The stagnation in India’s non-tax to GDP ratio at less than 3% has prevailed since the early 1950s. The main reasons for this relate to India’s loss-making or low dividend yielding public sector enterprises, and non-recovery of costs of publicly provided services, including health and education. User fees and charges, that refer to the charges for the public provision of goods and services, have remained administered or regulated. These charges remain delinked from the unit cost of service provision, which has been increasing along with the overall inflation. Periodic revision of user fees and charges and realization of much higher values of property owned by the government and the public sector, including land, are clear ways of improving the performance of non-tax revenues. Further, assets owned by the government in the skies and under water and land should also be exploited to generate additional non-tax revenues.
Re-visiting government’s sectoral priorities
If, over time, India is able to raise its tax-GDP ratio closer to the target of 25% and the non-tax to GDP ratio closer to about 5%, it can sustain a size of government in the range of 35-37% of GDP by adhering to a sustainable fiscal deficit level of about 6-7% of GDP, excluding a small component of non-debt capital receipts. As the revenue-GDP ratio increases, the government must ensure that the allocation of expenditures towards three priority sectors namely, education, health and physical infrastructure is progressively increased. Since the young dependency ratio is forecasted to remain higher than the old dependency ratio until 2056, it would be prudent to prioritize education ahead of health. At present, India’s government expenditure on education relative to GDP is at 4.4% (2018). This should be raised to 6%. Government expenditure on health has languished at about 1% of GDP (2019), which is much below the corresponding global average. This should be raised to at least 3%, closer to the corresponding average of middle-income countries at 2.8% (2019). Expenditure on physical infrastructure, including defence capital expenditure, may be raised to 6-7% of GDP, which would imply keeping combined revenue account of the government at least in balance if not in surplus. This would ensure adherence to the so-called ‘Golden Rule’, where government borrowing is matched by creation of corresponding assets. This requires maintaining strict fiscal discipline over economic cycles. For this purpose, both the central and state governments have enacted their respective fiscal responsibility legislations (FRLs).
Sustainable fiscal imbalance
Center’s recently amended fiscal responsibility and budget management act (FRBMA) in 2018 provided targets for the combined management of the central and state finances in terms of debt and fiscal deficit relative to GDP. It specified a combined debt-GDP ratio of 60% and a combined fiscal deficit to GDP ratio of 6%. The debt-GDP target for the Center and states was kept at 40% and 20% respectively, while the fiscal deficit to GDP target was at 3% each. Due to the deleterious impact of COVID-19, the combined debt-GDP ratio rose to an estimated level of 88.4% in FY21, exceeding the FRBM threshold by 28.4% points. Government finances need to be nursed back to sustainable levels in the medium term. In view of trends characterizing nominal growth and effective interest rate, there may also be a need to re-examine Center’s FRBMA with a view to re-fixing the debt and fiscal deficit targets. For a detailed discussion, see Srivastava et al. (2021)[3].
Conclusion
There is a strong likelihood that India may emerge as the largest economy in the world in terms of size of GDP in PPP terms within the next few decades after having emerged as the largest economy in terms of total population in a year’s time. One pre-requisite for achieving this target is re-strategizing government intervention in the economy to accord higher priorities to education, health, and physical infrastructure. For this, restoration of FRBM targets of fiscal deficit and government debt relative to GDP and achieving balance on the revenue account are critical so that adequate fiscal space can be created.
(Contributors: Muralikrishna Bharadwaj, Senior Manager, EY India; Tarrung Kapur, Manager, EY India; Ragini Trehan, Manager, EY India)
