India’s Public Finances and Public Financial Management: Selected Issues and Suggested Reforms
Authored By- Khushi Agarwal
Economic Development, Economic Growth, and Largest Economy are the common terms one gets to hear in day-to-day life. Not a single day goes away without news related to the Economy in the newspaper. Recently, India surpassed the United Kingdom and became the fifth-largest economy in the world. On the other hand, due to the ongoing crisis in Pakistan, Pakistan’s economy is on the edge of collapse, and to save its economy, the IMF is thinking to unlock a $ 7 Billion bailout. But what makes any economy grow or fall? Multiple factors lead to the growth or fall of any economy such as the production of goods and services in the country, their exports worldwide, infrastructure development, rise in GDP, and many other things. But the common thing in all the factors is the expenditure. In order to make the country’s economy grow, the government is required to make multiple expenditures on one or the other thing. But where does the Government get the finances to make these expenditures and how does the Government decides where and how much to invest and spend?
Public Finances or Indian Financial Management is the answer to these questions. As the name suggests, Public Finance is the approach to managing public funds. The process of planning, organizing, and controlling the country’s income, revenue, expenditure, and other related financial decisions is financial management. Management of public funds or finances is one of the crucial role played by the government as any decision taken by the government concerning public finances have the ability to make or destroy the country’s economy and development. Such decisions not only affect the country’s government or citizens but also the country’s level of growth, its policies, and also the other stakeholders who may have any indirect interest in the country such as the MNCs who may have been thinking to open up their business in the country. Hence, proper allocation of the funds after carefully assessing all the aspects and after multiple brainstorming sessions is what is required to be done.
Public Financial Management:
As stated above, decisions involving public finance are very crucial for the economy and thus, must be taken after carefully analyzing all the aspects. There is no specific provision as such in the Indian Constitution related to it. However, it provides for laying before Parliament the estimated income and expenses for the financial year. Besides this, India’s income and expenditure are maintained through three accounts, that is, the Consolidated Fund of India, Contingency Fund of India, and Public Account, all of which are mentioned in the Constitution of India.
Its proper management ensures the growth of the nation and the economy and helps encourage investment in the economy through various policies and schemes made by the government. It ensures optimum utilization of all the resources by properly managing the sources of income and public expenditures. One of the main objectives besides ensuring the stability of the economy of the country is addressing the general public's basic necessities, such as food, shelter, health, infrastructure, and education. The government is responsible for all of these in order to meet the requirements of the general populace and advance the economy.
Major Components constituting principles of Public Finance:
Public Finance management has multiple components such as the preparation of the budget, collection of the revenue, preparation of the fiscal policies, planning the borrowings and debts, public expenditure, etc. The following are some of the major components of public financial management:
The Budget: Every year as a measure to make the citizens of the country aware of its decisions of allocation of public funds in the upcoming fiscal year, the government in February releases the Budget. It is a blueprint of how the government is planning to invest public funds and allocate them in different areas in the upcoming financial year. It is based on this budget, the government makes policies for the country, allocates funds to the different ministries, takes its decision concerning borrowings and fiscal deficits, etc. Very recently, Financial Minister Nirmala Sitharaman announced the budget making the public aware of the government’s plans in the upcoming fiscal year. It has also released data on the government’s different sources of funds and the respective areas where those funds are utilized.
Tax Collection: Tax is one of the major sources of the government’s sources of income. The government in order to run the economy needs funds which it takes through multiple channels. Tax is one such channel and is divided into two parts, that is, direct tax and indirect tax. Direct tax is imposed on the income of persons while indirect tax is imposed on the suppliers and manufacturers of the goods and services. The Indian Constitution under Schedule 7 provides three lists, namely, the Union List, State List, and the Concurrent List, on which the state and the center can impose taxes on the general populace. Therefore, it can be determined that tax collection is crucial for any government to operate and pass laws that benefit the people, and that it is the most significant aspect of public finance. As per the recent analysis of 2021-22, tax collection is the biggest source of revenue for the government.
