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6/24/13 Mrunal [Economic Survey Ch3] Fiscal Marksmanship, Tax Buoyancy, 14th Finance Commission Print

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[Economic Survey Ch3] Fiscal Marksmanship, Tax Buoyancy, 14thFinance Commission

1. Overview2. What Is Fiscal Marksmanship?3. Why Poor Fiscal Marksmanship?4. Steps taken in Budget 2012-135. #3: GAAR (but delayed)6. #4: SERVICE TAX: negative approach7. Issues: Tax Buoyancy8. Issue: COLLECTION RATES9. Issue: Non-Tax Revenue

10. Issue: SUBSIDIES11. Public debt

12. 14th finance commission13. Background: why finance Commission?14. Finance Commission: structure15. Terms of reference16. Way ahead?17. Mock questions

Overview

We know that when Government spends more money than it earns= leads tofiscal deficit and high level of fiscal deficit = bad for economy. For moredetails, read the earlier Vijay Kelkar article click meChapter 3 of economic survey, deals with these issues of public finances anddeficits.

What Is Fiscal Marksmanship?

This is a new term introduced by Economic survey.Marksman= an expert shooter.Suppose Government decided that for the given year,

1. our direct tax collection target is xyz cr.,2. our indirect tax collection target is xyz cr.,3. our subsidy bill will be xyz cr.,4. our fiscal deficit will be xyz cr.these are all targets set by Government.



For the moment, lets concentrate on the fiscal deficit target.From the earlier articles, you know that high level of fiscal deficit is bad foreconomy. So in 2003, Government had enacted an act called fiscalresponsibility and budget Management (FRBM) ActThis FRBM act stipulated that Government will reduce its fiscal deficit.The original target was that fiscal deficit should be only 3% of the GDP forthe year 2008-09. And similarly Revenue deficit should be 0% of the GDPfor the year 2008-09.But actually for 2008-09 the fiscal deficit around 6% of the GDP! (instead ofthe target of 3%)That means, Governments gunman (finance minister) fired a bullet but insteadof hitting 3%, it hit 6%. That means Governments fiscal marksmanship waspoor (because they cant hit the target precisely).Now the question comes in mind.

Why Poor Fiscal Marksmanship?

How can Government overshoot the (fiscal deficit) target? Well, fiscal deficitwill happen when Governments outgoing money is more than its incomingmoney.Recall that in 2007, subprime crisis happened in USA and its shocks were felton every country, including India: export declined, business activity



declined.So, Government had to take some initiative to protect Indianeconomy from further damage.Therefore Government decreased excise duty, decreased the service tax +offered many tax incentives to businessmen, to boost demand of Indianproducts and services within India and abroad. (=incoming money ofGovernment reduced).Thus, Government missed the Revenue collection target (first proof ofpoor fiscal marksmanship.)On the other hand outgoing money was high because

1. MNREGA and other welfare schemes. (+ the lot of that money didnot go toactual poor people. so such schemes didnot show the desired positive resulton the economy.)

2. Subsidies on petrol, diesel, LPG, Urea etc.3. Since 2009s general election was coming, so Government wanted to woo the

farmers. So it gave debt waiver to farmers = again outgoing money increased.Government increased minimum support prices (MSP) to farmers for sugar,wheat etc. In other words, Government overshot (missed) the expendituretarget (second proof of poor fiscal marksmanship.)

And since Government already missed the first two targets (Revenuecollection and Expenditure) so obviously third target (fiscal deficit) wasgoing to be missed.Thus in 2008-09 Government could not show its sharp / precise / accuratefiscal marksmanship.To put this concept in refined words= Government overshot the deficit targetsin 2008-09 to obviate the adverse impact of the global financial crisis and togive largesse on the eve of the 2009 general elections.Anyways ^that was the story of 2008-09, but even in 2011-12, Governmentwas showing signs of poor fiscal marksmanship because

1. Policy paralysis in last two years. Combine this with slowdown in Europe=our(export) sector is not performing good, GDP is going down, low IIP=> lowtax collection.

2. Disinvestment targets could not be met because markets response waslukewarm. (Meaning Government wanted to sell its shares of some PSU butprivate players were not interested in buying them @high price).

3. Inflation continued to be above 7 per cent=again higher subsidy payments,lower tax collection.

4. high inflation = people opting for gold-purchase as safe-investment + highcrude oil price= CAD increased = rupee weakened against dollar= even moreinflation= profit of businessmen declined = less tax collection.

