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Fiscal Problem in West Bengal

The fiscal picture in West Bengal is characterised by a high debt-gross state domestic product ratio (the second highest in the country among the non-special category states) and a low own tax revenue-GSDP ratio (the lowest in the country). This paper attempts to understand the reasons for these twin features which underlie the fiscal stress in the state.

SPECIAL ARTICLE

Fiscal Problem in West Bengal

Towards an Explanation

Subhanil Chowdhury, Zico Dasgupta

The fiscal picture in West Bengal is characterised by a high debt-gross state domestic product ratio (the second highest in the country among the non-special category states) and a low own tax revenue-GSDP ratio (the lowest in the country). This paper attempts to understand the reasons for these twin features which underlie the fiscal stress in the state.

Non-incriminating thanks are due to C P Chandrasekhar, who gave valuable comments on an earlier draft of this paper.

Subhanil Chowdhury (subhanilc@gmail.com) is with the Institute of Development Studies, Kolkata. Zico Dasgupta (zico.dasgupta@gmail.com) is a research scholar at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

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T
he fiscal situation of West Bengal (WB) is characterised by the fact that it has a debt-gross state domestic product (GSDP) ratio of 42.5% (2008-09), which is the second highest amongst the non-special category states and an own tax revenue (OTR)-GSDP ratio of 4.1%, which is the lowest within the non-special category states in 2008-09. The high debt-GSDP ratio along with a low OTR-GSDP ratio in WB, compared to other states, is a cause of concern for the state. What explains such high debt-GSDP ratio and low OTR-GSDP ratio of WB? This paper seeks an answer to this question. The paper is divided into two main sections, the first deals with the problem of the high debt-GSDP ratio and the second with the low OTR-GSDP ratio in the state.

1 The Problem of a High Debt-GSDP Ratio in WB

The debt-GSDP ratio for WB and all states is shown in Figure 1. Three issues become immediately evident from Figure 1. First, the debt-GSDP ratio for all the states as well as WB started to increase from 1997-98. Second, the debt-GSDP ratio for all the states started to decrease from 2003-04, while that of WB started to decrease from 2005-06. Third, the debt-GSDP ratio of WB is higher than that of all the states taken together and increased at a much faster rate than the states between

Figure 1: Debt-GSDP Ratio for WB and All States (in %)

Debt Ratio

50 40 30 20All states West Bengal

1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 200808 09 Source: State Finances: A Study of Budgets, Reserve Bank of India (RBI), various issues.

1997-98 and 2005-06. The literature has mainly focused on the last point while discussing the problem of the debt burden of WB. But it should be noted that the debt burden of all the states in India increased since the late 1990s and only started to fall from 2004. The explanation for the high debt-GSDP ratio for WB has to be located in the context of the movement of the ratio for all the states. Therefore, we first try and locate the reasons for the increase in the debt-GSDP ratio for all the states.

Explanation for Increase in Debt-GSDP Ratio for All States

In order to understand the movement of the debt-GSDP ratio for all the states, we first need to understand some of the features of state government finances in India. One of the key features

57 of the federal structure of the Indian economy has been that resources are mainly concentrated in the hands of the centre, with the states having limited powers to collect taxes and mobilise resources, while undertaking the bulk of the development expenditure in the country. This asymmetry in centrestate relations leads to the dependence of the state governments on the transfer of adequate resources from the centre in order to carry out their expenditure responsibilities. Against this backdrop, the following features of state government finances can be ascertained:

