The Finance Commission is set up under Article 280 of the Indian Constitution once in five years (earlier if necessary) to make recommendations to the President regarding (a) the net proceeds of the taxes which are or may be required to be divided between the Union and the States and the respective shares of the States and (b) grants in aid of revenues of States and sums to be paid to States in need of assistance under Article 275.

A special clause

The Thirteenth Finance Commission was set up by Presidential Order issued on August 25, 2008. It is to submit its report by October 31, 2009, covering the five yearperiod from April 1, 2010.

Apart from the normal terms of reference the following unusual and special clause was added.

“Having regard to the need to bring the liabilities of the Central Government on account of oil, food and fertilizer bonds into fiscal accounting and the impact of various other obligations of the Central Government on the deficit targets the Commission may review the road map for fiscal adjustments and suggest a suitably revised road map with a view to maintaining the gains of fiscal consolidation through 2010 to 2015.”

The unusual task set for the Commission has become all the more difficult and onerous now after the fiscal stimulus packages. The final budget for 2009-10 reveals a grim picture with a quantum jump in budget deficits and a wide breach of the Financial Responsibility and Budget Management Act, 2003, (FRBM Act).

Further deterioration is on the cards when the impact of the Finance Commission’s recommendations on transfer of funds to the States is known and the special bonds for oil, fertilizer and food subsidies are brought within fiscal accounting.

It is interesting to note that even before the flagrant breach of statutory fiscal targets as highlighted in the latest budget, the Finance Commission had been given the special task of suggesting a revised road map of fiscal adjustments to aid fiscal consolidation through 2010-15. Apparently, the implementation of the FRBM Act, even prior to the fiscal stimulus, was flawed, placing overriding priority on achieving numerical targets instead of addressing the basic underlying fiscal issues.

Spending reform

This was tacitly acknowledged in the Medium Term Fiscal Policy Statement (MTFP) submitted with the budget which noted that the fiscal consolidation during 2004-08 was primarily revenue driven (revenue buoyancy). The following conclusion of MTPF is significant:

“The focus now should also be on expenditure reform in order to make the fiscal consolidation process sustainable and bring intergovernmental equity in fiscal management”.

Recognition of this weakness in approach to the FRBM Act is welcome. What is a matter of concern is the lack of urgency and hint of any action in the latest budget even to make a beginning on expenditure reform.

The budget speech merely reiterates that institutional reforms have to be initiated during the current year itself covering all aspects of the budget.

The government seems to be waiting for the recommendations of the Finance Commission before starting any action on reform. There is virtually no reform oriented road map.

This throws enormous responsibility on the Commission and highlights the complexity and difficulty of the task entrusted to it bearing in mind the constraints of time and expertise.

Major areas for action

If the road map for fiscal consolidation is to serve as a practical tool it should address the major issues of public expenditure vide a few examples indicated here.

Identification of problem areas for reform on the expenditure side, suggestions for practical steps of reform and time bound action plan. A few examples can be cited.

Major subsidies for oil, food and fertilizers, postal subsidy, subsidy of railway fares by freight and hidden subsidies due to inadequate recovery of user charges for many services provided by the government.

The reform steps have to deal with policy and cost reduction through operational efficiencies.

Review of all ongoing schemes, projects and activities to weed out non-priority and unproductive items. Zero base budgeting was introduced in the 1980s but seems to have remained in limbo.

Reducing the burden of public sector undertakings on the budget through larger generation of internal resources and closing down chronic non-viable units.

Providing for priority expenditure hitherto neglected. Ensuring effective monitoring of the huge expenditure to ensure targeted results and accountability. Improvement in project formulation and implementation especially large infrastructure projects under public private participation.

The crucial test of the road map will be the reliability and coverage of the data and projections for the medium-term. These should reflect the impact of the expenditure reforms to be suggested by the Commission.

Revenue concerns

The focus of this article is on expenditure as it has been a neglected area. The Commission will no doubt address all the revenue concerns in drawing up a road map. These include tax exemptions which are better brought under control by treating them as tax expenditure, undeclared income and efficiency in collection.

It should draw up a Code of Fiscal Conduct to serve as the guide for implementing the FRBM Act for sustainable fiscal consolidation.

The Commission can also suggest a means of assessing fiscal performance of the Central and State governments like the Fiscal Responsibility Index based on parameters in the Fiscal Code.

It can recommend a special mechanism for monitoring the implementation of the fiscal road map, for instance a cell under the Prime Minister, and quarterly progress reports to impart a sense of urgency to the fiscal reform.

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