Abstract
M. Govinda Rao’s book Studies in Indian Public Finance is the focus of the current review. The book covers a variety of themes in nine chapters. The introductory chapter presents an overview of studies in public finance in India, and the next one captures the debate around two schools of thought—public finance and public choice. Evolving fiscal structure of India is the subject matter of the next three chapters. Macroeconomics of Indian public finance, that is, dealing with deficits and debts, is the subject matter of the sixth chapter. Chapters 7 and 8 are devoted to an understanding of fiscal federalism and intergovernmental transfers in India. The final chapter deals with Indian public finance during a pandemic.
The book’s appeal lies, particularly, in its potential to generate a conversation around the course of public finance and fiscal policy in developing economies. Select issues of contemporary significance discussed in the book are considered in this review.
On Taxation and Redistribution
Taxation as a revenue instrument and/or a tool for redistribution, as articulated in various sections of the book, needs some deliberation. Rao justifies governments’ fiscal action for poverty alleviation through the expenditure side of the budget and lays emphasis on health and education expenditure. He dissuades against managing inequality through progressive taxes. Rao mentions that the role of direct tax, for revenue and redistribution, is circumscribed by the tax handle of the economy (due to limited formal sector activity) as well as political economy aspects (non-levy of agricultural income tax is cited as an example).
Rao also emphasizes the need for considering the distortionary effects of taxes by referring to the optimal tax literature of James Mirrlees. However, the validity of basic assumptions of optimal tax theory in the context of lower-middle income countries has not been established. Diamond and Saez (2011) call for a revisionism of optimal tax theory and demonstrate that there is a case for progressive taxes. Recent studies (see Saez et al., 2012; Zidar, 2019 for details) in the field do not unambiguously suggest a flat tax structure. A careful scrutiny of random and non-random factors affecting income, character of income distribution as well as tax elasticities of real economic behaviour in lower-middle income countries would be necessary for defining their tax structure.
Rao raises the issue of tax evasion and avoidance. While highlighting the issue of ‘termites of the state quoting Tanzi, he mentions: ‘The termites emerge from the tax abuse through wilful avoidance and evasion of the tax facilitated by technological advances through digital and e-commerce companies, swift financial transactions escaping the scrutiny of the regulators and emergence of multiple low tax jurisdictions and tax havens” (p. 3). He expresses concern over the fact that a majority of tax litigations are decided in favour of the taxpayers in tribunals or courts while citing the report of CAG 2018 on direct taxes. Rao has also dealt with the issue of tax avoidance, profit erosion and transfer pricing of multinational companies. He writes:
High mobility of capital and capital embodied in labour and increased international competition to attract them have dented the ability of the tax system to bring about significant reduction in inequality. The implicit incentive to evade taxes when the marginal tax rates are high has led to levying the taxes at reduced marginal tax rates. (p. 5)
However, more the evaders manage to escape the law, more the peak rates get dictated by them. Tax evasion or avoidance are not ‘immutable parameters’. The efficacy of regulatory bodies in lower-middle income countries in managing transnational and newer forms of business has been a matter of concern. Here, Rao’s suggestions for strengthening the arm of tax administration and aggressively dealing with many international disputes through economic diplomacy and tax coordination are of significance.
Rao highlights that poor countries are able to provide expenditure goods more effectively than devising tax exemptions. Nonetheless, political budget cycles, leakages and populism do affect redistribution through expenditure. Technology, cash transfers, public account reforms and social audits can aid in spending measures. Similar innovations have been and should be a constant feature of our tax and revenue organ as well. Stiglitz (2012) points out that unequal economic power translates into political power, leading to underfunding of expenditure programmes meant for poor and design of tax structures favouring a few. Recent work fiscal contracts highlight the expectations of the growing middle-class taxpayers in developing economies (see Bird & Zolt, 2015). The fiscal action for redistribution, therefore, has to consider the complex nexus of growth, inequality and poverty, on the one hand, and the underlying links between revenue and expenditure side of the budget, which are not direct and obvious, on the other.
