Indian Economy | Government Finances Download PDF

Indian Economy | Government Finances Download PDF

Fiscal Policy in India

The government does not perform any business so it cannot earn money to spend. Hence, the government has to raise the money from the economy to enable it to spend that money in terms of requirements and national priorities. The government raises money primarily through ‘taxes’ and the spending known as ‘public expenditure’. A policy which affects either the manner in which the government raises resource or spends is known as ‘fiscal policy’. The objectives of any fiscal policy of a country are as follows:
(1) To ensure that the expenditure in an economy is in terms of national priorities, to boost growth for the welfare of the people.
(2) Expenditure being incurred should not lead to a price rise situation.
(3) There should be efficiency in the way of resources that are raised and spent.
(4) Efforts are to be made to avoid wasteful expenditure in the economy.
(5) Resources being raised by the government through taxes should not create burden on the common man.
(6) Taxation should be ‘just’ and helpful in reducing income inequalities.
(7) The policy should aim for overall improvement of the welfare of the economy.
In India, there is no fiscal policy by the name; however, the objectives of those are being achieved by the annual financial statement popularly known as the budget which is tabled in the parliament. Hence, budget is not merely the details of expenditure and taxes but is also a policy tool to sub-serve objectives of a fiscal policy. The budget, thus, is more than a balance sheet of government receipts and expenditures presented to the parliament.

Public Expenditure of Government

Public expenditure is spending by the central government. Broadly, there are two kinds of expenditure—one is plan expenditure, which is expenditure ear marked for investment in different areas, in the five-year plans for various sectors of the economy. These could be either capital or revenue in nature. Capital expenditure represents creation of assets in an economy and is thus desirable for growth. For example, money spent for setting up power plant is a capital expenditure. Revenue expenditure is recurring in nature, for maintenance, etc.
The other is the non-plan expenditure which is an expenditure not covered in the five- year plan but yet has to be incurred and could again be either revenue or capital. In India, non-plan expenditure is 70 per cent of the total expenditure whereas plan expenditure is only 30 per cent. The highest expenditure is non-plan revenue expenditure accounting for 63 per cent of total expenditure.
What are the components of non-plan revenue expenditure? The first is the interest payments (servicing of the loans taken by the central government both internal and external) accounting for over 25 per cent of the total expenditure. Secondly, subsidies (food, fertilizers and retail petroleum goods). Thirdly establishment expenses of defense. Fourthly, loans to state governments/UT, establishment expenses of central government, pension to defence/central government retired personnel. Expenditure on these heads would account for over 90 per cent of non-plan revenue expenditure. These expenses are also known as consumption of the government as no assets are created.

Receipts by The Government

The expenditure in an economy is met out of receipts by the government through various sources. The receipts could be revenue (which do not create any interest liability for the government, regularity in their receipts and not representing borrowings) and the other as capital (either creating a liability for the government or less certain of their receipt or borrowings). Of the total receipts, 90 per cent is revenue and 10 per cent is capital receipts. The primary source of revenue receipts is tax revenue (84 per cent of total receipts). Taxes could be either direct or indirect. v
How to distinguish direct tax from indirect tax? Direct tax is a tax where the subject on whom the tax has been levied is identifiable, who has to pay the tax and the tax burden cannot be shifted. Examples can be income tax, corporate taxes, wealth tax, etc. In case if the subject is not identifiable or if the burden can be shifted it is an indirect tax. Common examples are excise duty (payable by companies on manufacturing activities), customs duty (duty on import of goods), service tax (tax on services being rendered by service providers), etc.
Fifty-five per cent of the tax revenue arrives through direct taxes while 45 per cent of the revenue is from indirect taxes. The base on which the tax is applied for indirect taxes could either be on value {ad valorem) or specific on a particular attribute (length of staples in cotton). India primarily follows an ad valorem indirect tax structure.
Certain taxes are levied by the central government and at the same time it is also collected by the central government (income tax, customs duty, excise duty and service tax), certain taxes levied by the central government but collected by the state governments (central sales tax levied on inter-state movement of goods). A few other taxes are levied and collected by the respective state governments (sales tax, octroi, municipal taxes, road tax, entertainment tax and agriculture tax).

The basis of sharing the tax revenue between the centres and the states are decided by the finance commission. The thirteenth finance commission under the chairmanship of Shri Vijay Kelkar has since submitted its report and is effective from 2010 to 2015.
There are two additional taxes—one is the surcharge which is imposed for additional revenue considerations by imposing an additional percentage on the absolute amount of tax payable. Suppose surcharge on a tax is 5 per cent and the tax payable is Rs. 100 then the total tax liability including surcharge would be Rs. 105.
The other is cess which is similar in application as the surcharge except that the amount collected by way of cess is meant solely for specific funding/cause like education cess, the amount collected would go for funding of education only.
Components of revenue receipts other than taxes are dividends received by the government from public sector, payment of interest by the state governments etc. Similarly, capital receipts of the government comprises of recoveries of loan, grants, assistance received by the government etc.

