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Fiscal Marksmanship

This paper brings out the problems caused by inaccurate forecasting of central government tax revenues for fiscal management by state governments. The analysis shows that use of poor forecasting methodologies has had an adverse impact on the states. The states suffer because the central forecasts are more in the nature of targets than carefully estimated forecasts.

Fiscal Marksmanship

Link between Forecasting Central Tax Revenues and State Fiscal Management

This paper brings out the problems caused by inaccurate forecasting of central government tax revenues for fiscal management by state governments. The analysis shows that use of poor forecasting methodologies has had an adverse impact on the states. The states suffer because the central forecasts are more in the nature of targets than carefully estimated forecasts.

PRATAP R JENA

I
n all multi-level fiscal systems, fiscal dependence of states on the central government to a lesser or greater extent is unavoidable. In general, the sources of revenues of the state governments are inadequate to finance their expenditure commitments. As poorer subnational jurisdictions have lower revenue capacities, their fiscal dependence is greater. Although in most federal systems, fiscal transfers are not specifically designed to offset such disabilities, poorer states tend to depend more on central transfers. This is partly because the tax base of own revenues in these states is low and partly because central transfers tend to be higher.

The problem with states’ dependence on the central government is that their fiscal systems are vulnerable to fluctuations in central transfers. The vulnerability varies directly with the degree of dependence on the central transfers as well as decline in the transfers from one year to another. When central transfers are defined as a ratio of central revenues, the decline in central revenues automatically result in lower transfers.

Heavy fiscal dependence of the states for transfers creates a number of problems. First, it reduces the resources available to the states. Although at five-year intervals finance commissions are appointed to recommend transfers based on the requirements, this does not account for the in-period reductions. The opening up of the economy results in reduction in revenue from import duties and domestic trade taxes are unable to compensate the loss. In the Indian case, the domestic trade taxes are at the state level and the reforms of these taxes are not calibrated alongside reduction in import duties. This reduction in central taxes creates losses to the states in terms of lower transfers. Second, when central revenues decline due to cyclical reasons, declining transfers reinforce pro-cyclical fiscal behaviour at the state level. Third, attempts to show lower deficits in the budgets for political purposes in a democratic polity, particularly when the central government has embarked on fiscal adjustment, may result in very optimistic projections of tax revenues. In the absence of a strategic plan for realising them, this may not materialise and as the transfers are reduced from the budgeted level, the fiscal management at the state level becomes problematic. With lower revenues the states are unable to fund the planned programmes and lower transfers also create cash management problems. In this note, an attempt is made to examine the impact of a shortfall in central tax revenues from the budget estimates on the finances of different states in 2001-02. A similar type of discrepancy in states’ own revenue realisation is also examined.

The Problem

Central transfers play a crucial role in fiscal management of states in India and in the process an element of vulnerability remains for the states that stem from poor fiscal marksmanship of central tax revenues. While relatively high income states depend upon the central government for a quarter of their total revenues, almost one half of the revenues of relatively poorer states come from central transfers (Table 1). In 2002-03, central transfers to Orissa and Bihar constituted 55 per cent and 72 per cent of their revenues respectively. Dependence of some of the special category states on central transfers has been as high as 80 to 90 per cent.

One of the major reasons for the sharp deterioration in fiscal health of states in the late 1990s was the decline in central transfers relative to GDP. This happened mainly due to a decline in central tax revenues relative to GDP by almost 2 percentage points, from

10.3 per cent of GDP in 1990-91 to 8.2 per cent in 2001-02, before marginally increasing in the next two years. Of this, 1 percentage point was passed on as lower tax devolution to the states [Rao and Rao 2005]. The estimate given by the Twelfth Finance Commission (TFC) shows a decline in central transfers as a ratio of GDP under finance commission awards from 3.05 per cent to 2.80 per cent and other transfers from 2.02 per cent to 1.22 per cent between 1993-94 and 2002-03. Besides a relative decline in central transfers, which is a grave concern by itself, there are fluctuations between budget announcements and actual transfers to the states.

