Notwithstanding Union Finance Minister Nirmala Sitharaman’s spirited defence of the government’s economic performance on Wednesday, the fiscal position of both the Central and state governments is becoming increasingly worrying with no clear solution in sight. The data presented in Parliament on Monday showed that direct tax collection
plunged 17 per cent in October. This means tax collection growth slipped further from 4.7 per cent in the first half of the fiscal year against the expected growth of over 17 per cent for the full year. However, it is not clear at this point as to what extent the reduction in corporation tax has affected collection. Since the performance on the goods and services tax (GST) front is also not encouraging, the Centre is likely to see a significant shortfall in revenues. It is thus not clear how the Union government expects to meet the fiscal deficit
target in the current year. Compressing or postponing expenditure is an option, but it will have serious implications for the economy in the medium term.
Meanwhile, states are complaining about delays in the release of GST
compensation. The due amount is reported to be more than Rs 20,000 crore. The Centre has to compensate states if GST
growth is below 14 per cent and this will again put pressure on Central government finances. Despite the guaranteed compensation on account of GST, state government finances are in trouble because the economic slowdown has affected the collection of excise and sales tax.
As a result, according to estimates, borrowing by state governments is likely to go up by well over 20 per cent in the current fiscal year. Therefore, it is quite likely that the aggregate fiscal deficit
of states will overshoot the Budget estimates of 2.6 per cent of gross domestic product. Also, the quality of state government expenditure has worsened in recent years with an increase in revenue expenditure, partly because of populist schemes like farm loan waivers.
The state of state government finances suggests that the trend is unlikely to reverse in the foreseeable future. Pressure on state government finances could have a disproportionate impact on the broader economy because states account for about two-thirds of the general government capital expenditure. Capital expenditure
by states is reported to have declined substantially in the current year as well. This will affect both demand and potential growth in the near to medium term. Further, higher government borrowing will create friction in the transmission of lower interest rates. In fact, a significant increase in the general government deficit would itself limit the space for monetary accommodation.
Since the economy is unlikely to recover to a higher sustainable growth path in the near term, the government would do well to comprehensively review the fiscal position, both at the Central and state levels in the next few weeks, possibly with the help of an expert panel. This will not only help gauge the true picture of government finances but also enable policymakers to redraw the fiscal road map. The government should also urgently address all pending issues in the GST
system to improve tax collection. It is important to accept that postponing expenditure and shifting liabilities to public sector undertakings will not solve the problem. This will only create confusion and affect the credibility of the government.