Ways and Means Advances

An interesting characteristic of expenditure and the receipts of an economy is that, all the receipts come with a lag over a period of time like direct taxes would be by the end of each quarter while committed expenditure as to be incurred immediately.
That is, for example, if there is a temporary mismatch between government’s receipts and expenditure in a financial year and to meet this mismatch the Reserve Bank of India provides temporary overdraft to the government through the ‘ways and means advances’.
This overdraft facility is for a time period of 90 days and the amount of overdraft is Rs. 20,000 crores during April to September and Rs. 6000 crores during October to March

Nature of Government-Budget

Thus, so far we have discussed the expenditure and receipts. What happens if expenditure exceeds receipts? It would result in a deficit or otherwise in a surplus and if both match then balanced.
What is good for an economy—a deficit, surplus or a balanced budget? To answer this question, a few aspects should be understood. There is a difference between personal and government budget and that being in a personal budget, spending is strictly in accordance with income. However, in a government budget, it is important to understand that expenditure is seen first and the reason for receipt is because of the need for spending in the economy. That is, a government budget by its very structure is deficit-oriented.
Only in an economy where receipts surpass spending can there be a surplus or the government scales-down spending to match the receipts. This could drag down growth as lesser expenditure is taking place. More so in India, given the inflexibility to bring down non-plan expenditure, any reduction in expenditure would imply lesser capital expenditure and expenditure on social sector.
A balanced budget is good only if the budget is seen as a balance sheet or a statement of accounts of the government of India. A better thing can be a balanced budget multiplier which is an incremental increase in expenditure in any given year is met out of incremental increase in receipts in a given year.

Tax Reforms—Indirect Taxes

A major source of indirect taxes is excise duty which is payable on value of manufacturing activities in the economy. Excise duty like other indirect taxes by its inherent structure is regressive in nature.
For example, the excise duty on salt is 10 per cent on a factory price of ?10 which means the retail price for a packet of salt is Rs. 11 with an excise of Rs. 1 per packet going to the government. The price of Rs.11 is being paid by a person who is earning Rs. 5000 per month and also even by a person whose earning is Rs. 1,00,000 per month. The tax burden is higher on the people with lower income and that is what is meant by regressive.
Secondly, multiple excise structure with multiple rates giving rise to different interpretation on tax payable giving scope for evasion, litigations and revenue loss to the government.
The third issue in excise is the cascading effect of taxes. For example, Maruti buys tyres from MRF company. The purchase price of tyres from MRF would have a component of excise duty, which becomes the input price for Maruti and excise duty has to be paid on the full value of car. This is known as the cascading effect, that is, taxes increase the manufacturing cost and get again taxed.
The government has tried to address the issue by reducing the slabs of excise duty only and lower excise duty on essentials or mass goods to minimize the regressive character. With regard to the cascading effect, the best way to prevent it is by introducing value added tax (VAT) which is a tax on the value additions at each stage of production rather than on the finished goods. Provided the federal structure both centre and state government VAT would have to be at both levels.
An initiation was made with the government by first introducing the modified value added tax (MODVAT) scheme which allowed partial adjustment of duties on capital goods purchased, however, it was restrictive in nature. The government replaced MODVAT with a wider scheme of input credit for the excise duties inputs (raw materials, capital goods and services) purchased for direct use in production known as central value added tax (CENVAT) at the central level during 2004.
A major reform has been at the state level with the replacement of sales tax with state VAT. The credit for this goes to Shri. Asim Das Gupta the then Finance Minister, West Bengal and can be hailed as a landmark in tax reforms.
‘Why’ it is a major reform? First to make all the state governments to agree for the replacement of sales tax with a state VAT. The sales tax regime was very complicated with different sales tax rates for same products in different states. A state VAT required ‘one product one tax rate’ across all states and to drive a consensus for this was herculean effort as some states would stand to gain and others would tend to lose.
If in a particular state sales tax was a high of say 24 per cent but the consensus under a state VAT was only 12.5 per cent for that good clearly there would be revenue loss for that state government. ?
State VAT made effective from 1 April 2005 has the following salient features:
(1) State VAT is not a new tax but only a change in the way of collecting tax from the final stage to the value addition stage.
(2) This allows for set-off of duties from the tax payable but against original invoices/ challans of the tax paid on the inputs purchased.
(3) There would be a uniform 4 per cent state VAT on 270 mass-consumed goods across all states, a uniform VAT of 12.5 per cent on 280 goods and 1 per cent on gold and silver ornaments across all states.
(4) Those with a turnover of Rs. 5 lakh and less would not be liable for any VAT, from Rs. 5 to 50 lakh a composite tax but with no set-off. VAT is payable for turnover exceeding Rs. 50 lakhs.
The state VAT has helped in checking tax evasion by introducing a ‘bill culture’, transparency in tax administration and collection, increased revenue for the state government. Further, as part of deeper reforms, the government is proposing to integrate taxing of goods and services at differential rate separately into one tax with one tax rate as goods and services tax (GST) with both the centre and states taxing concurrently as the central government GST (CGGST) and the state government GST (SGGST).
This would considerably simplify the indirect tax regime, enlarge the tax base for larger resource generation and thus lower GST rate resulting in lower prices does of goods and services but also in ensuring the revenue for the government not to suffer. The government proposes to implement the GST regime as soon as there is broad based consensus with the states and technology put in place. Reforms in indirect taxes are commendable and the governments proposal of propelling to GST would place India with an efficient indirect tax regime at par with other mature economies of the West.