The quantum of central transfers to states depends upon the availability of revenues with the central government. For instance, a share in central taxes – a statutory and formula-based transfer – constituting a substantial portion of finance commission’s transfer to states, varies depending upon the buoyancy of central tax revenue. Management of state budgets in terms of meeting the projected outlays becomes extremely difficult due to volatility in the collection of central revenues. Poorer states are especially at a disadvantageous position to absorb any fluctuations in revenue transfers during the year due to their weak fiscal base. The

Economic and Political Weekly September 16, 2006

Figure 1: Percentage Change in Actual Collection over Budget

10.00 5.00 0.00 -5.00 -10.00 -15.00 -20.00 1993-941994-951995-961996-971997-981998-991999-20002000-012001-022002-032003-04

constitutional mandate of transfers of resources notwithstanding, a portion of the decline in central tax revenue collections can be passed off to states and that, in turn, may upset the state finances.

Budget Estimates and Actual Collection: Fluctuating Trend

Gross revenues of the central government have witnessed a wide fluctuation between budget estimates and actual collection. Revenue targets set in the budget are rarely achieved. Budget estimates and actual collections of central gross revenue over a decade since 1993-94 given in Table 2 show this trend. More often than not, actual revenues fell short rather than being in excess of the budget estimates. The shortfall in revenue collection was the highest in the year 2001-02 by the amount Rs 39,589 crore and this was 17.47 per cent lower than the budget estimate (Table 2, Figure 1). Shortfalls in actual revenue collection from the budget estimates were seen in seven out of the 11 years since 1993-94 and in two years, 1993-94 and 2001-02, the shortfall was particularly large. It was 15.3 per cent in 1993-94 and 17.5 per cent in 2001-02.

Such a wide variation shows poor fiscal marksmanship in forecasting central revenues. It is apparent that the budget estimates of revenue are kept as targets rather than making realistic projections, taking into account the determinants of central tax revenues. Another probable reason could be the objective of deficit covering in the budget that compels the government to fix higher revenue targets. Unforeseen factors like a recession in the manufacturing sector, a change in the policy regime and natural calamities can also contribute to such deviations.

When the tax revenues are lower in seven out of the 11 years, the finger of suspicion is more on the quality of forecasts rather than any unforeseen exigencies. Further, a decline in central revenues relative to GDP has been mainly due to a deceleration in the growth of indirect taxes following the customs duty reduction and decline in the buoyancy of union excise duties. It is also seen that the growth rate used for forecasting central tax revenues show wide variations from one year to another and there is no reason to presume that the buoyancy of the tax will vary so much from one year to another. Adoption of a proper forecasting methodology can foresee the impact of a change in tax rates and recession on revenue collection and usually deviations should not persist over a long period of time. It has been the case that the natural calamities in different parts of the country have a negligible influence on central revenue collection as the Indian economy is now resilient enough to absorb such disturbances.

Impact on State Budgets

Fluctuations in central gross revenue collection have an impact upon the state budget through changes in both actual tax devolution and grants; the former determined by the devolution formula and the latter by revenue constraints. During 2001-02, following the shortfall in central tax revenue collections of about 17.5 per cent, there was a heavy shortfall in actual revenue realisation of all states over the budget estimates. The shortfall was to the tune of Rs 27,344 crore – a decline of 10 per cent in actual revenue realisation over budget estimates. The link between shortfall in central gross revenues and the state budgets is unmistakably visible.

Table 3 gives the percentage change in actual revenue realisation over the budget estimates in the year 2001-02 for all states. The actual central transfers to all states declined by 12.54 per cent over the budget estimates. A major fluctuation is seen in the case of tax devolution as it declined by 13.45 per cent for all states. For general category states the decline in tax devolution was

13.62 per cent and for special category states it was 11.36 per cent. State specific variations are there. For instance, Andhra

