On the face of it the state of government finances gives room for optimism. Helped by the robust and sustained economic growth, tax collections both by the Centre and the States have been buoyant. For the third year in a row, according to some early forecasts, the GDP is expected to grow by 9 per cent during 2007-08. The average annual growth in central tax revenue has been at a healthy 20 per cent. As a proportion of GDP, central tax revenue has increased from 8.2 per cent in 2001-02 to 11.36 per cent during 2006-07 and is expected to touch 12 per cent this year. The buoyancy in direct taxes has been particularly impressive, the annual average growth rate being 26.6 per cent since 2001-02. Both corporate tax and personal income tax have registered a phenomenal growth of 31.4 per cent and 20.6 per cent respectively. In what is seen as a significant development that brings India close to the pattern in developed countries, the share of direct taxes has drawn level with that of indirect taxes. Five years ago direct taxes accounted for 35 per cent of the central tax revenue. By 2006-07 this share had climbed to 50 per cent. Both personal income tax and corporate tax have been growing at a fast clip this year.

The higher tax collections have helped the Centre and the States to adhere to the norms set under the fiscal responsibility legislation. According to the Economic Outlook for 2007-08, the aggregate fiscal deficit of the Centre and the States, estimated at 6.3 per cent of the GDP for 2006-07, is likely to be lower at 5.2 per cent this year. While the fiscal deficit of the Central government is estimated at 3.3 per cent for 2007-08, the aggregate fiscal deficit of the States has already dropped below the target of 3.0 per cent set for 2008-09. There are, however, a few important caveats that need to be entered in evaluating the generally bright picture on fiscal consolidation. While the States have actually been reporting a marginal revenue surplus, the Centre has found it very difficult to prune down the revenue deficit even at a time when economic growth is at its peak. Whatever consolidation has occurred is due to tax buoyancy and not to a curtailment of non-productive expenditure. Besides, the government has assumed substantial off-budget liabilities under oil bonds, fertiliser subsidy and so on — they are estimated to add another 2 percentage points to the reported revenue and fiscal deficits. Also looming on the horizon is the Sixth Pay Commission report, which could increase the expenditures of the Centre and the States.