When income growth slows down in an economy, so does the growth of tax revenue within the given tax regime. Since the government has certain expenditure obligations, to meet these obligations it has to either impose additional taxes or expand its fiscal deficit.
Enlarging the fiscal deficit in such a situation, which was the typical response everywhere under post-war capitalist dirigisme, has the additional effect of ensuring that one component of demand, namely, that arising from government spending, remains unchanged, even as the economy is otherwise slowing down, thereby checking this slowdown itself. This was referred to in economics textbooks as the economy’s having an “automatic stabiliser”: government expenditure under these circumstances acted as an “automatic stabiliser” and served to restrict the downturn.
All this was under the earlier dirigiste regime. Under neo-liberalism, however, matters are completely different. When tax revenue collections under the neo-liberal regime slow down because of the slowing down of the economy, the government can neither impose additional taxes on the capitalists (imposing additional taxes on the working people to finance its expenditure does not add to aggregate demand and hence does nothing to arrest the downturn), nor expand the fiscal deficit. This is because both these measures will be opposed by international finance capital which would start a capital flight within the liberalised regime, causing a hurtful financial crisis.
In fact, since virtually all countries with the exception of the United States have adopted laws restricting their fiscal deficits to 3% of gross domestic product or GDP (in India the Centre and the states have each a limit of 3%), with the slowing down of the economy there has to be a slowing down not only in the growth of the tax revenue but also in the fiscal deficit and hence in the total public expenditure.
Within a neo-liberal regime, therefore, public expenditure does not act as an automatic stabiliser, as it had done earlier. When the growth of the economy slows down, so does the growth of public expenditure, thereby further contributing to the slowing down of the economy. This is sometimes referred to as public expenditure being “pro-cyclical” rather than “anti-cyclical” (which is somewhat misleading because it suggests that the crisis is always a cyclical crisis).
This is the crux of the perversity of the fiscal regime under neo-liberalism, namely, that it removes what otherwise would have been a bulwark against the slowing down of the economy, by enjoining so-called “fiscal responsibility” upon all governments; it thereby compounds the process of slowing down.
Against this basic background, governments, of course, resort to all manner of subterfuges to wriggle out of the predicament in which they find themselves. We are currently witnessing in India two such efforts. One consists in the Central government’s squeezing the states, passing on the burden of its own fiscal crisis on to the shoulders of the state governments, even violating its constitutional obligations; the other is its mad rush to privatise the public sector, in an utterly reprehensible short-sighted bid to get some money within the constraints of a neo-liberal economy. Let us look at each of these seriatim.
One way in which the Centre is trying to squeeze the states, by off-loading a part of defence expenditure on to their shoulders, has already been discussed in this column. Defence is exclusively in the “Union List” of the Seventh Schedule of the Constitution, which means that the Centre has exclusive responsibility to spend on defence and to decide on all defence matters. But the Central government has asked the 15th Finance Commission to deduct defence expenditure from the divisible pool, which means that the state governments are being asked to bear a part of this burden, even though the constitutional arrangement with regard to the Seventh Schedule remains unchanged and all decisions regarding defence will continue to be taken by the Centre alone.
But this at least remains a threat until now. In another area, however, the Centre has already squeezed the states, and this relates to GST compensation. When the Goods and Services Tax (GST) was introduced, in order to persuade the states to agree to it, the Centre had promised to compensate them for a period of five years for any revenue loss that they may face. The revenue loss was to be calculated by taking a base revenue level and applying to it a 14% annual rate of growth in nominal terms; whatever was the shortfall from the revenue estimated in this manner was to be compensated by the Central government. This was to happen every two months and a Compensation Cess Fund was set up for this purpose into which the revenue from certain taxes was supposed to go.
But the Central government has stopped making any such compensation payments August onward. Its argument is that there is not enough money in the Compensation Cess Fund. The states, however, point out, very correctly, that the promise to pay compensation to the state governments was not linked in any way to the size of the Compensation Fund; it was a stipulation contained in the Constitution Amendment Bill. If there is no money in the Compensation Fund, or not enough, then the Centre should pay compensation out of its own share of the GST revenue.
It is well known that there has been a substantial revenue shortfall on account of the GST, with the monthly revenue falling below Rs.1 lakh crore for most months of the current financial year. This shortfall is both because of the flawed nature of GST itself and also because of the slowing down of the economy. The fact that GST collections for November, which falls within the festive season, were marginally in excess of Rs.1 lakh crore, is because GST revenue is closely related to the magnitude of business turnover, and hence to the level of activity in the economy.
Faced with this revenue loss, the Central government is squeezing the states, going back on its own promise of making good their revenue short-fall, in a bid to keep its own head above the water. In addition, out of the Integrated Goods and Services Tax (IGST) collections, which are to be shared between the Centre and states, the Centre has kept the lion’s share for itself.
Because of this double squeeze, states are in utterly dire straits. Since much of the welfare expenditure going toward the poor comes out of state revenues, a shrinking of such revenues has a direct effect on welfare expenditure, including on healthcare, and education.
All this could have been avoided if the Central government had not squeezed the states, but had stuck to its promise of making good the revenue shortfall for the states, and enlarged the fiscal deficit for this purpose (the fact that it never had the gumption to tax capitalists is amply shown by its recent measure to actually give them tax concessions). An enlargement of the fiscal deficit would have boosted aggregate demand and hence employment and output, without having any inflationary consequences.
True, inflation in the economy is creeping up of late, but that has to do with specific sectors (onions being one example) and requires specific measures of supply management (through the use of the Public Distribution System); raising the fiscal deficit in such a situation would scarcely have led to an acceleration of inflation, once such specific supply management measures were in place.
But such an enlargement of the fiscal deficit would be unacceptable to international finance capital; and the Narendra Modi government, with all its bluster against hapless minorities within the country, and with all its pretensions to machismo, has no stomach for standing up to finance capital. It would rather squeeze state governments, it would rather see a cut in welfare expenditure directed towards the poor, than take measures frowned upon by international finance capital. It is a mere conduit through which the dictates of finance capital are made to impinge on the economy, and the perversity of the neo-liberal regime makes itself felt.