Table 1: Total Transfers as Percentage to Total Revenues

1993-94 1999-2000 2000-01 2001-02 2002-03

General category states
Goa 30.17 13.99 15.35 12.97 12.97
Punjab 21.80 16.59 19.96 16.24 15.56
Maharashtra 22.45 16.12 14.38 13.85 12.28
Haryana 20.66 18.02 13.15 13.37 15.81
Kerala 32.40 28.21 25.52 28.96 25.22
Gujarat 28.20 27.62 27.85 28.55 27.76
Tamil Nadu 31.79 24.96 23.70 22.69 22.37
Karnataka 28.20 27.62 27.85 28.55 27.76
Andhra Pradesh 37.16 31.86 31.73 33.77 29.80
West Bengal 45.62 44.36 50.78 49.80 47.06
High income states 29.53 24.76 25.22 25.00 23.98
Rajasthan 45.20 37.64 43.65 40.92 40.20
Chhattisgarh 0.00 0.00 44.88 37.94 39.38
Madhya Pradesh 42.28 37.41 42.65 43.98 41.75
Jharkhand 0.00 0.00 46.60 45.78 44.55
Orissa 60.25 58.87 58.43 55.19 54.58
Uttar Pradesh 55.32 46.91 47.77 52.66 47.23
Bihar 63.62 60.12 59.05 66.27 72.44
Low income states 52.93 46.83 50.28 51.16 48.63
Special category states
Himachal 74.39 54.89 70.27 70.19 70.95
Mizoram 92.78 94.00 93.46 92.69 92.16
Sikkim 81.39 82.01 82.52 82.74 76.19
Nagaland 92.84 93.11 93.22 92.63 92.17
Tripura 90.31 87.63 86.56 86.28 85.01
Jammu and Kashmir 83.13 82.17 79.01 80.50 74.85
Manipur 91.89 92.33 91.35 93.26 90.87
Uttaranchal 0.00 0.00 61.81 61.33 56.73
Arunachal 86.80 91.99 91.24 90.63 89.75
Meghalaya 84.76 80.22 81.89 79.53 81.58
Assam 71.03 65.51 65.65 64.96 61.32
Total special category
states 80.31 75.87 77.00 76.10 72.97

Note: States are arranged in descending order of average per capita GSDP (1999-2000) as given in TFC Report. Relatively rich states are defined as those whose per capita income is more than Rs 17,000.

Source:Basic Data, Finance Account, CAG, relevant issues.

Economic and Political Weekly September 16, 2006

Figure 2: Relationship between Per Capita Shortfall in Transfersand Per Capita SDP

(General Category States excluding Jharkhand and Kerala)

Per Capita Shortfall

600 500 400 300 200 100 0

10000 20000 30000 40000 50000 60000 70000 Per Capita SDP

Pradesh and Haryana were badly hit as their actual devolution was less by 31 and 22 per cent respectively. Relatively more prosperous states like Maharashtra, Punjab, Gujarat, Tamil Nadu, Karnataka, and West Bengal and low income states like Orissa, Bihar, and Rajasthan all experienced a decline in actual central tax devolution by 15 per cent on an average in 2001-02. The decline in tax devolution is likely to affect low income states more as a substantial portion of their revenues is from central sources. The inverse relationship between per capita shortfall in central transfers and per capita income of general category states emphasises the problem faced by low income states (Figure 2).

In the case of grants that include both plan and non-plan, the actual grants were less by 18.61 per cent in the case of general category states. The grants to special category states seem to have met the target as it overshot the budget marginally by 1.91 per cent. However, the change in actual revenues over the budget varies across states. The decline in actual grants over budget was highest for Gujarat – 62 per cent, followed by Punjab 54 per cent and Chhattisgarh 38 per cent. The states like Goa, Rajasthan and West Bengal have received grants more than what they have budgeted for. Severe volatility seen in the case of grants points to the fact that in addition to decline in central transfers, some states have anticipated larger grants that did not come through.

Own Revenues of States: Fluctuations Exist

Growth of own revenues of the state governments slowed down in the 1990s as compared to the earlier decade, which has contributed to fiscal imbalances [Lahiri 2000, Rao 2002, World Bank 2005]. Own tax revenues of the states have started picking up since 2000 and thereafter mainly due to reforms in sales tax (adoption of floor rates) and other revenue augmentation measures taken in other state taxes. Own tax revenue, which was 4.93 per cent of GDP in 1998-99 improved to 5.52 per cent in 2002-03 (Report of Twelfth Finance Commission). A recent revival in growth of own tax revenue has some positive impact on the process of fiscal consolidation in the states. But the decline in growth of non-tax revenues of the state remained unabated.