Tax Reforms—Direct Taxes

Direct taxes as seen earlier contribute 55 per cent of the tax revenue and it is a better way of taxation as it is progressive in nature and based on ‘ability to pay’, higher the income, progressively, more the tax rate leading to greater revenue with least burden on the masses or those with low income. Direct taxes particularly income tax is progressive and in contrast to other taxes which are regressive in nature.
The progressivity of income taxes in periods of inflation pushes people up the tax bracket, as pay packets get inflated due to inflation resulting in higher taxes paid and reduced spending by the individuals. On one hand, the coffers of the government fills up because of people moving up the tax bracket and on the other there is a reduced spending. This phenomenon is known as ‘Fiscal drag’.
How many people do you think are tax payers in the economy?
At present, 3.5 per cent are tax payers in the Indian economy, about 31.5 million in a population of over one billion people. This number is low especially considering the fact that India in its growing economy, with increased income, rising middle class, the affluent class and large number joining the elite billionaire club. In comparison, the number of tax payers has only increased by 11 per cent.
What are the ways through which tax payers and tax revenue can be increased? There could be three ways through which it can be increased and are as follows:
(1) Increase in the direct tax rates.
(2) Increase in the tax base.
(3) Enforce tax compliance.

Increase in Tax Rate

Any increase in tax rate is seen negatively and resented by the people. There is also a relationship between the direct tax rate and revenue generated. Starting from a low tax rate and gradually increasing it, is positively related and increases tax revenue. However, beyond a level, any increase in tax rates becomes counter-productive as it lowers tax revenue rather than in increasing it. This is popularly known as the ‘Laffer curve’.
An economy being on the Laffer curve implies that any increase in tax rates would lower the tax revenue and on the contrary lowering of tax rate would lead to increased revenue for the government. It is widely believed that India is on the Laffer curve with limited prospects of raising taxes.

This is because high tax rates lead to tax evasion, non-disclosure of income and generation of black money (taxes not paid). All efforts are made to minimize the incidence of taxes legally and illegally. It serves as a disincentive in the economy leading to lowering of income and the output. Hence, raising tax rates is not an option available in India.

Increase in Tax Base

Tax base refers to that threshold level of income on which taxes become applicable. India has an exemption level, that is, if income is less than Rs.1.6 lakh (f 1.9 lakh for women) per annum taxes are not payable. So one way could be to lower the exemption level so that more people are drawn in the tax net and thereby an increase in tax payers and tax revenue.
At present, the exemption level is very low given the present inflation. Besides the inflation does not factor in cost of education, transport and property prices all of which have increased manifold in recent times creating hardships and making it difficult for the middle class to make both the ends meet. Lowering the exemption would further burden the middle class and more so by this way it may be possible to increase the ‘number of tax payers’ but ‘not necessarily tax revenue’ as many would be marginal tax payers.
The other way to increase the tax base is to bring in untaxed sectors under the tax net. All sectors with the possible exception of the agricultural sector are already under the tax net. Agriculture being a state subject can be taxed only by the state government and not by the central government. Thus, like increasing tax rate, even increasing tax base is not a feasible option for raising direct tax revenue in India.

Ensuring Tax Compliance

This is to ask the question that, is every person who ought to pay taxes is paying his/her taxes in terms of existing laws and the second are the people who are not paying should actually be paying taxes. This is what is meant by tax compliance. The government has made an initiation by making the income tax return form user friendly and easy to fill up by an individual and it is known as ‘Saral’.
The problem in India is that of tax compliance with lot of leakages, large-scale tax evasion and black money. It is estimated that over 40 per cent of GDP is black money which is circulating in the economy on which no taxes are paid.