5. In earlier years, Government could make truckload of money through properauctioning of spectrum and coal mine licenses, but both were ridden withscams and corruption. So when Government tried to auction 2G again in thelate 2012 (after supreme courts order), private players werent muchinterested.

6. Controversies surrounding Vodafone case and GAAR implementation =foreign players felt less confident investing in India.



Lately Government has woken up and started firefighting: the increasing of petrol-diesel prices, decreasing number of subsidized LPG cylinders, increasing FDIlimits in multibrand retail, insurance, aviation, increasing the railway ticket prices,direct cash transferthese are all measures to decrease the fiscal deficit(=achieving fiscal consolidation).anyways back to the story:

Steps taken in Budget 2012-13

1. In Budget 2012-13, FM announced that Government will restrict expenditureon central subsidies to under 2 per cent of GDP. (meaning if Indias GDP was100 billion rupees, then Government will only spend 2 billion or less onvarious central subsidies on petrol, diesel, urea, PDS).

2. FM introduced the concept of effective Revenue deficit. = Revenue deficitMINUS grants given to states for creation of capital assets. (this meanstechnically, on paper, Governments Revenue deficit will look smaller!)

#3: GAAR (but delayed)

GAAR was already discussed in earlier article, click meThis was #EPICFAIL, because led to huge protests from business lobby.Government setup Shome Panel to look into GAAR. Shome says, delayGAAR implementation till 2016. Chindu agrees.

#4: SERVICE TAX: negative approach

Usual approach is: Government would say the service tax on xyz item is xyz%.But in 2012-13: Government introduced a new approach negative list. Here,Government would say xyz items are exempted from service taxpayment(e.g. doctor, lawyer)= It means service tax applies on all theremaining services that are mentioned in the Negative list.Service tax=12%* on all services that are not included in the negative list.(rate is same for both 2012 and 2013s budget)Government also implemented service tax on railways (first class or an air

conditioned coach) from 1st October 2012.

*By the way service tax is 12% but some books/material/websites might say servicetax is 12.36%. WHY?Because they include cess on the service tax.

Service tax 12.00%

2% educational cess. Meaning tax on tax = 2% of 12% +0.24

1% Senior & Higher Education Cess= 1% of 12% +0.12

Effective service tax =12.36%

#5: IT in IT

To increase the tax collection, Government is making extensive use of



information technology is continuing, viz. along with e-filing of income taxreturns, various forms, audit reports, and statements of tax deduction atsource have been made compatible with electronic filing and computerizedcentralized processing. This helps checking tax evasion and black money.

Issues: Tax Buoyancy

A tax is buoyant when revenues increase by more than 1 per cent for a 1 percent increase in GDP.After the FRBM act, both direct and indirect taxes remained buoyant except inthe crisis years (2008-9 and 2009-10).But in 2011-12, the tax buoyancy declined sharply in corporate tax sector.Because high level of inflation decreased the actual profits of corporatesector.

Issue: COLLECTION RATES

It is the ratio of revenue collected from imported items vs the value of imports in ayear. Collection rates have decreased last year because

1. petroleum, oil, and lubricants (POL) are expensive in terms of value butGovernment is levying lower levels of duties on them.

2. Tax exemptions are given on various imported items.

Issue: Non-Tax Revenue

Last year, Government couldnt get sufficient incoming money from non-tax Revenue sources becauseMarket gave lukewarm response to disinvestment.Government was expecting to auctions of telecom spectrum and phase III FMRadio for around 15,000 cr. But it did not work out.As the 2G telecom spectrum auction elicited lukewarm response on accountof the high reserve price.

Issue: SUBSIDIES

The Budget for 2011-12 had estimated total expenditure to be contained at14.0 per cent of GDP but Government also overshot this target due to highglobal oil prices and subsequent increase of subsidy bill (for oil andfertilizers) = another example of poor fiscal marksmanship.Government should give priority to food subsidy due to extent of malnutritionin the country.The government aims to do this via National Food Security Act.But there is also need to reduce leakages involved in subsidy delivery=Government aims to do this via Direct benefit transfer (DBT) / direct cashtransfer.

Public debt



It is further classified into internal (domestic) and external debtInternal debt makes up around 91 per cent of public debt.State governments are not allowed to directly borrow externally hence theirentire debt is domestic.