A similar trend of fluctuation in realisation of own revenues

– tax and no-tax – has been witnessed across states. Actual own revenue collections in 2001-02 for all the states show a decline of 8.52 per cent over the budget estimates (Table 3). Most of the shortfall in own revenue collection is seen in the case of general category states (9 per cent). In the special category states, except Arunachal Pradesh, Manipur and Nagaland, others have exceeded their budget target and the overall change was positive. In the special category states, actual collections surpassing the budget estimates also does not reflect efficient fiscal marksmanship as they either fail to project or suppress their revenue

Table 3: Percentage Change in Actual Revenues over Budget Estimates: 2001-02

Own Own Share in Grants Own Total
Tax Non-Tax Central Revenue Trans-
Revenue Revenue Taxes fers
Special category states
1 Arunachal 26.83 -44.83 -54.06 4.20 -32.40 -3.53
2 Assam -2.47 1.92 -3.58 -21.42 -1.39 -14.47
3 Himachal 17.91 2.90 -19.93 23.69 14.93 15.81
4 Jammu 7.88 -0.19 7.17 9.49 5.66 9.19
5 Manipur 2.87 -45.53 -38.88 7.79 -21.85 -1.86
6 Meghalaya -3.19 -10.71 -10.01 -18.35 -6.41 -16.93
7 Mizoram 30.51 28.09 -65.02 0.12 28.80 -9.09
8 Nagaland -19.17 3.67 -5.94 0.58 -9.62 -0.04
9 Sikkim 38.77 21.80 -22.59 -8.15 30.25 -10.52
10 Tripura 20.64 2.77 -19.80 -3.83 13.15 -6.51
11 Uttaranchal 11.87 -15.93 -14.84 17.51 6.47 8.83
Total special
category states 6.78 -4.71 -11.36 1.91 3.57 -0.86
General category states
1 Andhra 6.99 3.38 -30.98 -3.18 6.29 -18.84
2 Bihar -4.07 -20.53 -15.55 -1.40 -6.56 -13.46
3 Chhattisgarh 4.63 -2.93 -5.66 -37.57 2.51 -17.90
4 Goa -8.04 -0.59 -2.27 4.38 -3.21 -0.01
5 Gujarat -13.20 -8.86 -15.04 -62.32 -11.98 -47.81
6 Haryana -2.61 2.40 -21.53 -21.57 -1.40 -21.55
7 Jharkhand 1.96 -10.97 15.70 26.85 -2.51 18.67
8 Karnataka -6.76 -16.14 -14.57 -16.70 -7.79 -15.44
9 Kerala -19.84 -31.71 -1.40 21.28 -20.99 6.07
10 Madhya Pradesh -8.95 13.36 -1.42 -35.26 -4.16 -14.96
11 Maharashtra -11.37 -1.96 -14.95 -14.47 -9.81 -14.75
12 Orissa -2.68 -14.94 -16.89 -26.70 -5.41 -20.29
13 Punjab -17.94 -16.25 -15.56 -53.96 -17.31 -39.27
14 Rajasthan -7.99 -9.60 -14.74 5.82 -8.33 -7.15
15 Tamil Nadu -8.83 12.41 -14.76 -21.19 -6.95 -16.96
16 Uttar Pradesh -18.87 0.51 -13.63 -13.87 -16.50 -13.69
17 West Bengal -17.68 -23.11 -14.56 6.68 -18.29 -7.07
Total non-special
category states -9.73 -5.74 -13.62 -18.61 -8.98 -15.40
Grand total -9.19 -5.68 -13.45 -11.39 -8.52 -12.54

Source:State Finances – A Study of Budgets, RBI, relevant issues.

Table 2: Difference between Budgeted and Actual Collection of Central Gross Revenue

(Rs crore)

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02 2002-03 2003-04
Difference* 13646 -5158 -7475 691 Percentage change -15.27 5.92 7.20 -0.53 Growth of budget estimates 16.81 -2.52 19.08 24.76 Note: * Positive figures are shortfalls (Difference = BE – Actual). Source:Central Government Budgets, relevant years. 14126 -9.21 18.46 4709 -3.17 -3.16 -4226 2.52 12.81 4781 -2.47 15.44 39589 -17.47 17.20 19534 -8.28 4.04 -2821 1.12 6.67
Economic and Political Weekly September 16, 2006 3973

