enrolment and dropout rates, 100 Primary Health Centre (PHC), 64, 332 Prime Minister’s Gram Samrudhi Yojana (PMGSY), 356 Procedures, simplification of, 333 Profit before tax (PBT), 160 Promotions, 335–36 Public debts, 45 Public health expenditures, 414–17 Public intervention, 255 Public limited companies, nongovernment non-financial financial ratios of, 121 Public sector banks (PSB), 68, 69, 70, 71, 81 Public sector enterprises (PSEs), 165 Public sector undertakings (PSU), xli, 47 Pupil–teacher (PT) ratio, 426, 431 Purchasing Power Parity (PPP), 62, 408

Rashtriya Krishi Vikas Yojana (RKVY), 390 Rashtriya Swasthya Bima Yojana (RSBY), 61, 419 Real estate, bank group-wise lending to, 139 Receipts, states capital, 187–88 trends in, 184 revenue. See Revenue receipts Recruitment, 335–36 Regional inequalities, and horizontal imbalance, 246–48 Regional rural banks (RRBs), 129 Reproductive and Child Health programme (RCH), 400 Reserve Bank of India (RBI), 41, 136, 178, 306 Resources mobilization, 23–31, 34–37 Revenue deficit elimination of, 197 of states, 195 Revenue expenditures, 54, 55 share of centre and states in, 236 trends in, 188–90 Revenue forgone (RF), 50, 51, 166 Revenue receipts share of centre and states in, 236 of state government, 186 transfers relative to, 235 Right to education (RTE), li, 422–38 financing, 430–38 provisions of, 426–30 areas of concern, 428–30 Right to Information (RTI) Act, 89, 423 Rural agricultural households, unemployment rate among, 106 Rural development

Quality assessment, 331 Quick estimates (QE), 224

457

Progressive Fiscal Policy in India

central government social sector expenditures for, 353–56 intra-sectoral allocation, 354–55 Rural–urban income disparities, 107–09, 111–12 Sarva Shiksha Abhiyan (SSA), 218, 330, 378, 383, 403, 425, 433, 434, 436 funds, utilization by educationally backward states, 436 Satisfaction, measurement, 332 Scheduled Castes (SCs), 55, 96, 358 below poverty line, 96 Scheduled Tribes (STs), 96, 100, 105, 358 below poverty line, 96 School Management Committee (SMC), 428, 429 Secondary education enrolment and dropout rates, 100 Secondary market turnover in financial and commodities market, 141 unmitigated operations, 140–45 Securities and Exchange Board of India (SEBI), 42 Self-Help Groups (SHG), 68–69 Sen Committee, 286 Service standards, 331–32 Small and medium enterprises (SMEs), 145 Small-scale industries (SSIs), 41, 66, 67, 73, 74, 75, 122, 129, 130, 132 credit to, 65–77 Social audit, 333 Social deprivation, 96–102. See also Poverty distribution, 90

458

social sector development, 97–102 Social sector expenditures, 339–72 by centre, 352 effectiveness of, 361–65 effective implementation, inclusive governance for, 364–65 states’ experiences, 363–64 trends in, 341–61 central government expenditures, 349–56 combined expenditures, 341–47 comparisons with other countries and international norms, 347–49 growth rates, 357 state-wise expenditures, 356–61, 369–72 Social sectors definition of, 340 development, 97–102 expenditure, trends, 99 ratios, 349 state and central government expenditures on, 56 Social security, 60–65 Software Technology Parks of India (STPI), 36, 51 Special Central Assistance (SCA), 390, 393 Special Economic Zones (SEZs), 36, 51, 166 Sri Lanka, health facilities per capital income in, 62 State budgets central government funds bypassing, 397–98 State Domestic Product (SDP), 109, 358

