The Chartered

FRBM

The Centre has breached the 45% limit of revenue deficit for the first half of the financial year prescribed by the Fiscal Responsibility and Budget Management (FRBM) Rules. As per the Rules, Union finance minister P Chidambaram will have to make a statement in Parliament during the ongoing winter session, explaining the reasons for the breach and the corrective steps proposed. FE takes a closer look at what is the FRBM Act and why it is important.

What is the FRBM Act?
The FRBM Act was enacted by Parliament in 2003 to bring in fiscal discipline. It received the President’s assent in August the same year. The United Progressive Alliance (UPA) government had notified the FRBM Rules in July 2004.

As Parliament is the supreme legislative body, these will bind the present finance minister P Chidambaram, and also future finance ministers and governments.

How will it help in redeeming the fiscal situation?
The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government to stick to the deficit targets.

As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, have to be reduced to nil in five years beginning 2004-05. Each year, the government is required to reduce the revenue deficit by 0.5% of the GDP.

The fiscal deficit is required to be reduced to 3% of the GDP by 2008-09.It would mean reduction of fiscal deficit by 0.3 % of GDP every year.

How are these targets monitored?
The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government to restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the financial year).

In case of a breach of either of the two limits, the FM will be required to explain to Parliament the reasons for the breach, the corrective steps, as well as the proposals for funding the additional deficit.

What is fiscal deficit?
Every government raises resources for funding its expenditure. The major sources for funds are taxes and borrowings. Borrowings could be from the Reserve Bank of India (RBI), from the public by floating bonds, financial institutions, banks and even foreign institutions. These borrowings constitute public debt and fiscal deficit is a measure of borrowings by the government in a financial year.

In budgetary arithmetic, it is total expenditure minus the sum of revenue receipts, recoveries of loans and other receipts such as proceeds...

Do economies need a fiscal deficit?
Many economists, including Lord Keynes, had advocated the need for small fiscal deficits to boost an economy, especially in times of crises. What it means is that government should raise public investment by investing borrowed funds. This exercise is also called pump-priming. The basic purpose of the whole exercise is to accelerate the growth of an economy by public intervention. Hence, there is nothing fundamentally wrong with a fiscal deficit, provided the cost of intervention does not exceed the emanating benefits.

The darker side of the story is that the borrowed funds, which always remain on tap, have to be repayed. And pending repayment, these loans have to be serviced.

Ideally, the yield on investment on borrowed funds must be higher than the cost of borrowing.

For example, if the government borrows Rs 100 at 10%, it must earn more than 10% on investment of Rs 100. In that situation, fiscal deficit will not pose any problem.

However, the government spends money on all kinds of projects, including social sector schemes, where it is impossible to calculate the rate of return at least in monetary terms. So, one will never know whether the borrowed funds are being invested wisely.

And how grave is the problem of fiscal deficit?
Over the years, public debt has continued to mount and so have interest payments. According to budget figures (revised estimates for 2003-04) the government borrowed Rs 1,32,103 crore. The interest payment during the year was Rs 1,24,555 crore.

What is alarming is that except for a comparatively small sum of about Rs 7,500 crore, more than 94% of borrowed funds are being used to pay interest for past loans. This is what is called the debt trap, where one is compelled to borrow to service past loans.

The other way of looking at the fiscal problem is that more than 66% of government taxes, totalling Rs 1,87,539 crore in 2003-04 were used to pay interest on past borrowings.

Servicing of loans also erodes the government’s ability to spend money on critical areas such as health and education and on essential sovereign functions like policing, judiciary and defence....

ABOUT GST

The goods and services tax (GST) is a comprehensive value-added tax (VAT) on goods and services.

France was the first country to introduce this system in 1954.

Today, it has spread to over 140 countries.

Through a tax credit mechanism, GST is collected on value-added goods and services at each stage of sale or purchase in the supply chain.

GST paid on the procurement of goods and services can be set off against that payable on the supply of goods or services. But being the last person in the supply chain, the end consumer has to bear this tax and so, in many respects, GST is like a last-point retail tax.

Many countries have a unified GST system. However, countries like Brazil and Canada follow a dual system wherein GST is levied by both federal and state or provincial governments.

In India, a dual GST is being proposed wherein a central goods and services tax (CGST) and a state goods and services tax (SGST) will be levied on the taxable value of a transaction.

The central and state governments are discussing the GST system proposed to be implemented in India from April 1, 2010.
Representing the statesin the discussions is the empowered committee of state finance ministers.

Here are some questions on GST and their answers:

Will dual GST be levied in addition to the existing taxes?
No. It is proposed that the CGST will subsume central excise duty (Cenvat), service tax, and additional duties of customs at the Central level; and value-added tax, central sales tax, entertainment tax, luxury tax, octroi, lottery taxes, electricity duty, state surcharges related to supply of goods and services and purchase tax at the state level.

What will be the rate of GST?
The combined GST rate is currently being discussed by the Centre and the EC. The rate is expected to be in the range of 14-16 %. Once the total GST rate is determined, the states and the Centre have to agree on the CGST and SGST rates. Today, services are taxed at 10% and the combined incidence of indirect taxes on most goods is around 20%.

Will prices go up after the implementation of GST?
In fact, the prices of commodities are expected to come down in the long run as dealers pass on the benefits of reduced tax incidence to consumers by slashing the prices of goods.

What are the implications of GST on imports and exports?
Imports would be subject to GST. Exports, however, will be zero-rated, meaning exporters of goods and services need not pay GST on their exports. GST paid by them on the procurement of goods and services will be refunded.

What are the benefits of shifting to a dual GST system?
Dual GST is expected to be a simple and transparent tax structure with only one or two rates of taxes. The result would be a reduction in the number of taxes at the Central and state levels, cut in effective tax rate for many goods, removal of the current cascading effect of taxes, reduction of transaction costs for taxpayers through simplified tax compliance, and increased tax collections due to wider tax base and better compliance.

How will dual GST affect the fiscal health of states?
Being a consumption-based tax, dual GST will result in better revenue collection for states with higher consumption of goods and services.

The backward and less-developed states would see fall in collections. The Centre is expected to put in place a mechanism to compensate states for any revenue loss due to GST.

The introduction of the GST system is by far the most important tax reform in India. Consensus and coordination among states is required for it to succeed. Before it can be introduced, the Centre and states have to sort out issues like agreement on GST rates, constitutional amendments empowering states to tax services, taxation on inter-state transactions of goods and services, drafting of CGST and SGST laws, consultation with all stakeholders including trade and industry associations before finalisation, administrative preparedness to implement the new tax regime and resolution of all other issues under discussion.

This is a formidable challenge given that we have only limited time left. The Union Budget, which is to be presented on July 3, should lay down a clear roadmap with defined timelines for GST to become a reality on April 1, 2010