Kerala’s Finance Minister KN Balagopal presents the State Budget for 2023-24 in the Legislative Assembly, in Thiruvananthapuram on February 3, 2023. Photo Credit: PTI
Kerala’s Budget 2023, presented by Finance Minister KN Balagopal on February 3, 2023, was focused on raising revenue. In this budget, the narrative of Kerala state finances has undergone a relative change from focus on debt financing to revenue mobilization. Apart from the tax rate hike, Budget 2023 also focuses on raising non-tax revenue, including raising revenue from revision in royalty rates of minor minerals and increasing user fees.
Why do these tax rate hikes look compelling? The hike in tax rates was to identify the fiscal space between maintaining the fiscal rule-based deficit ceiling ratio and due to high volatility in intergovernmental fiscal transfers from the Union to the States. Kerala’s Finance Minister pointed out that the decline in revenue deficit grant and discontinuation of Goods and Services Tax (GST) compensation have further impacted the state’s finances.
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The fiscal consolidation framework mandates all state governments in India to keep their fiscal deficit-GDP ratio at 3.5%. Additional borrowing powers of states (0.5%) linked to restructuring of the power sector. Kerala is no exception to this rule. In Kerala’s budget, the fiscal deficit-GDP ratio is pegged at 3.5% for FY23. However, last year’s data showed a decline in the fiscal deficit-GDP ratio from 3.91% (BE, or Budget Estimates) to 3.61% (RE, or Revised Estimates). However, the Fiscal Responsibility and Budget Management (FRBM) framework’s golden rule of zero revenue deficit is not viable at this point of time as it would negatively impact the recovery process of economic growth. The revenue deficit-GDP ratio is pegged at 2.11% in FY23. The decline in revenue deficit-GDP ratio from 2.30% (BE) to 1.96% (RE) for the year 2022-23 is a matter of concern. It is important to analyze whether this reduction has been achieved through a reduction in revenue expenditure or through a jump in revenue receipts.
To maintain the state’s high human development achievements and strong economic growth trajectory, Kerala has resorted to innovative deficit financing. Off-Budget Borrowings (OBBs) through a corporate entity called the Kerala Infrastructure Investment Fund Board (KIIFB) have been used to strengthen physical and social infrastructure in the state. However, the Finance Minister of Kerala raised his concerns with the central government for reducing the borrowing powers of the states by including borrowings by public sector entities including special purpose vehicles like KIIFB in their public debt account.
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The total revenue receipts for FY23 have been estimated at Rs 1,35,418.67 crore (BE). This is an increase from the Revised Estimates (RE) of 2022-23 by Rs. 1,29,268.15 crores. Total expenditure Rs. 1,76,088.95 crores. The primary deficit (fiscal deficit minus interest payments) which reflects the current fiscal stance is pegged at 1.18% of GDP in FY23. Discretionary fiscal space (total expenditure minus interest payments) is important for expenditure design.
In times of rising inflation, the unprecedented tax hike in petrol and diesel has come unexpectedly, which may hurt disposable income in the hands of people. This fiscal measure has been resorted to to find fiscal space between decreasing tax devolution from the central government and the fiscal deficit-fiscal rule-based ceiling ratio at 3.5% of GDP.
Happy paying taxes?
Citizens generally prefer to pay tax only when there is a strong connection between the unit of tax paid and the unit of public services citizens use – what is called a “Wickellian connection” in the public finance literature. . However, this relationship breaks down when citizens fear that their taxes are used for fiscal extravagance rather than for strengthening economic growth and welfare. In Scandinavian countries, people happily pay taxes because these connections are maintained because of the government’s “welfare model”. The Kerala model has been lauded as a welfare model with an emphasis on social infrastructure in education and health. However, over the years, RBI state finance analysis has shown that expenditure functions under economic and social services in Kerala have been shrinking, leaving more expenditure on general services including interest payments, salaries and pensions. The demographic change in Kerala, with a population structure of a large dependent population, puts pressure on public finances in terms of pensions and other social security measures.
The narrative in Kerala so far has been the state’s high debt burden and its “inter-generational inequality” in the sense that today’s deficit is tomorrow’s tax. However, using it to strengthen capex infrastructure and narrow productivity gaps across sectors has confirmed high debt and losses. High debt and deficits have been confirmed in an era of low interest rate regime. However, with rising global inflation, interest rates have started rising globally, and this has made public debt management difficult. In a higher interest rate regime, the cost of borrowing tends to rise, and hence the loan becomes more expensive to service. A high interest rate regime will make it difficult for fiscal policy to remain “accommodative” over long periods of time. Given these constraints in the fiscal space, it is unwise to resort to revenue collection.
, Lekha Chakraborty is Professor, NIPFP, New Delhi and Member, Governing Council, International Institute of Public Finance (IIPF), Munich.,