  • (1) Partial Exogeneity of Revenue Receipts: The revenue receipts of the states, as we know, consist of not only its own revenue receipts, but also revenue transfer from the centre in the form of grants and shares in the central taxes. Since the level of revenue transfers remains outside the purview of the states’ own economic policies, the determination of total revenue receipts also becomes partially exogenous to the state government policies.
  • (2) Exogenously Determined Interest Rate: The interest rate of an economy is determined by the actions of its central bank depending on the monetary policy of the government. In India, it is determined by the Reseve Bank of India’s (RBI) credit and monetary policy. For the states in particular, the centre has the constitutional power to determine both the extent and the terms of borrowing by the states from all sources. Thus, the interest rate is assumed to be determined exogenous to state government’s policymaking.
  • Given the fact that revenue receipts and the rate of interest are exogenous (partly exogenous in case of revenue receipt) for the states, let us now analyse the impact of economic liberalisation and other exogenous shocks on these variables. One of the characteristic features of the neo-liberal regime has been the objective of reducing the fi scal defi cit of the central government and pursuing a policy of “sound finance”. This was required, in the neo-liberal perception, in order to maintain “macroeconomic stability”. This proposition was based on a theoretical framework which has been argued to be logically fl awed (Chandrasekhar and Ghosh 2002; Patnaik 2003; Das 2004 and Rakshit 2005). However, one of the raison d’êtres of such a policy came from the advent of financial liberalisation and the inflow of international finance capital. In order to maintain the inflow of fi nance capital or even to avoid its outflow, a fi nancially liberalised economy needs to abide by the preferences of fi nance. And finance capital prefers the pursuit of a policy of “sound finance”, entailing the curtailment of the fi scal deficit as a proportion of the gross domestic product (GDP) (Patnaik 2006).

    This curtailment of the fi scal deficit of the centre has consequences for state finances in the following manner. First, with liberalisation there was also a rise in interest payments and a fall in the tax revenues of the centre till the early years of 2000s. While on the one hand, the fall in the tax-GDP ratio of the centre till the early years of the last decade was entailed by a fall in the tariff rate and excise duties as a logical corollary of trade liberalisation, on the other hand, the rise in the interest rate (leading to a rise in the interest payment of the centre) was primarily on account of financial liberalisation (Chandrasekhar and Ghosh 2002). This inherent contradiction between the objective of ensuring “fiscal balance”, and, ceteris paribus, the tendency of the fi scal deficit to rise (through a rise in the interest rate and interest payments), was “resolved” partially by the centre by cutting back its development and capital expenditures (ibid). In addition, the centre resorted to another mechanism: namely, that of reducing transfers to the states in order to manage its own budget.

    The necessity to reduce transfers to the states in the relevant time period, however, did arise not only from the requirement of the centre to manage its own budget for pursuing a “sound finance” policy; it was also an attempt to push the states towards a financial crunch and subsequently, impose a neoliberal agenda on the latter. It is particularly in this context, that state government finances need to be analysed. Let us fi rst examine the issue of an increase in interest rates in the postliberalisation period on state fi nances.

    Interest Payments: It has already been stated that with the policies of liberalisation the rate of interest in the country has a tendency to rise. Moreover, as is evident from Figure 2, the rate of interest paid by the state governments is higher than that paid by the central government. It is also the case that the rate of interest charged by the centre from the states on central loans and the National Small Savings Fund (NSSF) loans is much higher than the average rate of interest paid by the centre and state governments.

    Figure 2: Effective Interest Rate of the Centre and State Governments and the Rate of Interest Charged on Central Government and NSSF Loans from the States (in percentage)

    5 7 9 11 13 States’ interest rate Centres’ interest rate Interest rate on NSSF and central loans

    1981-82 1984-85 1987-88 1990-91 1993-94 1996-97 1999-2000 2002-03 2005-06 2008-09 Source: Handbook of Statistics of Indian Economy, various issues, RBI.

    A condition for the debt-GDP ratio to rise is that the rate of interest should be greater than the growth rate of GDP. With the rate of interest for the states rising, it became greater than the growth rate of GSDP of the states, from the late 1990s to the initial years of the 2000s, leading to a rise in the overall debt-GSDP ratio. Additionally, the implementation of the recommendations of the Fifth Pay Commission, which was de facto an exogenous shock to the state government finances (ibid 2002) increased the debt burden of the states. Keeping the interest rate over and above the growth rate of the GSDP was particularly the centre’s policy, which was ensured by keeping the interest rate on NSSF and central loans sufficiently high. In a situation where the states were already stressed with a debt burden, the Twelfth Finance Commission (TFC) emerged by linking debt-relief with the conditionality of implementing the Fiscal Responsibility and Budget Management (FRBM) Act, and hence, imposing a neo-liberal agenda of “sound finance” on the states. Thus, the rise in the debt-GSDP ratio of the states in the relevant time period was an exogenous shock to state finances, brought about by the centre’s policy.

