Sub-national fiscal correction

Context:

• Recent concerns over excessive doling out of freebies by States are often interpreted as intrusion into the federal powers of the States.
• As both the Union government and States are expected to work closely in a co-operative federal structure, frictions arising out of freebies by States might have repercussions on both resource sharing and expenditure prioritisation. Hence, it is important that the Centre and States are on the same page on these issues.

Issues in India’s fiscal federalism: In recent times, three issues have emerged as major discussion points in India’s fiscal federalism, leading to back-and-forth exchanges between the Centre and States.

• Issues related to Goods and Services Tax (GST) such as the rate structure, inclusion and exclusion of commodities, revenue sharing from GST and associated compensation.
• State-level expenditure patterns especially related to the welfare schemes of States.
• Implementation of central schemes.

Discretionary expenditure: In this context, it is important to distinguish between two kinds of public expenditure.

• Mandatory spending is expenditure that is governed by formulae or criteria set forth, rather than by periodic appropriations and as such, unless explicitly changed, the previous year’s spending bill applies to the current year for these items of expenditure.
• Discretionary spending is expenditure that is governed by annual or other periodic appropriations.
• While States demand more fiscal space for increasing discretionary spending, the Centre is pushing for more fiscal discipline by reducing the scope for discretionary spending and limiting States to focus on mandatory expenditures.
• Discretionary expenditure is, at the same time, more volatile than mandatory expenditure. Cross country empirical evidence also shows that discretionary expenditure is not contemporaneously correlated with output growth and the correlation is low for the next immediate time period.

Sub-national fiscal consolidation:

• The current debate around freebies needs to be viewed in this larger context of sub-national fiscal consolidation.
• In a federal system, States’ fiscal stress gets spilled over to the Centre, leading to a situation of overall magnified fiscal slippages.
• As the economy is recovering from crisis- economic slowdown and COVID-19, there exists a need to adhere to the path of fiscal correction both by the Centre and by the States, as a crisis demands more discretionary spending than normal times.
• However, in the Indian context, many States indulge in higher levels of expenditures towards maintaining what they call as their ‘models of welfare provisioning.’

Fiscal consolidation

• Sustained increase in welfare expenditure by the States leads to fiscal expansion, which necessitates additional resource mobilisation. When efforts towards additional resource mobilisation yield limited success, as in the case of many States in India, the States resort to borrowings.
• Fiscal expansion financed through debt and the resultant debt accumulation have important impacts on the economy both in the short run as well as in the long run.
• On the contrary, if use of borrowings is to finance only the current expenditure, it poses the risk of debt rising to unsustainable levels.

FRMB Act or Financial Responsibility and Budgeting Management Act:

• As per the FRBM Act 2003, the Indian parliament sets a target for the government to establish financial discipline, improve the administration of public finances, strengthen fiscal prudence, and reduce the country’s fiscal deficit to a tolerable 3% of GDP by 2008.
• However due to financial crises like the 2008 global financial crisis, 2019 economic slowdown and COVID-19, the target Under FRBMA is being continuously delayed.

N.K. Singh committee to review the FRBM Act, 2003: Important recommendations made by the committee:

• A debt-to-GDP ratio of 40% for the central government, 20% for the state governments
• A fiscal deficit of 2.5% of GDP (gross domestic product), both by financial year 2022-23 (this was later relaxed)
• Enact a new Debt and Fiscal Responsibility Act after repealing the existing Fiscal Responsibility and Budget Management (FRBM) Act, and creating a fiscal council.
• Revenue deficit-to-GDP ratio has been envisaged to decline steadily by 0.25 percentage points each year from 3% in 2016-17 to 0.8% in 2022-23.
• To deal with unforeseen events such as war, calamities of national proportion, collapse of agricultural activity, far-reaching structural reforms, and sharp decline in real output growth of at least 3 percentage points, the committee has specified deviation in fiscal deficit target of not more than 0.5 percentage points.

Way forward: Data published by the RBI show that in recent years, States’ outstanding debt has registered an upward movement.

• With dwindling revenue receipts, many States had to opt for expenditure compression to adhere to the fiscal responsibility legislation target.
• This scenario underscores the importance of fiscal correction at the State level. While there exists a need for raising additional resources at the sub-national levels, expenditure prioritisation must be carried out diligently.

Must Read – Freebies

Source: The Hindu

Previous Year Question

Q.1) Consider the following statements: (2018)

1. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
2. The Central Government has domestic liabilities of 21% of GDP as compared to that of 49% of GDP of the State Governments.
3. As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.

Which of the statements given above is/are correct?

1. 1 only
2. 2 and 3 only
3. 1 and 3 only
4. 1, 2 and 3