Figure 3: Impact of Revenue Shortfall on Budget Management

? ? ? • •? ? Revenue Shortfall • Inefficient Poor Resource Budgetary Allocation Practice • Expenditure Management Problem Compressing Compressing • Arbitrary Poor Cash Capital Outlay O and M Budgetary Management Expenditure Adjustments • Distortions in Priorities • Inadequate • Deterioration • Non-Resorting to Project of Assets achievement • Ways and Funding • Inefficient of Plan Means • Time and Cost Service Targets • Overdraft Over run Delivery • Low • Rise in Productivity Interest • Inefficient Payments Service • Deficit Delivery Impact

potential. States like Andhra Pradesh, Chhattisgarh, Jharkhand, have met their budget estimates out of own tax revenue. All other states have shown a shortfall in meeting their target and the shortfall was large in states like Kerala (20 per cent), Uttar Pradesh (19 per cent), Punjab (18 per cent), West Bengal (18 per cent), Guajarat (13 per cent) and Maharashtra (11 per cent). Realisation of non-tax revenue across states has been very volatile and the aggregate decline in actual collection over budget estimate was 5.68 per cent.

Fiscal Marksmanship and Management

Analysis shows that the forecasting techniques adopted by the states are equally bad, if not worse and this has further contributed to their poor fiscal management. The variations in the actual collections of states’ own revenues from their budget estimates is as much a problem as it is of central tax revenues. This has serious implications for the poorer states whose dependence on central resources is large. In 2001-02, the shortfall in actual own revenue collection was Rs 14,322 crore as compared to a Rs 13,591 crore decline in central transfers in 2001-02.

The year end shortfall in revenue realisation affects the expenditure management and efficiency in budget making as sectoral allocation of resources on the basis of budget estimates go haywire. The adjustment process due to inefficient fiscal marksmanship becomes arbitrary and the priorities set at the beginning of the fiscal year get distorted (Figure 3). States in India face a severe incompatibility between policy, planning and implementation while framing their budget. The budgetary process operates does not have expenditure ceilings for the line departments. The major weaknesses in resource allocation and use in this kind of budgetary process can be identified as (1) poor expenditure control, (2) inadequate funding of operation and maintenance, and (3) little relationship between budget as formulated and budget as executed [World Bank 1998]. When a shortfall in revenue realisation occurs at the end of the year, all these weaknesses accentuate resulting in poor resource allocation and non-achievement of plan targets. When expenditure compression when becomes inevitable, it is carried out in an ad hoc manner without being calibrated properly based on any economic criteria. Given the sociology of fiscal politics, the adjustment to a shortfall in revenues is done by compressing capital and maintenance expenditures and to some extent expenditures on social services. Cost over-runs occur in various projects due to a delay in completion and compromises are made in operation and maintenance expenditures.

The state governments can perform better in terms of fiscal management and delivery of services by infusing accuracy in their forecasts of own revenues. In this context, it should be recognised that the predictability of revenue is as important an

Economic and Political Weekly September 16, 2006

issue as its augmentation. Predictability of revenue receipts imparts stability which is an integral part of efficient and effective implementation of policies and programme. Fiscal policy, therefore, requires ensuring timely flow of resources to various projects and programme undertaken to avoid cost over-runs and better service delivery.

A medium term – over five years, as well as short-term – annual, fiscal framework should be prepared under which revenues can be projected that will enhance policy-making performance at head quarters and implementation ability in line departments. There could, however be constraints – both technical and political. One major constraint is the unpredictability of central transfers as argued above on which states have less control except that it can be projected taking past trends and overall growth prospects. An independent projection of state revenues has the advantage of softening the budget constraint on strategic priority setting and improving policy implementation. The decision-making on medium-term and the short-term framework should be transparent that implies all the information and relevant issues should be known beforehand and the decision-makers should be responsible and accountable.

Expenditure Linkages

Expenditure compression in response to poor revenue realisation seems to have fallen on capital outlay. Table 4 presents the percentage change in actual revenue expenditure and capital outlay over the budget estimates for 2001-02. There has been a decline in actual revenue expenditure and capital outlay over what was actually budgeted; the decline is sharper in the case of the latter in percentage terms. The decline in actual capital outlay was 18.68 per cent aggregated over all the states. General category states show a huge decline of 21.24 per cent, while it is rather small for the special category states (0.65 per cent). West Bengal leads the pack as its actual capital outlay falls short by 55 per cent of the budget estimates followed by Gujarat 50 per cent, Goa 38 per cent, Punjab 32 per cent, Jharkhand 29 per cent, Bihar and Tamil Nadu 24 per cent. Only two states, Haryana and Madhya Pradesh can manage to better their budget estimates by spending higher amount of capital outlay.