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    The subsequent decline in the interest rate and debt-GSDP ratio was made possible as the states were de facto forced to accept the conditional debt swap scheme of the TFC by implementing the FRBM Act. Such a decline in both the interest rate and debt-GDP ratio in the recent period, in turn, led to the decline in the interest payments of the states as a proportion of GDP. Thus, both the rise and the fall in the interest payments were led by the centre’s policies, and hence, remained outside the purview of the state government policymaking.

    Let us now see the impact of central government policies on the revenue receipts of the states.

    Revenue Receipts: While the devolution of grants comes under the expenditure side of the centre’s budget, the share in central tax involves parting with a portion of the tax revenues. Thus, while any reduction in the devolution of grants would reduce the centre’s expenditures, any decline in the states’ share in central tax revenue would raise, ceteris paribus, the net revenue receipts retained by the centre.1 As is evident from Figure 3, the fall in the revenue receipts of the states from 1992 to 1999 was led primarily by the fall in revenue transfers from the centre (as percentages of GDP).

    Figure 3: Revenue Transfers, OTR and Revenue Receipts of the States as a Percentage of GDP (1982-2009)

    7 16

    Revenue transfers

    4

    1980-81 1984-85 1988-89 1992-93 1996-97 2000-01 2004-05 2008-09 Total Revenue Receipts of the states as % of GDP is plotted along the secondary axis. Source: Same as Figure 1.

    2

    Figure 4: Gross Tax-GDP Ratio of Centre and Revenue Transfer to States as a Percentage of GDP

    Revenue Receipt as percentage of GDP OTR and Revenue Transfers as percentageof GDP 8 12 6 4 Revenue receipts OTR
    3.5 4 4.5 5 5.5 6 8 9 10 11 12 Gross tax Transfers

    1980-81 1984-85 1988-89 1992-93 1996-97 2000-01 2004-05 2008-09 The revenue transfer to state-GDP ratio is plotted in the secondary axis. Source: Same as Figure 1.

    Such a decline was particularly led by the centre’s attempt to manage its own budget against the backdrop of its falling tax-GDP ratio in the relevant time period. The later rise in the revenue receipts of the states was due to the rise in both the revenue transfers and the OTR of the states. The rise in the former, particularly after 1999, was possible as the revenue receipts of the centre increased during this time period. This

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    congruent movement of the centre’s tax-GDP ratio and the revenue transfer to states are shown in Figure 4.

    While the decline in the revenue transfers has adversely affected the revenue receipts in the relevant time period, the very nature of revenue transfers (in terms of proliferation of central sector schemes) and the retreat of the central government from undertaking capital projects have adversely affected OTR of the states. In the neo-liberal era the proliferation of CSS comes with conditions, where the states are asked to reduce some of their resource mobilisation instruments in the name of parity across states and creating an investor-friendly climate. This has an adverse effect on the revenue receipts of the states through a reduction in the OTR. With the withdrawal of the centre from undertaking investment in the states, they are asked to invite private capital from the market. Private capital in search of higher returns demands more and more tax concessions from the various state governments. The cut-throat competition that emerges among the states to entice private capital by providing ever-increasing tax concessions negatively affects the revenue receipts of the states.

    However, in spite of such adverse effect of centre’s policies on OTR of the states, the latter has actually increased over the years (Issac and Ramakumar 2006). Thus, if anything has led to the deterioration of the revenue receipts of the states in the relevant time period, it was primarily the decline in the revenue transfers from the centre. With the revenue receipts of the states falling from the late 1990s and the exogenous expenditure shock of the Fifth Pay Commission, the states had to borrow from the market, which was reflected in a higher debt-GSDP ratio. With an increase in the revenue transfers such borrowing was reduced, thereby reducing the debt-GSDP ratio.