Expenditure: In order to make the economy grow and run the country, the government has to make multiple expenditures in different areas. Public expenditure is the redistribution of the funds received by the government through various sources, as explained above. Social programs, health, infrastructure, education, allocation to ministries, subsidies, allocation of funds to states, etc. are some of the expenditures of the government. As per the recent analysis, interest payment on the borrowings made by the government forms the major part of the government’s expenditure. Besides this, centrally sponsored schemes and allocation to the Defense ministry are other major portions of the government’s expenditure.
Deficit/Surplus: It’s not always possible to earn sufficient to meet all the expenses of the country. To finance the over and above expense, the government has to make borrowings from foreign governments, from IMF, or even from the public by issuing bonds, etc. Borrowings constitute 2nd largest source of income for the government. This stage is called a deficit. Government always tries to reduce its fiscal deficit to a specific portion of the GDP. The term surplus means the exact opposite of the term deficit; it means the government has extra funds that it does not need to spend and does not have a place to spend them. In this situation, several things may occur, such as the government of that country lowering prices or, in other phrase, distributing the funds equally among its citizens who may need them, or lending the funds to other nations or financial institutions in exchange for interest, which will generate income. The best example of a nation with excess funds is Japan, which has in the past lent money to our nation at no interest.
Issues and Reforms that can take place in the existing system:
A robust public financial management system is essential for India to achieve its objectives of fiscal discipline, strategic planning, and improved service delivery. This need has recently gained increasing public attention. Because public financial management reforms implemented sporadically over the years have not produced the expected results in these areas, studies and recommendations from government-appointed committees and expert bodies have identified gaps that need to be filled in order to strengthen the institutional framework for public financial management and to increase the effectiveness of government spending.
Issues in the Tax System: The tax system is a crucial instrument for moving money from the private sector to the government to pay for public services. Since taxes affect the incentives to save, invest, and take risks, distortions are inevitable wherever taxes are applied. In order to obtain the required revenues, a good tax system should reduce expenses associated with the collection, compliance, and distortions.
Part of India's inability to impose a comprehensive income tax might be attributed to the constitution's mandate. The Union government exclusively taxes non-agricultural incomes as a result of the States being given responsibility for collecting the tax on agricultural income. Only the income from plantation crops is subject to the agricultural income tax in the States. Even corporations investing in the agricultural industry are exempt from paying taxes. The agriculture sector's exemption shields it from comprehensive income taxation and creates a simple means of evasion and avoidance.
The overflow of exclusions, concessions, and allowances presented in immediate and aberrant charges is the second huge element adding to the restricted base of assessments. The intricacy and shortcomings of the duty framework in accomplishing the numerous objectives can be perceived by investigating the number of objectives it yearns for. The expense framework is important to achieve objectives like empowering reserve funds, advancing products, advancing foundation speculations, empowering business development, as well as creating income. Likewise, the extract obligation is expected to energize the improvement of immature regions and little size enterprises are supposed to get particular treatment. The consideration of this multitude of objectives in charge rules opens up a lot of chances for avoidance.
One effect of ambiguous tax rules and inadequate management has been the accumulation of enormous tax debt. Although the issues with the organizational structure and how the tax administration operates are widely recognized, there haven't been many attempts to fix them.
Issues with Deficits and Borrowings: A country’s increase in the level of fiscal deficit can lead to huge debt. There must be restrictions on the use of borrowing as a source of funding for public spending, even if it is generally required to finance public spending through borrowing. According to the general rule, all current costs, including paying wages and interest, maintaining capital assets, disbursing subsidies, and making other transfers, should be met by current revenues from tax and non-tax sources, whereas capital costs may be financed by borrowing. This is merely a guideline to ensure that borrowing is only done to fund expenses that would boost economic growth by an amount at least equal to the interest rate on the loan.