Revenue expenditure targets have also been missed; the aggregate actual revenue expenditure has fallen short of the budget estimates by 6 per cent. The fluctuations across states vary while Gujarat has deviated from its budget estimates by 21 per cent, which is in fact the highest. Goa and Maharashtra could manage to meet the revenue expenditure target and for West Bengal the slide is minimal at 0.32 per cent. The states have experienced fast growth of expenditure in revenue account mostly fuelled by high wages and salaries, pension and interest payments on the past debt overhang. These expenditure items are committed in nature and by and large are met from the exchequer. The adjustment of revenue expenditure in response to shortfall in revenues during the year invariably falls on operation and maintenance expenditures. Decomposition of the shortfall in revenue expenditure reveals the highest compression in social services (9.17 per cent), which is nothing but the non-salary component in this category. Such an adjustment deteriorates already existing assets, resulting in low productivity and inefficient service delivery.

Capital outlay that contributes to the creation of new assets was invariably compressed to accommodate ever increasing current expenditures. A relative decline in actual capital outlay over the budget has been larger than that in revenue expenditure. A huge compression of capital outlay across states (50 per cent in some cases) shows that this in fact, is a residual and a low priority item in policy planning. This raises doubt regarding the efficiency in budgetary practice and its development orientation. The expenditures on infrastructure, directly productive economic services and maintenance of capital assets have a positive impact on growth in the states [Jena 2004]. The poorer states especially which have severe infrastructural bottlenecks can ill afford compression of capital outlay resulting in unfinished infrastructure projects and cost over-runs.

The expenditure side of the budget needs to be integrated in the medium-term framework and linked with availability of resources. The budgetary allocation on various programme and projects could be better managed with prior knowledge of fund availability in any particular year. The priority setting in project selection and the expenditure decision on maintenance can be carried out in the overall resource framework. The expenditure decision should be closely aligned to what is feasible over the medium-term and, in turn, with the annual budget. When expenditure choice tends to be appropriately allocated to match policy priorities, it would produce intended results at lower cost.

Table 4: Percentage Change in Actual Expenditures over Budget in 2001-02

Revenue Expenditure Capital
Social Economic General Total Outlay
Services Services Services
Special category states
1 Arunachal 32.98 -11.49 3.07 5.07 -3.68
2 Assam -26.92 -17.55 -7.09 -17.83 -19.81
3 Himachal 2.23 -3.35 -6.68 -3.02 7.64
4 Jammu 4.75 -5.05 10.13 5.26 10.67
5 Manipur 0.35 7.63 13.75 7.44 -26.15
6 Meghalaya -12.49 -15.56 -16.02 -14.61 -39.78
7 Mizoram 20.79 20.49 10.22 16.81 24.34
8 Nagaland -8.00 -2.63 -2.13 -3.84 45.90
9 Sikkim 0.08 -5.43 219.66 -2.66 7.44
10 Tripura -14.67 -16.23 -14.33 -14.73 9.63
11 Uttaranchal -10.21 -25.63 -35.49 -24.60 -33.84
Total special
category states -9.48 -10.10 1.19 -8.04 -0.65
Non-special
category states
1 Andhra -8.69 -1.49 -7.08 -5.96 -18.99
2 Bihar -0.95 -2.54 -4.13 -2.81 -24.25
3 Chhattisgarh -10.52 29.76 -10.54 -2.70 -17.31
4 Goa 2.35 15.61 -4.74 1.47 -38.84
5 Gujarat -36.96 -13.58 -4.83 -21.28 -50.49
6 Haryana -2.51 -5.56 -3.88 -3.79 11.67
7 Jharkhand 10.19 10.06 6.66 8.75 29.34
8 Karnataka -6.71 -5.14 -7.17 -6.75 -3.37
9 Kerala -14.75 -24.48 -0.09 -10.23 -17.89
10 Madhya Pradesh -7.82 43.93 -18.08 -2.29 8.65
11 Maharashtra 6.98 42.56 -4.92 4.52 -21.99
12 Orissa -3.23 9.68 -8.70 -4.10 -11.67
13 Punjab -20.64 -13.04 -4.09 -8.93 -32.34
14 Rajasthan -2.00 -2.52 -1.29 -1.76 -5.30
15 Tamil Nadu -14.37 -16.61 -1.00 -12.09 -24.46
16 Uttar Pradesh -11.11 10.42 -9.00 -6.97 -20.23
17 West Bengal -0.40 -7.03 2.08 -0.32 -54.96
Total non-special
category states -9.14 0.50 -5.03 -5.65 -21.24
Grand total -9.17 -0.66 -4.45 -5.88 -18.68

Source:State Finances – A Study of Budgets, RBI, relevant issues.

