From UPSC perspective, the following things are important :
Prelims level : Basics of Budget
Mains level : Capital expenditure and fiscal consolidation
- The 2023-24 Union budget will be announced on February 1, followed by the states’ respective budgets. These budgets will set the policy tone for the rest of the year and, as such, are followed closely.
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Situation of Capex and fiscal consolidation after pandemic
- Rise in fiscal deficit: The overall fiscal deficit of the government has soared and we believe the next few years will be all about getting it back on track.
- Rising interest payments: This is important because interest payments on past debt make up a whopping 50 per cent of net tax revenues for the central government, leaving very little room for other spending.
- less room for social spending: Given the needs of the economy on various fronts like health, education and capex, it is important to lower the interest burden over time. That can only be achieved by fiscal consolidation.
Analysing the tax revenue and expenditure of central and state Government
- Central government tax revenues have risen faster than state revenues: Both benefitted as small and informal firms struggled with the lockdowns and lost market share to large firms, which tend to pay more taxes.
- Disparity in revenue collection: A large chunk of the tax revenues in the early part of the pandemic period came from the “special” duty and surcharge on oil, which went primarily to the central government. To be fair, the central government subsequently cut the duty on oil (in both 2021-22 and 2022-23) and the tax share that went to the states rose somewhat.
- Capex of centre is more: The Centre has committed to more current expenditure than the states. While it increased across the board during the pandemic, current expenditure rose more for the central government.
- Higher spending on social schemes: This was led by higher social welfare spending (for instance, on the free food distribution scheme) and, more recently, higher subsidies (for example, fertilisers) in the face of rising commodity prices.
- States have a moderate capex: The common perception is that states have gone all out on unsustainable current expenditure. But the data shows that it’s just a few states which have spent heavily (for example, Telangana, Assam, West Bengal and Punjab).
Analyzing the capex and fiscal deficit of central and state government
- The central government capex has risen but state capex has contracted: Making a commendable choice, the central government used both its tax bounty as well as its ability to borrow more at a time when banking sector liquidity was loose to raise capex spending, which rose by 1.2 per cent of GDP between 2019-20 and 2021-22.
- Cut in state capex: On the other hand, the states cut back on capex, which has fallen as a percentage of GDP over the last few years, and continues to be on a weak footing in the current year. In fact, putting the central government’s capex alongside the state and public sector capex shows that the overall public sector thrust is not any stronger than it was back in 2018-19.
- Centre has breached the fiscal deficit target: The central government’s fiscal deficit has overshot targets while the state deficit is relatively contained. At a budgeted 6.4 per cent of GDP in 2022-23, the central government’s fiscal deficit has risen above the pre-pandemic level of 3.4 per cent in 2018-19, and is well above the 3 per cent medium-term target.
- Sharp fall in states fiscal deficit target: Even though the state fiscal deficit rose in the first year of the pandemic (from 2.5 per cent of GDP in 2018-19 to 3.8 per cent in 2020-21), it has fallen sharply since (to 2.7 per cent in 2021-22).
- Low borrowing by states: In fact, state government borrowing is rather low in the current year so far. If this continues, the fiscal deficit could be even lower in 2022-23 (around 2.5 per cent of GDP), which is well under the 3 per cent medium-term target, and bang in line with pre-pandemic levels.
What are the challenges?
- Less consolidation by states: The states have less fiscal consolidation to do than the central government.
- High quality spending: Both have a common challenge to commit to more capex, which is considered high quality spending as it “crowds in” private investment if done responsibly. And we believe investment is the only sustainable way to increase the capacity of the economy to grow and create jobs.
- Balancing the capex and fiscal consolidation: For the central government, the challenge is to hold on to its capex push at a time of fiscal consolidation. For the states, the challenge is to start doing more.
What should be the way forward?
- Lowering the fiscal deficit: The central government’s aim is to lower the fiscal deficit by about 2 per cent of GDP over the next three years. About half of this consolidation can come from lowering current expenditure to pre-pandemic levels.
- Raising the tax revenue through formalization: Continued formalisation of the economy that raises tax revenues (though “organic” formalisation will likely be more sustainable than “forced” formalisation).
- Disinvestment of PSUs: A bigger push for disinvestment by selling stakes in public-owned companies, and further tax reforms (in terms of direct taxes and the GST).
- Capex cut is the last option: If these don’t work, the default option will be to cut capex, which is a concern as it has implications for medium-term growth.
- Fiscal consolidation and capital expenditure should go hand in hand. More government spending means more infrastructure building and more chances of growth and employment. However, this spending should be done with sound fiscal base.