On Fiscal Prudence: From Rules to Watchdog(s)
Rao proposes an Independent Fiscal Institution (IFI), a fiscal council for India. The Thirteenth and Fourteenth Finance Commission (in which Rao was a member) as well as FRBM Review Committee have made such recommendations albeit with variations in the institutional structure and functions. Rao recommends a council on the following grounds. He espouses ‘orthodox position’ on deficit and debt and observes that the initial positive outcome of the rule-based fiscal policy regime after the implementation of Fiscal Responsibility and Budget Management (FRBM) Act, 2003, in India cannot be entangled from other developments, namely better economic environment, introduction of the Tax Information Network (TIN) and widening of the service tax base. Moreover, data issues camouflage the extent of the problem. Rao cites widescale fabrication and manipulation of figures inter alia through repeated shifting of debts, usage of new concepts like ‘effective revenue deficit’ and creative accounting through off-budget liabilities, advance collection of taxes, unplanned adjustments through pruning of capital expenditure and postponement of bills. The council is expected to ensure adherence to rules in a transparent manner while resolving data constraints and can also serve as a much-needed platform for neutral assessment of the desirability, viability and transparency of new programmes, policies and schemes.
Regarding its form, the FRBM Review Committee had recommended that the Finance Ministry will act as the nodal authority for appointment and supervision of the council. The Fourteenth Finance Commission went a step ahead and recommended the setting up of an independent council by the Parliament and the notification of the same through an amendment of the FRBM Act. Rao adds that the fiscal council will be an independent body. Its ‘independence’, unlike that of the central bank, will be with reference to only operational autonomy necessary for non-partisanship approach in performing the council’s tasks and would not imply legal separation. He also clarifies that the fiscal council will have the oversight objective and its functions will be different from those of the auditor (Comptroller and Auditor General). The fiscal council would play an ex ante role of planning and policy formulation through largely a macroeconomic approach, whereas the focus of the audit is ex post evaluations based on a legal or microeconomic approach.
In this context, issues of fiscal prudence and IFI require deliberation. First, availability of credible information is a prerequisite for forming an IFI. Assessment of the nature and extent of fiscal profligacy and the need for and role of an IFI necessitate reliable data. Second, the mandate and form of IFI would depend on fiscal questions that it is supposed to handle. Different institutional mechanisms may work differently depending on the fiscal issue under scanner inter alia settled knowledge/ambiguities, the horizon (time and space context) and the political economy concerns. The performance of IFIs elsewhere has not been uniform. Rao admits, ‘it is important to note that even as the fiscal council can help to improve fiscal performance, it cannot be a “silver bullet.” … Safeguarding the independence of the IFI is a difficult challenge particularly as the government may find the institution inconvenient” (p. 149). He cites the case of Hungary, where political interferences made the IFI redundant. As Datta et al. (2023) point out, the genesis of the problem lies in the very concept of money bill in India. Fiscal institution building is important, but the constitutional provisions need prior scrutiny as a part of that exercise.
Changing Contours of the Discipline
It is worth reckoning that a large part of intellectual effort, in recent decades, has gone into public choice, public budget accounting and management and allied fields. In his book, apart from a chapter on public finance and public choice, Rao makes only some passing comments on the shifting emphasis of public finance as a discipline. He only hints at the changing boundaries and focus of the subject while mentioning that ‘Technological changes have narrowed the scope of public provision, expanded the scope of co-provision with the private sector (through public-private partnerships) and regulation requiring different capacity in terms of knowledge and skills by governments’ (pp. 4-5). There is limited discussion on issues such as international tax coordination and expenditure side of the budget, particularly pension reforms and social insurance, which assume significance in developing economies. One would have liked to see a fair treatment of these newer topics in this volume.
Overall, the book gathers up Rao’s earlier works on many issues. An account of recent tax reforms and contemporary fiscal policy issues is a useful addition in the volume. It is largely free of jargon and accessible to students, practitioners and other readers interested in this field.