14th finance commission

Background: why finance Commission?

India is a quasi-federal country.Weve union Government, weve state Government.Both have their De Jure heads (President vs Governor),Both have their De Facto (Real) heads (PM vs CM)Both have their separate administrative machinery (central service employeesvs state service employees)Both have their taxation powers and so onPoint is: Taxation power of state Governments is limited. Majority of taxespaid by the public goes to the Union Government via income tax, corporatetax, service tax, excise duty.So if the Union did not give even single paisa from its pocket to the states,then state Governments cannot survive. (because state Government also needto pay salary to staff, public amnesties and interest on previous borrowings.)Therefore, Constitution of India mandates that Union has to share some of itstaxes with the states.But who will decide how much tax money must be shared between union andthe states? Ans. Finance Commission. (for more, read financial relations onpg 13.8 to 13.13 in Laxmikanth).

Under art. 280, President sets up this Commission every 5 year.

Finance Commission Chairman Year

13th Vijay Kelkar 2010-15

14th Y.V.Reddy, Former RBI Governor 2015-20

Finance Commission: structure

1 chairman + 4 members.1 Chairman = experience of public affairs4 members need to have following qualifications

1. Serving or retired judges of High Court, or someone who is qualified tobecome one

2. knowledge of Government finances or accounts, or3. experience in administration and finance.4. Special knowledge of economics.



Terms of reference

The 14th finance Commission will look into following matters

1. Distribution of certain taxes between union and state.2. What principles should Union follow while paying grants-in-aid to states?

(from the consolidated fund of India)3. What measures should be taken to augment the Consolidated Fund of a states

so they can help the panchayats and municipalities.4. Review the state of finances, deficit, and debt levels of the union and states5. Give suggestion to maintain a good fiscal environment and equitable growth.6. Give suggestions to amend the FRBM Act.7. How much money should be spent for the maintenance of capital assets8. How to monitoring ^such expenditure?9. Should Government insulate the pricing of public utility services like drinking

water, irrigation, power ,and public transport via through laws?10. How to make public-sector enterprises competitive and market oriented;11. Matters related to Disinvestment12. Should Government giveup non-priority enterprises?13. Climate change, sustainable economic development14. What will be the impact of the proposed goods and services tax (GST) on

Centre and State?15. Will GST implementation lead to Revenue loss to States? If yes, then how to

compensate that loss?16. How to arrange money for disaster Management related activities?

Way ahead?

Prolonged fiscal deficit leads to

1. higher real and nominal interest rates,2. slower growth in capital formation3. potentially lower the rate of output growth.

Therefore Government must stick to the fiscal targets. Although, Governmentcannot rapidly reduce its outgoing money (expenditure) because

1. Government has to pay interest on earlier borrowings2. Continued payments on defense, civil service pay and pensions, etc.

Thus the annual budget has to maintain a delicate balance between

1. Non-developmental Expenditure that is necessary.2. development expenditure for inclusive growth.

Mock questions

Q1. What is the correct equation of effective revenue deficit?



a. Revenue deficit MINUS grants for creation of capital assets.b. Revenue deficit PLUS grants for creation of capital assets.c. Primary deficit plus fiscal deficit.d. Fiscal deficit MINUS Revenue deficit.

Q2. Find Incorrect statement(s) about service tax?

a. The service tax rate was 12% for 2012-13 and increased to 12.36% for 2013-14.

b. Railways is exempted from service tax.c. Service tax is levied on the items listed in the negative list.d. All of above.

Q3. Find Incorrect statement(s) about Finance Commission

a. The time frame for 14th finance Commission is from 2010-15b. It has 1 chairman and 3 members.c. One of the member must be a serving or retired judge of Supreme Court.d. All of above.

Q4. Find Correct statements

1. Major portion of Indias public debt is financed from external sources.2. The debt of all state Governments is internal.

Choice

a. Only 1b. Only 2c. Bothd. None

URL to article: http://mrunal.org/2013/03/economic-survey-ch3-fiscal-marksmanship-tax-buoyancy-14th-finance-commission.html

Posted By Mrunal On 24/03/2013 @ 21:33 In the category Economy

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Mrunal » [Economic Survey Ch3] Fiscal Marksmanship, Tax Buoyancy, 14th Finance Commission » Print