    From the above discussion it is obvious that the problem of debt of the states has been influenced to a significant extent by the policies adopted by the central government. However, it is also a fact that the debt-GSDP ratio of WB has been signifi cantly higher than all the states taken together. We now turn to the issue of the high debt-GSDP ratio of WB in particular.

    Explaining the High Debt-GSDP Ratio in WB

    While the debt ratio has increased more or less for the states (including WB) from 1998-99 onwards, the rate of increase in debt ratio has been much sharper for WB than the states as a whole. This, however, leads one to address the following questions: first, why did the debt ratio increase for WB from the late 1990s till the early years of the 2000s, and, second, why has the rate of increase been much higher in the case of WB than that for all the states as a whole?

    Condition of Debt-Sustainability

    The Domar condition for debt-sustainability requires that the debt-GDP ratio of the government does not rise over time.2 This can be written as

    ǻD

    ș”g, where ș= and

    D

    ǻY

    g = ,

    Y where D=debt stock and Y=GDP Now, by defi nition, F = ǻD and P = F – i.D, where F=Fiscal Defi cit, P=Primary Deficit and i=rate of interest P = F – i.D = ǻD – i.D Ÿ P = (ș – i) D ...(i) From (i) it implies that if ș” g then

    P D

    ” (g – i). Y Y In other words, the debt-sustainability condition implies that the primary defi cit-GDP ratio must be less than the product of the difference between the growth rate and rate of interest and the debt-GDP ratio. We plot the P and (g – i). D for WB in Figure 5.

    YY

    Figure 5: Debt-Sustainability Condition for WB

    0.06

    0.05 0.03 0.01 0 -0.01 1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 2008-08 09 Primary deficit ratio (g – i).D/Y

    -0.03 Source: Same as Figure 1.

    From Figure 5 it is clear that the primary deficit ratio of WB increased between 1993-94 and 1999-2000 and was consistently higher than (g – i).D till 2005-06. Therefore, according to

    Y

    the debt-sustainability condition the debt-GSDP ratio of WB increased consistently till 2005-06 and has started to decline subsequently. But the question is what explains the higher primary deficit ratio and the lower (g – i).D for WB.

    Y

    The primary defi cit-GSDP ratio for WB increased sharply upto 1999-2000 as a result of an increase in the primary expenditure and a reduction in the revenue receipts during this period. Subsequently, the primary defi cit-GSDP ratio declined both as a result of a rise in revenue receipts and a fall in the primary expenditure (Figure 6).

    Figure 6: Share of Primary Deficit (PD), Primary Expenditure (PX) and Revenue Receipt (RR) in GSDP (in %) 16

    13 10 7 RR PX
    4 1 0 1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 2008-PD

    08 09 Source: Same as Figure 1.

    -2

    This rise in the primary expenditure GSDP ratio up to 2000 is a result of not only an increase in expenditure as a result of the implementation of the Fifth Pay Commission report (like other states), but also a result of an increase in development expenditure. Subsequently, however, the development expenditure-GSDP ratio of WB declined (Figure 7).

    60

    Figure7: Primary and Development Expenditures as Proportions of GSDP

    (in %) 16

    8 12 Dev PX
    4
    1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 2008
    08 09
    Source: Same as Figure 1.

    If we look at the revenue receipts of WB, then it is clear that the decline in revenue receipts from 1993-94 to 1999-2000 was led by a decline in the OTR as well as revenue transfer from the centre (like other states). But after 1999-2000, the rise in the revenue receipts was a result of both a rise in OTR and revenue transfer from the centre, with the latter clearly rising more (Figure 8).

    Figure 8: Revenue Receipt (RR), OTR and Revenue Transfers (RT) as Proportions of GSDP (in %)

    16 6

    OTR and RR as percentage of GSDPRT as percentage of GSDP4 2
    12 8 4 RR RT
    OTR
    0 0
    1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 2008
    08 09

    RT is measured in the secondary axis. Source: Same as Figure 1.