Economic and Political Weekly September 16, 2006

Conclusions

This paper brings out the problems caused by inaccurate forecasting of both central and states’ revenues for the fiscal management of the states. The analysis shows that poor forecasting methodologies employed to forecast central and state tax revenueshave already had an adverse impact on the fiscal management of states.

In recent years, the central government’s forecast of tax revenues are in the nature of target setting rather than forecasting, and this has had a negative impact on the states finances. In 2001-02, for example, there was a shortfall of 17 per cent in central revenues from the budget estimates and this caused central transfers (both tax devolution and grants) to decline by 12.54 per cent of the budget estimates of the states. Each of the states had to cut down expenditures as a result. The problem is compounded by the poor forecasting techniques used by states to forecast their own revenues.

The adverse implications of poor fiscal marksmanship of revenues can be severe. First, the compression of expenditures that has to be done as a result falls on developmental expenditure on the creation of maintenance of physical infrastructure and social services. This causes, inter alia, severe, time and cost overruns of various projects and reduces the productivity of capital expenditure. Second, invariably, the adverse impact of the shortfall from the budget estimates in central revenue is more on the poorer states because, in per capita terms the reduction is higher and the fiscal dependence on the central transfers is more. Third, the shortfall in central transfers creates cash management problems and resort to ways and means, and overdrafts increase the interest burden of the states.

The important point is that the states are made to suffer from poor fiscal management when the central government fails to accurately forecast its revenues. Of course, the fact that the states themselves have been equally bad in their fiscal marksmanship shows their own lack of concern for fiscal management. The paper shows that it is important that both the central and state governments should prioritise their expenditure plans by adopting a medium-term framework and adopt more scientific techniques of forecasting in making budgetary projections.

m

Email: jena@nipfp.org.in

[The author is grateful to M Govinda Rao, for his valuable comments and suggestions on the first draft of the paper. Errors, if any in the content, are the responsibility of the author alone.]

References

Government of India (2004): Report of the Twelfth Finance Commission (2005-10).

Jena, Pratap Ranjan (2004): ‘Public Expenditure and Growth: A Decomposed Expenditure Analysis for States in India’, Asian Economic Review, Vol 46, No 2, pp 247-62.

Lahiri, Ashok K (2000): ‘Sub-National Public Finances in India’, Economic and Political Weekly, April 29, pp 1539-49. Rao, M Govinda (2002): ‘State Finances in India: Issues and Challenges’, Economic and Political Weekly, August 3, pp 3261-71.

Rao, M Govinda and R Kavita Rao (2005): ‘Trends and Issues in Tax Policy and Reforms in India’, National Institute of Public and Policy, New Delhi.

World Bank (1998): Public Expenditure Management Handbook.

– (2005): State Fiscal Reforms in India: Progress and Prospects, Macmillan, New Delhi.

REVIEW OF AGRICULTURE June 30, 2006

Measuring the Marginal Value of Water and Elasticity

of Demand for Water in Agriculture – E Somanathan, R Ravindranath Is Bt Cotton Cultivation Economically Viable for Indian Farmers?

An Empirical Analysis – A Narayanamoorthy, S S Kalamkar Globalisation and Expanding Markets for Cut-Flowers: Who Benefits? – Sucharita Sen, Saraswati Raju Lease Farming in Kerala: Findings from Micro Level Studies – K N Nair, Vineetha Menon Drought, Agricultural Risk and Rural Income:

Case of a Water Limiting Rice Production Environment, Tamil Nadu – K N Selvaraj, C Ramasamy Diversification towards High Value Agriculture:

Role of Urbanisation and Infrastructure – P Parthasarathy Rao, P S Birthal, P K Joshi Institutional Credit, Indebtedness and Suicides in Punjab – P Satish Farmers’ Suicides and Response of Public Policy:

Evidence, Diagnosis and Alternatives from Punjab – Anita Gill, Lakhwinder Singh

For copies write to Circulation Manager

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