Can we work from the revenue side? Financial Express: 10th March 2012

Whenever we talk of budgetary challenges, attention invariably turns to the expenditure side where we pontificate on whether the government should spend more on subsidies or project expenditure. This is so because, unlike individuals who have an income to spend, the government has a list of expenses, and has the prerogative to then see how this money can be raised. When all things fail, it can always borrow, which individuals cannot do. Should this thinking actually change?

Once we get into the FRBM framework, there is always pressure to perform and governments then walk the razor’s edge of balancing revenue with expenditure. Revenue generation is actually an extraneous concept because while the rates are fixed by the government, the assumptions made are on certain growth targets being realised. When they do not materialise, then problems start.

The main source of revenue is taxation. The ability to increase revenue depends on the taxable base increasing steadily, for if it does not, then the entire edifice stars cracking. Income tax, for example, showed an elasticity of 1.3 to growth in GDP in the last five years, meaning thereby that if our GDP in nominal terms grows by, say, 15% (sum of, say, 8.5% real GDP and 6.5% inflation), then income tax receipts could grow by 19.5%. Similarly, the elasticity of corporate tax collections is around 0.80 for the last 5 years while that of customs is 1.36 with respect to change in imports. Curiously, in FY09, when imports soared due to high imports of crude oil when prices had touched the $150 mark, the government reduced the tariffs sharply, which led to a fall in customs collections. Excise has not shown any clear trend, though low growth in industry has necessarily meant low collections. Quite clearly, the revenue collections for the government are, in a way, beyond its purview and the assumptions made could go awry.

Last year, the government based the budget on 9% GDP growth, which though in retrospect looked ambitious, seemed okay then as the economy had grown by 8.5% in FY11. Now that this has been scaled down to 7%, inflation has helped to maintain the growth in base. But the problem is that IIP growth has been lacklustre while corporate profits have shown signs of declining in the third quarter. Clearly, revenue has come under strain because the growth scenario has not materialised.

The point here is that the government should hence start off a different note and try and operate like an individual or corporate entity. As there is a move to manage public debt through the ministry and not RBI, the amount of borrowing should be capped with limited flexibility to deviate from this number. Alternative budget scenarios should be drawn up in terms of ‘conservative’ and ‘optimistic’ outcomes. The starting point hence for FY13 could be nominal GDP growth of 12% at a conservative level, including 7% real GDP and 5% inflation and, say, a higher number of 14%, which can go with IIP growth of, say, 6% and 8%, respectively. Revenue collections could then be drawn up on how various sectors including the service sector would behave during the year under these scenarios. The borrowing level could then be added here to have a feel of the maximum resources to be mobilised through conventional means.

The expenditure part is where the government would have to take a tough call. There are basically three kinds of expenditure. The first is mandatory, such as interest, over which there is no choice. The second is subsidy, where it should cap it on grounds that it will not spend more and, in case we are talking of fuel subsidy, the public has to bear the additional cost if global prices increase. The same holds for, say, food subsidy where the MSPs and issue prices are worked out with no flexibility for any further discussion once fixed. Intuitively, we are integrating the petroleum and agriculture ministries in this exercise. The third would be project expenditure, which is what is really required for growth. This would be a residual and will increase depending on the resources being garnered. Therefore, project expenditure becomes the last component and can actually be earmarked to, say, disinvestment. Disinvestment is a dicey component because it materialises only when the market does well. If it does not, then there is a reputation risk carried when it is undertaken. To eschew such controversy, the two may be linked.

Does this sound too simplistic? In fact, even today, the government invariably lowers project expenditure towards the end of the year once there are strains in terms of revenue collection. As interest, subsidies are non-negotiable; the onus does fall on capital expenditure. This model only makes an extension to capping all expenditures so that there are no slippages.

Do budgets work like this anywhere? The answer is no, but since we are in uncertain times when our macro projections have gone awry too often, we need to think differently. There could still be slippages on account of revenue falling in case the two scenarios we talk of do not materialise. But this will be an improvement. The downside is that the private sector has to play a larger role in investment and cannot really depend on the government for the big push. Is this acceptable?