Finance ministry has a poor forecasting record3 min read . Updated: 19 Jan 2019, 09:13 PM IST
Given the over-optimistic revenue estimates and under-budgeted expenditure, the finance ministry's budget projections should be taken with a pinch of salt
Dark clouds are gathering over the fiscal horizon. Finance minister Arun Jaitley will table an interim budget on 1 February—just weeks before India goes to polls.
There’s a growing consensus among analysts that the government will miss its revenue target for the year, largely because the collections from the goods and services tax (GST) have been lower than expected.
The insipid revenue growth in fiscal year 2019 has also put a question mark on the government’s capacity to meet its fiscal deficit target for the year, unless there are unexpected revenue windfalls—or spending cuts.
The difficult transition to the new indirect tax regime is common knowledge. What is less known is that poor marksmanship has been a feature of Indian budgets over the past two decades.
Indian finance ministers have usually overestimated revenue and underestimated expenditure. In other words, Indian budgets need to be read with a sceptical eye.
We have here considered budget data from fiscal year 1998 to fiscal year 2017. The budget estimates for any particular fiscal year have been compared to the actual numbers released at the end of that particular fiscal year.
The finance ministry overestimated revenue receipts — or the sum of tax and non-tax collections—in 15 out of these 20 years. The three most important exceptions were in the fiscal years 2007, 2008 and 2011. The reason was a growth surprise combined with high inflation. The Indian economy was in the midst of an unprecedented economic boom in the first two cases and it saw a sharp recovery from the post-crisis slowdown in 2011.
The record on the spending side of the budget is almost a mirror image of the revenue trend. The finance ministry underestimated total expenditure in 12 out of the 20 years since fiscal 1998. The tightest control on spending was in fiscal years 2001, 2002, 2013, 2014 and 2015—all years when there were fiscal corrections despite weak revenue growth.
However, the Indian government has generally earned less tax and spent more than it has budgeted for. None of this takes into account the fact that governments have sometimes hidden fuel or fertilizer subsidies by keeping them off- budget. Such tricks together with off-budget spending have strained the credibility.
But even after such creative accounting, successive governments have found it difficult to meet targets. Historically, budgets have been too optimistic about revenue collections, while being too modest about how much will be spent in the year. The deviations seem to be more striking on the revenue front rather than the expenditure side. The biggest miss on the spending budget was in fiscal 2009, when the government chose an aggressive fiscal expansion to minimise the impact of the global financial crisis on the Indian economy.
Why do revenue receipt budgets miss the mark so often? The answer lies in the tax collection forecasts—as Jaitley is now realizing. The finance ministry ideally bases its tax collection expectations on the growth in the underlying economy in nominal terms, or after taking the growth of both output as well as prices into account. Faster growth in nominal gross domestic product (GDP) usually leads to faster growth in tax collections, at least in years when tax rates do not change much.
There are two problems here. First, tax buoyancy in India shows no stable pattern. So forecasting tax revenues for the next year is not easy.
Second, episodes of disinflation tend to hurt tax collections as nominal GDP slips into single digits.
Nominal GDP growth is now almost half what it was at the start of the decade.
As the first report of the Tax Administration Reform Commission (TARC) headed by Parthasarathi Shome pointed out, tax projections in India are often not in sync with economic realities.
Tax officials who are given such unrealistic targets then have strong incentives to pile up pressure on taxpayers so that they can meet their targets. A rampaging tax bureaucracy is often the direct result of unrealistic tax collection targets written into the budget by the finance minister of the day.
India’s fiscal arithmetic tends to be the most untrustworthy in a pre-election interim budget, an analysis of budget data since 1990-91 by Deepa S. Vaidya and K. Kanagasabapathy of the EPW Research Foundation showed.
That’s something you might want to keep in mind while going through the numbers Jaitley presents on 1 February.
Sharmadha Srinivasan and Prakhar Misra are associates, and Niranjan Rajadhyaksha is research director and senior fellow at the Mumbai-based IDFC Institute.