    From the above discussion it is clear that the rise in the debt-GSDP ratio for WB is because of a higher primary defi cit resulting from lower revenue receipts which is again primarily a result of low OTR, which will be discussed in details in the next section.

    While the phenomenon of rise in debt-GSDP ratio of WB is explained by a mechanism stated above, the question remains, why has WB witnessed a much sharper rise in the debt-GSDP ratio than that for the states as a whole. In order to understand this problem let us go back to the debt sustainability condition where

    P D

    ” (g – i). Y Y

    To understand why the debt-GSDP ratio of WB is higher than all states taken together, we compare pY and (g-i) for WB and all states. To assess the differences of WB with the states in the above-mentioned parameters we plot the following fi gures.

    Figure 9 (p 61) shows the difference in the primary defi cit between states and WB. It is seen that the primary defi cit of WB is much higher than the states. This is again mainly because of the revenue receipts of WB are less compared to the states. It is also interesting to note that the primary expenditure of WB was

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    higher than the states only between 1999-2000 and 2001-02, the period when the Fifth Pay Commission was implemented. For the rest of the period, the primary expenditure-GSDP ratio remained below that of the states taken together. In other words, the debt problem of WB was not due to higher expenditure, as compared to other states.

    Figure 9: Difference in the Share of Primary Deficit (PD), Primary Expenditures (PX) and Revenue Receipts (RR) in GSDP between WB and Other States (in %)

    -4 -2 0 2 4 1993-94 1995-96 1997-98 1999-2001-02 2003-04 2005-06 2007-08 2008-09 PD PX RR 1999-2000

    Source: Same as Figure 1.

    Figures 10 and 11 show the difference in growth rates and effective interest rates between WB and all states taken together. It is seen from Figure 10, that the growth rate of WB has been lower than that of the states in most of the year in the relevant time period, while Figure 11 shows that the effective rate of interest for WB has been higher than that of the states.

    From Figure 11, a question immediately arises as to why the effective rate of interest for WB is higher than that of the states. This is mainly because of the fact that the share of NSSF loans in total liabilities is the highest in WB and much higher than the states taken together (Figure 12). It is also true that the interest rate charged from NSSF and central loans is higher than the other rates of interest (Figure 4). As a result, WB is having a higher share of NSSF loans and has a higher effective rate of interest. Figure 10: Difference in Growth Rate (in %)

    9

    -3 0 3 6 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 g Linear (g)

    -6

    Source: Same as Figure 1. Figure 11: Difference in Interest Rate (in %)

    2.5

    2.0

    1.5

    1.0

    0.5

    0.0

    1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 -0.5

    Source: Same as Figure 1.

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    Figure 12: Composition of Liabilities of WB and States (2008-09, in %) 50

    40

    30

    20

    10

    0

    West Bengal States

    SDL NSSF Centre’s Loan Others Source: Same as Figure 1.

    From the above discussion it is clear that WB has a debt-GSDP ratio higher than the states is mainly because of the fact that the revenue receipts of WB is lower than the other states and the effective rate of interest is higher for WB compared to other states. The effective rate of interest for WB is higher mainly because of the composition of liabilities of WB having a higher share of NSSF loans. States have to compulsorily borrow a fi xed portion of NSSF funds that they collect. Since WB has a much higher proportion of NSSF loans, it has to borrow more from this pool. The higher interest rate on these loans in turn increases the interest burden of WB.

    It should also be noted that the TFC, in the face of the mounting debt problem of the states, proposed debt relief measures. However, these debt relief measures were attached to strict conditionalities, whereby the states had to enact the FRBM Act, the total salary bill net of interest payments should not be more than 35% of revenue expenditures and closing of all loss-making public sector units (PSUs) to be eligible for debt relief.3 Given the federal set-up of India, where the state governments are free to choose their own policies within their domains, such conditions laid down by the TFC were highly objectionable. The WB government decided not to enact the FRBM and not to follow other measures of “fi scal prudence” as proposed by the TFC. This disqualifi ed WB from availing the debt and interest reliefs from the centre due to which the debt-GSDP ratio of WB did not decline as much as all states put together.4

    Notwithstanding the rigid conditions imposed by the TFC and its non-compliance by the WB government, the issue of low revenue receipts of WB remains unresolved. We now turn to this problem in details.