Excessive borrowing to fund government spending can have highly detrimental effects. First, as already mentioned, a disproportionate reliance on savings in the household sector would raise interest rates and deter private investment. Furthermore, high debt levels result in expensive interest payments, which limit government spending on fruitful pursuits. Third, since in the future, more taxes would be needed to return the money borrowed, borrowings can be a huge burden on future generations. Fourth, substantial deficits could result in balance of payment problems. For these reasons, credit rating agencies view governments with high levels of deficits and debt as high risk, which boosts the cost of borrowing overseas. As a result, several countries pass fiscal legislation into law to cap the levels of deficits and debt.
Internal Auditing System: One of the biggest problems the nation currently has is that we have not kept up with international accounting standards and practices. This situation is unlikely to change any time soon because the government has not yet proposed any legislation or made any official plans in this regard. Internal auditing is still carried out in accordance with outdated guidelines set forth in a number of rules and manuals that have only infrequently been revised in the past. The main issue with these is that they mostly concentrate on only timely record auditing and don't pay much attention to the audit's quality or scope of the audit. The government established a task committee in 2006 to address this issue, and they suggested a number of measures, including the appointment of different people in positions like Chief Internal Auditor, who would be in charge of the Board of Internal Audit, could concentrate on the aim of auditing, whose major objective is to build cutting-edge procedures and promote transparency, which would improve governance.
External Auditing System: The Comptroller and Auditor General of India, or CAG of India, is the single individual currently responsible for the system and all external audit procedures. The CAG has previously performed significant roles. Throughout several governments, the CAG has cooperated and enabled the Parliament set up Financial Control over the executive. The CAG has released a number of reports that have significantly exposed and uprooted the grave issue of corruption in several government and administrative offices. Additionally, if not for the CAG, the general public, and taxpayers would not have been aware of major scams including the 2G spectrum scam and the coal scam. However, the problem with the CAG's position is that, while it is a powerful position according to the constitution, the CAG's authority is extremely broad but not at all explicit, which results in irregularities in reports, neglecting to run risk analyses when necessary, and gradually raising audit quality to meet international standards. The ARC (The Second Administrative Reform Commission) discovered all of these facts.
Public finance regulations have the power to greatly accelerate development, support human growth, and significantly lessen poverty. They can be used to fight poverty by giving capital to individuals who lack access to material goods through education, healthcare, and skill development. They can also be used to protect people's safety and security and defend their property. They can also be applied to develop environments that encourage development. However, taxes or borrowing are required to pay for governmental spending. Each of these sources has the potential to have a considerable impact on equity, economic growth, and resource allocation. The administration has recently been working to improve the effectiveness of our public financial system, and significant measures have been done in that direction. The country's citizens are now forced to follow rules and regulations that will have an effect on public funding as a result of the country's substantial increase in financial discipline and strategic planning for how the country's revenues should be used.
The fact that there have been far too many reforms in this specific field over the past few years, some of which came too late and increased the government's costs, is another truth that cannot be ignored. These reforms have produced some outcomes, but not to the amount that was necessary. Public finance policies are constrained by a number of restricting variables. Low revenue productivity and accidental distortions are two characteristics of the tax system. Narrow bases caused by various tax benefits offered, widespread tax evasion, and insufficient administrative capacity have all hampered revenue output. In order to guarantee competitive levels of social and physical infrastructure, as well as to combat poverty and achieve economic redistribution, public spending is predominantly utilised. Funding for physical infrastructure and human development has suffered as interest payments, growing wages and salaries, subsidies, and transfers account for more than 28% of total income. India has been burdened by debt and massive, recurrent deficits.
The necessity of a strong institutional system to oversee budgetary regulations for the center and states is brought to light by the experience of fiscal adjustment. A significant flaw is the lack of an independent body to ensure parliamentary accountability and monitor and execute the law. It may be necessary to have a Federal Council that is impartial, knowledgeable, and responsible for keeping tabs on the budgetary laws and informing Parliament. To ensure fiscal compliance and report regularly to legislatures, certain nations have established Fiscal Councils. While doing so might aid in spreading awareness of the issue, in the end, solid and long-lasting public finance policy in India depends on political will.
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