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Saturday, February 1, 2003

The AP state government has recently released a document titled “ Annual Fiscal Framework 2003-04” (AFF). This document is ostensibly intended to serve as a basis for formulating the budget after considering the feedback received from the public. Without resorting to financial mumbo jumbo, I would like to draw your attention to the real issues, which get obfuscated by the mirages the government is trying to create.

Let us say you are running a business or household. How would you go about budgeting your income? First you will have an idea of your needs and priorities, after which you arrive at a projected expenditure and depending upon the surplus or deficit of expenditure over income, you will plan for either savings/investments or borrowing. If you have to borrow, you will also think twice about the need for your borrowing and for what purpose those funds are going to be used and your ability to repay.

Contrast that with what happens in our government. The state’s revenue receipts (income), which are projected to be approximately Rs 27964 cr for the fiscal year 2003-04, will be hardly enough to meet the revenue expenditure, projected to be Rs 30372 cr. The state is actually borrowing to bridge the gap between revenue receipts and revenue expenditure - i.e. you have to borrow in order to meet your running expenditure comprising of salaries, pensions, interest and subsidies. In fact, the state’s own revenues (excluding central grants) are not even enough to pay for wages, pensions and interest on loans.

The state’s AFF shows that only 4261 cr, which is less than 10 % of the total expenditure of 42000 cr is earmarked for capital expenditure. Capital expenditure is what creates capital assets, which will spur economic growth in the future. On the other hand the state’s annual borrowing for the year 2003-04 is projected to be in the range of 7500 cr raising the debt burden to about 57000 crores!

So what are the real issues behind this whole smoke and mirrors and exercise? The reality is that in the existing framework, there is very little room for maneuvering and the state (and for that matter the union also) is fast spiraling towards a classic debt trap, where you borrow just to service the old debt. This is a vicious cycle into which we cannot afford to fall. In the current centralized setup, where the bulk of the expenditure is going towards wages, how can the government control spending, short of retrenching staff? How does the government increase its revenues short of fleecing the state’s population? Will the people of the state be willing to burden additional taxes?

The answer to all these questions lie in true decentralization. While the economic dimensions of the crisis are well understood, it is often not recognized that this is largely a governance crisis. Fiscal deficits can only be addressed by significant increase in revenues or reduction in costs. Revenues can be raised painlessly only by very high, sustained growth rates. As our infrastructure is weak and inadequate, and as the productive potential of the bulk of the population is shackled on account of low levels of literacy and poor health care, there cannot be rapid growth on sustained basis.

The more painful way of increasing revenues is higher taxation. As much of the tax revenue and public expenditure do not result in realizable public goods and services, citizens resist and evade high taxation. With rampant corruption in a centralized governance structure, there cannot be tax compliance in high-tax regime, nor is high taxation politically feasible in a liberal democracy without tangible improvement in public services and community assets.

There are two ways of reducing public expenditure – reduction of wage bill and elimination of subsidies. Savings through wage reduction or retrenchment of employees are very hard to accomplish. In a centralized governance structure, no government has the power or will to antagonise the vast army of employees. In any case, the problems with public employment are not the excessive number of workers and high wages, but the wrong deployment and lack of accountability. We have too many support staff and too few teachers and health workers, and where public employment is in the right sectors, there is hardly any effective delivery of services. Subsidies cannot be eliminated unless the beneficiaries are satisfied that the money so saved is improving the quality of their lives in some other manner. In centralized structures where such a link is not visible, de-subsidization is difficult. All these factors make our fiscal crisis a highly intractable problem in our centralized governance model.

This fiscal crisis can be addressed only through effective and far-reaching decentralization of power and citizen-centered governance. We accept tax burden voluntarily only when we see the link between the taxes we pay and the public services we receive locally. Finally the vast army of employees can be redeployed from areas where they are redundant to sectors where they are needed only in local governance.

Therefore the truth is that unless there is a fundamental structural change in the governance process, accompanied by true decentralization and massive investments in infrastructure, health and education, the state’s economy is not going to improve. Whatever else the state might attempt to do will at best be a smoke and mirrors exercise and is nothing short of a farce.