    2 The Problem of Low OTR-GSDP Ratio in WB

    We have already seen that the revenue receipts of WB as a proportion of GSDP is less than all states taken together. The two major components of revenue receipts are the OTR and revenue transfers from the centre (which consists of the share of tax and grants from centre). The revenue transfer from centre as a share of GSDP for WB is less than all states taken together (Figure 13, p 62) except in 2000-01, 2001-02 and 2005-06.

    However, it is also seen from Figure 13 that the gap between the revenue transfer of WB and all states has not been very significant. Therefore, this shortfall in WB’s revenue transfer from the centre as compared with all the states cannot fully account for the revenue receipts share of GSDP falling behind that of all the states taken together.

    Figure 13: WB’s Revenue Transfers as a Share of GSDP and States’ Revenue Transfers as Share of GDP (in %)

    46WB RT States RT
    2
    1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 2008
    08 09
    Source: Same as Figure 1.

    The other major component of revenue receipts, the OTR, is significantly less than all the states taken together (share of GSDP). Figure 14: WB’s Tax-GSDP Ratio and States’ Tax-GDP Ratio (in %)

    States OTR

    6 4
    WB OTR
    2 1980-81 1983-84 1986-87 Source: Same as Figure 1. 1989-90 1992-93 1995-96 1998-99 2001-02 2004-05 2007- 200808 09

    Figure 14 shows that the OTR-GSDP ratio of WB almost moved hand in hand with the OTR-GDP for all states taken together till 1996-97. After this point, the OTR-GDP ratio of all the states increased, but that of WB continued to decline till 1999-2000. After 1999-2000 the OTR-GSDP of WB also rose but the states’ OTR-GDP ratio rose much more sharply. As a result, the OTR-GSDP ratio of WB has been signifi cantly below that of all states taken together. In fact, WB has the lowest OTR-GSDP ratio in India.

    Explaining the Low OTR-GSDP Ratio in WB

    The composition of the OTR in WB shows that the two biggest components of the total OTR of the state are commodity and services tax (CST) accounting for 78% of the total tax revenue in 2008-09 and the property and capital Transaction

    Tax (PKT) accounting for Table: Composition of Own Tax 19.9% of the total tax reve-

    Revenue for WB (in %)

    nue in 2008-09 (Table). Therefore, in order to under- Income Tax (IT) Property and Capital Transaction Commodity and Services Tax (CST)
    stand the movement of the Tax (PKT)
    OTR-GSDP ratio in the state, 1993-94 3.62 13.95 82.43
    it is sufficient to under 2008-09 2.07 Source: Same as Figure 1. 19.89 78.04

    Figure 16: PKT as a Percentage of Construction and Real Estate, etc (in %) 14

    stand the movement of the PKT and CST. Additionally, 77.4% of CST is accounted for by sales tax only in 2008-09.5 Therefore, for our analysis we mainly concentrate on PKT and sales tax to understand the movement of OTR in WB.

    According to the Indian system of fiscal federalism, the direct taxes in the form of income tax and corporation tax are mainly collected by the central government. Whatever taxes the state governments collect are mainly in the nature of indirect taxes. Moreover, the taxes collected by the state governments can be basically thought to be a variety of an expenditure tax. If one is buying a product in the market, then only that tax accrues to the coffers of the state government, since the tax collected at the site of production is collected by the central government in the form of central excise duties. Now, these expenditures are incurred in various sectors of the economy and the different taxes have different sectors as their bases. Therefore, in order to understand the movement of the OTR in WB we need to understand the structural change in the WB economy.

