FISCAL CONSOLIDATION

Subject: Economics

Context: COVID-19 will significantly erode the fiscal consolidation achieved by the State governments in the past three years, the RBI said in a report.

RBI has also said that Gross Fiscal Deficit (GFD) of the States would spiral during the current fiscal.

Concept:

Fiscal consolidation implies reduction in debt accumulation and fiscal deficit. Governments undertake different policies to achieve fiscal consolidation.

• Better targeting of government subsidies and extending Direct Benefit Transfer scheme for more subsidies.
• Improving efficiency of tax administration by eliminating evasion of tax, increasing tax compliance, reducing tax avoidance, etc.
• Enhancing tax GDP ratio by widening the tax base and minimizing tax concessions and exemptions also improves tax revenues.
• Higher economic growth rate will help the government to get higher tax revenues as well. Augmentation of tax revenue is necessary to bring fiscal consolidation as there are limitations for reducing government expenditure in India.

Fiscal Responsibility and Budget Management Act

• It was enacted in August 2003.
• It aims to make the Central government responsible for ensuring inter-generational equity in fiscal management and long-term macro-economic stability.
• The Act envisages the setting of limits on the Central government’s debt and deficits.
• It aims to limit the fiscal deficit to 3% of the GDP.
• To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws.
• The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.
• It also mandates greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework.
• The Budget of the Union government includes a Medium Term Fiscal Policy Statement that specifies the annual revenue and fiscal deficit goals over a three-year horizon.
• The rules for implementing the Act were notified in July 2004. The rules were amended in 2018, and most recently to the setting of a target of 3.1% for March 2023.
• The NK Singh committee (set up in 2016) recommended that the government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020 cut it to 2.8% in 2020-21 and to 2.5% by 2023.

Escape Clause:

• Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing certain grounds. They are ,
• National security, war
• National calamity
• Collapse of agriculture
• Structural reforms
• Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.
• The lockdown could cause severe contraction in economic output and the COVID-19 pandemic could be considered as a national calamity.
• Also, the government has already made the use of escape clause this year.