The National Democratic Alliance (NDA) government, which came to power in May 2014, riding on a wave of hope, optimism and development rhetoric inherited a socio-economy which required the attention of the state. While corruption, black money and price rise dominated the headlines, other macro-indicators of the economy and social sector also did not look good. The economy was marked by almost double-digit food inflation, slowing down of GDP growth rates, virtual stagnation of industrial and services sector growth, slump in agricultural growth rate and doubling of spending-gap between the rich and the poor in the previous five years. In the social sector, while school enrollment rates have improved, every third illiterate person in the world is Indian and more than 35 percent of children in the 6-14 age group drops out of school before they reach class VIII. India is also home to the greatest burden of maternal, newborn and child deaths in the world, and accounts for 21 percent of the global burden of disease. Inequalities on the basis of caste, religion and gender also continue to plague the country. Despite this, India’s spending on health, education, water supply and sanitation has been below par compared to developed and most large developing countries. This short piece attempts to make a case that the size of the Indian state has been decreasing relative to the size of the economy.

Budgeting for Policy Priorities

The Union Budget is the primary vehicle for the Centre’s fiscal policy. One way to see if the government intends to do what it has promised is to check budget allocations. While the NDA’s election manifesto as well as all three Union budgets presented by the current government do mention the challenges indicated above, the policy priorities underlying the proposals and allocations in the budget do not differ much from those of the United Progress Alliance II (UPA-II), the previous regime. The policy paradigm that the UPA-II followed was that of fiscal consolidation through cutting expenditures on essential public services while not improving efforts to raise revenues. The argument for this fiscal parsimony has been made in the name of reducing the fiscal deficit, in the wake of the government’s inability to step up the tax-GDP ratio. However, this scenario eventually resulted in inadequate provisioning for the social sectors.

Size of the Union Budget

The size of the Union Budget (indicated by the total Union Budget expenditure) relative to the size of the Indian economy has been continuously decreasing over the past several years. The Budget Estimate (BE) for 2016-17 is Rs. 19.8 trillion which is 13.1 percent of GDP. The following figure shows the decreasing size of the Union Government’s budget relative to the size of the economy.

If we include the state government expenditures as well, then the latest data available from the Indian Public Finance Statistics (2015) indicates a total spending of Rs. 35.4 trillion by states and the Centre combined, which is around 25.3 percent of GDP according to 2014-15 BE. Within this, the total budgetary spending on social sectors is still at 7 percent of GDP, of which the Union Government’s contribution is a meagre 2 percent of GDP.

Resource Mobilisation

The inadequate level of public resources available to the government in India as compared to several other countries is attributable to the low magnitude of tax revenue collected in the country. The tax-GDP ratio for the  country  is  low  compared  to  most  developed  countries  and  some  developing  countries like Brazil, South Africa, China and Mexico. The Gross Tax Collection expected by the Centre in 2016-17 BE is Rs. 16.3 trillion which is a tax-GDP ratio of 11.7 percent. India has the lowest tax-GDP ratio among the BRICS countries. Also, there has been no significant improvement in the country’s tax-GDP ratio over the last few years.

The net amount available with the Centre after transferring the share mandated by the Finance Commission (the constitutional body that recommends intergovernmental fiscal transfers) to the states, inclusive of loans from domestic and foreign sources, is depicted below. A little more than half is expected from tax sources, almost one-fifth from non-tax sources and the rest from borrowing and disinvestment.

If you take a look at the components of the tax revenues, up to 52 percent of the Union Government’s receipts are from direct tax sources like corporation tax and income tax while 48 percent are from indirect sources like customs, union excise duties and service taxes.

The Union Government’s dependence on indirect taxes seems to be increasing. Indirect taxes are considered to be regressive in nature because the proportion of taxes paid as a percentage of one’s income increases with decreasing incomes. In the 2016-17 BE, the proportion of direct taxes and indirect taxes in the gross central taxes is estimated at 52:48, as compared to the ratio of 56:44 in 2014-15. The figure below depicts the changes in the composition of the gross central taxes over the last few years.

If the states’ receipts are also included, almost two-thirds of Combined Receipts of Centre and states are from Indirect Taxes (Indian Public Finance Statistics 2014-15).

Co-operative Federalism and the 14th Finance Commission

An argument that has been repeated by the current government when it comes to its decreased intervention in various social sectors is that more funds have been transferred to the states as part of the 14th Finance Commission recommendations. While it is true that there has been a 10 percentage point increase (32 to 42 percent) in the share of states in the divisible pool of taxes collected the Centre, it was accompanied by savage cuts on several plan schemes by the Centre known as ‘Central Assistance to State Plans’. In fact, the net amount transferred to the states has increased only by 2-3 percentage points. But the so-called ‘increased resource envelope’ has resulted in increased transfer of expenditure to the states. There are reports from several states that, in the current fiscal year (2015-16), they have had to resort to multiple supplementary budgets to make up for the decrease in transfer of funds from the Centre. The extent of the damage may only be clearly visible with the presentation of the budgets by all the states for the fiscal year following the next one i.e. 2017-18.

Conclusion

The broad takeaway from this short analysis is that the government is not raising enough tax revenues to spend on sectors that it has promised to spend on. In fact, it has transferred several of those responsibilities to the states without adequately providing them with resources in terms of fiscal space or time to adjust to the shock. The optimist may call it a master stroke as states are better positioned to identify priority areas to spend on, but the pessimist may wonder how or why the states would want to take up responsibilities that they are not used to without adequate incentive. In both the cases, lack of adequate tax revenues is constraining the State from fulfilling its constitutionally mandated responsibilities.