    The structural change

    Figure 15: Sectoral Composition of WB GSDP

    of the WB economy has

    1993-94 2008-09
    0 10 20 30 been such that the most Agr and allied prominent increase has

    Mining

    been in the share of real estate and construction in Manufacturing GSDP. The share of agri-

    Construction

    culture and manufacturing has decreased sub-Electricity, gas stantially while that of

    Transport, etc

    banking and insurance has increased (Figure 15). Trade, etc As is evident from the

    Banking, etc

    above chart, the weight of the real estate and Real estate, etc construction sectors has

    Public administration

    increased signifi cantly in the GSDP of WB. The PKT Other services basically consists of stamp

    Source: Economic Review, Bureau of Applied duties and registration Economics and Statistics, Government of WB, various years.

    fees and land revenue, which is dependent on the performance of the real estate and construction sector.

    PKT PKT RE

    = , ,

    Y RE Y

    where, Y=GSDP and RE=GSDP of real estate and construction.

    Here, the term PKT/RE, denotes the effective tax rate from the real estate sector. From the above equation it is clear that the movement of the PKT-GSDP ratio is dependent on the share of real estate and construction sector in GSDP and the effective tax rate from the real estate sector. Now we know that the

    12

    10

    8

    6

    4

    2 1993-94 1995-96 1997-98 1999-2000 2001-02 2003-04 2005-06 2007- 200808 09 Source: Same as Figure 1.

    second term in the above equation is increasing. Therefore, whether the PKT-GSDP ratio increases or not depends on the PKT-RE ratio or the effective tax rate, which is shown in Figure 16.

    From Figure 16, it is clear that the PKT-RE ratio is falling. This fall in the effective tax rate is a reflection of two phenomena,

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    not necessarily mutually exclusive. First, tax concession is being Figure 17: Share of Manufacturing and Sales Tax GSDP Ratio in WB

    given to the real estate sector. Second, there exist revenue leak

    20 3.3

    ages in the system, perhaps due to inefficiencies in the tax col

    18
    16
    14
    12
    10
    8 1.5

    lecting administrative apparatus. The policy implication imme

    diately follows from this analysis, that the tax concessions given

    to the real estate sector should be withdrawn and the adminis

    trative apparatus for collecting taxes should be improved. With

    the growth of the share of real estate and construction in GSDP,

    if the tax rate is increased in this sector, it will defi nitely signifi -

    Manufacturing as percentage of GSDP

    Sales Tax as percentage of GSDP 3.1 2.7 2.3 1.9 Manu ST

    1980-81 1984-85 1988-89 1992-93 1996-97 2000-01 2004-05 2008-09

    cantly help in increasing the overall tax-GSDP ratio of WB. Sales tax is measured in the secondary axis. Source: Economic Review, Government of West Bengal, various issues and State Finances:

    The other major revenue source for WB is the sales tax (ST).

    A Study of Budgets, RBI, various issues.

    Now, within the three major sectors of the economy, viz, agri

    culture, industry and services, the agriculture sector is basi

    cally negligibly taxed. A large part of the service sector similarly falls outside the scope of taxation. Therefore, ST is mainly collected from the industry and manufacturing sector. It is, therefore, generally believed that there exists a strong correlation between the manufacture-GSDP ratio and the sales tax-GSDP ratio for the states.

    Let us assume that sales tax is collected at the rate ‘t’ from the manufacturing sector. This implies that S M

    S = t.M Ÿ — = t. —

    Y Y where, S= State sales tax

    M= Manufacturing output,

    Y= GSDP

    Now from the above equation it can be written that ǻS ǻY ǻt ǻM ǻY

    – = + –

    t

    S Y t M Y From the above we can derive two conditions: can increase if ǻt

    S

    M

    >0 and suffi ciently high (1) If

    falls, then

    Y

    YY

    (2) If ǻt>0 and if ǻǻ

    MIt is evident from Figure 17 that the share of sales tax in GSDP

    increased till 1992-93 in spite of a decline in share of manufacturing in GSDP. It is clear from condition 1 above that this can only be possible if growth rate of effective tax rate is suffi

    t

    ciently high. However, with the introduction of neo-liberal policies, the states cannot go for higher taxes from the private sector and have to provide tax concessions to them. This is true for all the states. But the problem with WB is that the share of manufacturing in GSDP also witnessed a continuous fall. With the share of manufacturing in GSDP falling and no change in the tax rate, the ST-GSDP ratio had to fall, according to condition 2 above. The recovery of the share of sales tax from the late 1990s was only possible with the recovery of the share of manufacturing sector in GSDP.