Black Money

Black money has nothing to do with the colour except to convey that it is necessarily an evil. It is an unaccounted income, earned through illegal channels and put to unproductive anti-national use and conspicuous consumption. Checking black money and tax evasion are the critical aspects of tax compliance.
Black money gets generated when big transactions are performed in cash, source and end use not possible to ascertain. For example, a friend gives you cash of Rs. 1000. Technically, it is black money, may be not so in your case because the amount is small. However, say somebody gives Rs. 10 lakh in cash it is definitely black money.

In other way, all transactions where payments have to be made or received beyond a level of say Rs. 10,000 and above if done in cash is black money. Or still differently, transactions performed other than by way of cheques, drafts, credit cards, debit cards, direct transfers of money in bank accounts would be black money.
If you deposit Rs.10 lakh in cash in your bank account it is black money (unless and until if you show the source from where you got it). If your father sends you a cheque of the same amount and you deposit it in your bank account it is a ‘white transaction’. Thus, transactions performed other than through banks and post offices would generate black money.
Why does black money get generated? The primary reason for the black money generation is high tax rates, complex tax laws and provisions, strict controls on transactions, large amount of cash dealing, people not having bank accounts, land and property deals in cash, need for money to get jobs performed through various government departments, donations required for admission in schools and colleges, meeting dowry needs, compulsions of social functions and also for doing illegal activities both within and outside the country.
What has the government done to curb black money? Not much except the voluntary disclosure schemes and giving amnesty for the amount disclosed and demonetization of higher denominated currencies. (Recall India had earlier Rs. 5000 and Rs. 10,000 notes which have now been discontinued and cease to be legal tenders.)
The government has also declared that all transactions over Rs. 10,000 should be done through cheques/drafts. Drafts would not be made by banks against cash exceeding Rs. 50,000 in one day. A permanent account number (PAN) has been issued to all tax payers and it is mandatory to quote the PAN number for all transactions over Rs. 50,000.
The income tax offices at the fojur metros have been computerized and networked, creating a database of tax payers and transactions being performed by them. All Registrar offices registering land deals, credit card companies, automobile manufactures, etc., are required to furnish information beyond a cut off level.
The government with a view to have better tax compliance, lesser tax evasion, is proposing the direct tax code which would simplify tax laws and provisions, plug leakages, raise exemption levels and consider further lowering tax rates. However, till then tax compliance will be a major constraint to further raise tax revenue for the government.

Views on Tax Compliance

(1) Has it ever occurred why people do not want to pay taxes? Paying taxes globally is a matter of pride and joining hands with the government to provide better for the masses and improved civic amenities. Not so in India.
(2) That is, because, people doubt the intentions of the government in using it productively for the masses. Tax compliance would thus require austerity measures on the government lesser lavish spending and more responsiveness and sensitiveness towards the spending for masses.
(3) Tax compliance should be top-driven. Have you ever seen any top political leader, bureaucrat going to file his income tax return at the IT office in-person. No! it is not required officially but it sends the right message to people that how it is of high priority despite their busy schedule. Who is the first person seen as voting in an election? It is the President, Prime Minister and other top leaders. ‘Why?’ Just to send the right message to the people to come out and cast their vote.
Hence tax compliance should start right from the top. The President, PM, Chief Ministers and senior leaders all of them filing their tax returns in-person.
Who is the highest tax payer in the country? It is difficult to say or even more difficult to say who are the top 100 tax payers in the country. What prevents the government from honouring them at a public ceremony acknowledging their contribution to the national cause? It will transmit positive signals and encourage people to pay their taxes.
What if one is seen by one’s friend or relative at the income tax office? It would definitely not be positive. The perception of the income tax officials has got to change from treating everyone as a tax evader to that of trust, a friend guiding and supporting the people. Let them have ‘May I help you counter’ at their offices for any assistance people may want. They could send out staff to assist tax payers in correctly filing their returns. It should not be difficult but could go a long way in increasing the compliance. It is not difficult to find out regular tax payers, a small well-worded thank you card can be sent to them each time after they have filed their return. Today, technology support is available to generate such computerized letters. What is being meant here is that the incentive for a tax payer to pay his taxes, a mere token of appreciation can work.
Our policies for tax evasion can be said to be ‘soft’. What is required is strong punishment for tax evaders, those generating black money uniform for all irrespective of whether political leader, bureaucrat, private organization, etc., to serve as a lesson and a source of discouragement.