Index

State Finance Commission (SFC), 287, 288, 290, 291–92, 293 State finances, 190–93 State Goods and Services Tax (SGST), 230 State-level public enterprises (SLPEs), 208 States/State government borrowings, interest rates, 191 capital receipts of, 187 central schemes, 216 deficit indicators, 211 economic and social services expenditures, 310 expenditure pattern of, 188 fiscal deficits, financing sources, 215 gross devolution from centre to, 215 non-plan revenue surplus/deficit of, 278, 279 outstanding liabilities, 194 revenue deficits of, 195 revenue receipts of, 186 shrinking flexibility to, 396 social sector expenditures, 356–61 experiences, 363–64 total receipts, composition of, 212 total tax revenues, share of, 213

reform measures, 168–70 Taxation, 46–53 Tax buoyancy, 163–65 central taxes estimates, 164 Tax collection, 155–63 corporate income tax, 160–62 direct taxes, 156–58 personal income tax, 159–60 tax compliance, issues in, 162–63 taxpayers and rates, 158–59 Tax compliance, issues in, 162–63 Tax Deduction at Source (TDS), 153, 165 Tax devolution states’ shares in, 241–42 Tax expenditures, 165–67 revenue forgone, 166 Tax–GDP ratios, 24, 27, 28 by country, 25–26 Taxpayers and rates, 158–59 Tax policy/compliance, assessment, 148–72 tax administration, 167–70 reform measures, 168–70 tax buoyancy, 163–65 tax collection, 155–63 corporate income tax, 160–62 direct taxes, 156–58 personal income tax, 159–60 tax compliance, issues in, 162–63 taxpayers and rates, 158–59 tax expenditures, 165–67 tax reform, 150–55 basic approach, 150–51 direct taxes, 151–53 indirect taxes, 153–55 Tax reform, 148, 150–55 basic approach, 150–51 direct taxes, 151–53 indirect taxes, 153–55

Tamil Nadu Integration Nutrition Project (TNIP), 364 Tax(es) capital gains, absence of, 115–16 corporate income, 160–62 direct, 151–53 income, 112–15 indirect, 153–55 personal income, 159–60 Tax administration, 167–70

459

Progressive Fiscal Policy in India

Tax revenue, 47 Terms of reference (ToR), xlii, 199, 207, 224, 265–67, 289, 381 Tertiarization of Indian economy, 299 Third stratum, and emerging fiscal federalism, 284–86 Thirteenth Finance Commission (FC13), 222–45, 265, 289, 381 climate change and environment, 231–34 context of, 267–68 debt management and fiscal deficit, 226–29 horizontal imbalance, resolving, 239–43 projections and economic crisis, 223–26 value added tax to GST, shift from, 229–31 vertical imbalance, resolving, 234–39 TOR of the Thirteenth Commission (ThFC), 289–90 Total expenditure, 53, 54 share of centre and states in, 236 Total Fertility Rate (TFR), 98 Total Sanitation Campaign (TSC), 378, 397, 400 Total transfers, states’ shares in, 240 Treasury View’, 6 Twelfth Finance Commission (TFC), xliii, 197, 199, 227, 228, 234, 235, 237, 238, 239, 244, 268, 269, 272, 274–76, 279, 289, 292, 293, 382, 383, 395 per capita grants-in-aid to states, 275, 279–81 report, implications of, 207–08 Unbalanced growth, 299 Unemployment

460

among rural agricultural households, 106 among youth, 105 and inequality, 103–06 rates of male/female workers, 312–13 Union budget flow of funds, 379 shares for plan schemes of central government ministries, 394 Union Finance Commission (UFC), 287, 290, 293 Union Territories (UTs), 109, 230 United Nations Children’s Fund (UNICEF), 331 United Nations Development Programme (UNDP), 347, 356 United Progressive Alliance (UPA), xlvi, 38–41, 46, 56, 57, 60, 65, 70, 72, 80 Unorganized Workers Act (2008), 61 Urban employment guarantee scheme (UEGS), 59, 60 Usual Principal and Subsidiary Status (UPSS), 104, 105, 106 Value added tax (VAT), 233, 266 to GST, shift from, 229–31 Vertical imbalance, resolving, 234–39 Vertical transfer issues, 268–70 Ways and Means Advances (WMA), 179–80, 184 states that availed, 180 Wealth, concentration of, 77–79 ‘Wealth creators’, 52 Workers distribution of, 105 male/female, unemployment rates, 312–13

Index

real output per, 304 World Bank estimates of poverty, 93–95 World Health Organization (WHO), 63, 64

Youth unemployment rate among, 105

461