    It is therefore seen that the reasons for the performance of WB being worse than most other states with regard to the OTR-GSDP ratio are twofold. First, the manufacturing sector

    MMS

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    decreased, thenwill also fall –

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    of the state has performed consistently worse than the other

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    march 31, 2012 vol xlviI no 13

    states in India, with the share of manufacturing in GSDP declining sharply for WB compared to other states. Second, the tax concessions and revenue leakages that exist in the state have also resulted in a poor OTR-GSDP ratio compared to other states.

    Conclusions

    The debt problem of WB is a reflection of two independent factors. First, there is a shortfall in revenue receipts of WB

    Notes References

    compared to other states. This shortfall in revenue receipts is again because of a low OTR-GSDP ratio in WB compared to other states. The low OTR-GSDP ratio in WB is a result of a low manufacturing base and tax concessions provided to the private sector. Second, the effective interest rate paid by WB is much higher than the other states. This is because the interest rate charged by the centre on NSSF loans is higher than other loans and the share of NSSF loans in total loans is much higher in WB than in other states.

    and Restructuring of State Government Debt:

    1 One of the primary features of the Terms of Reference of various finance commissions in the post-liberalisation period has been the requirement to allocate the resources to the States keeping in view the centre’s requirement to finance its committed expenditures including interest payments. In the context of rising interestpayment, falling tax revenues and the objective of ensuring “fiscal balance” in the post-liberalisation period, thus, implied that the greater the interest payment of the centre relative to its revenue receipts, the lower would be the revenue transfers from the centre to the States.

    2 The following condition of debt sustainability

    is derived from Pasinetti (1998).

    3 For more details see Ghosh (2005).

    4 These conditions laid down by the TFC, however,

    raise bigger questions of fiscal federalism in India, which is currently outside the scope of this paper. 5 State Finances: A Study of Budgets, RBI.

    Chandrasekhar and Ghosh (2002): The Market that Failed (New Delhi: Leftword).

    – (2005a): “The Crisis of State Government Debt”, viewed on 20 May 2011, http://www. macroscan.org/fet/may05/fet250505State_ Government_Debt.htm

    Das, S (2004): “Effect of Fiscal Deficit on Real Interest Rate”, Economic & Political Weekly, 39(12): 1299-1310.

    Dasgupta, A (2008): “Centre-State Relations: Need for a Change”, paper presented in National Seminar on Centre-State Relation in the Context of 13th Finance Commission, Trivandram, Kerala, 6-7 May, mimeo.

    Datta, D (2010): “West Bengal Government Finances: A Critical Look”, Economic & Political Weekly, 45(44): 99-105.

    Ghosh, J (2005): “Twelfth Finance Commission

    A Note”, Economic & Political Weekly, 40(31): 3435-39.

    Issac, T M T and R Ramakumar (2006): “Why Do the States not Spend? An Exploration of the Phenomenon of Cash Surpluses and the FRBM Legislation”, Economic & Political Weekly, 41(48): 4965-76.

    Pasinetti, L (1998): “The Myth (or Folly) of the 3% Deficit/GDP Maastricht ‘Parameter’”, Cambridge Journal of Economics, 22(1): 103-116.

    Patnaik, P (2003): The Retreat to Unfreedom: Essays on the Emerging World Order (New Delhi: Tulika).

    – (2006): “What Is Wrong with ‘Sound Finance’”, Economic & Political Weekly, 41(44): 4560-64.

    Rakshit, M (2005): “Budget Defi cit: Sustainability, Solvency and Optimality” in Bagchi (ed.), Readings in Public Finance (Oxford: Oxford University Press).

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