Signs of a weakening public sector

States may have got more through tax transfer, but the composition of the PSU capital outlay causes concern

From a political economy perspective, the Union Budget is an important document to understand how the Centre’s fiscal relations with the states have evolved. Equally important is the way the Budget reveals the nature of the Centre’s financial engagement with public sector undertakings (PSU), which continue to play a significant role in the Indian economy, even after years of disinvestment and a few cases of privatisation. A week after Finance Minister Nirmala Sitharaman presented her fifth Budget, it would be useful to study the numbers in her annual financial statement from both these perspectives.

The Centre’s fiscal relations are principally governed by the recommendations of the Finance Commission, according to which the states have a 41 per cent share in the total taxes collected by the Union government. There is, however, a catch. The devolution is to be calculated as a proportion of the net shareable tax proceeds, or the divisible pool. In the last few years, the share of collections from various cesses and surcharges has gone up steadily — from about 5 per cent of the Centre’s gross tax collections in 2017-18 to about 11 per cent in 2021-22. In the current year, this share would be higher at about 13 per cent, according to the revised estimate of the Budget.

This has had an obvious adverse impact on the amount of devolution, which the states are entitled to under the formula mandated by the Finance Commission. Since cesses and surcharges are not part of the divisible pool, the states get a relatively reduced share in the Centre’s gross tax collections. Indeed, cesses and surcharges in the last couple of years have been growing at a faster rate than taxes and other levies that form part of the divisible pool. Thus, even as overall tax transfers in this period have been growing at a decent rate, their share in the Centre’s gross tax collections has languished at 30-33 per cent.

Is this trend likely to change in the coming year? The Budget has a few pointers that could please the states and their finance ministers. Cesses and surcharges in 2023-24 are expected to see one of the lowest increases in recent years — at about 4 per cent to Rs 4 trillion, with their share in gross tax collections also declining to about 12 per cent. This is not a big relief, but if total tax transfers to the states are set to go up by about 8 per cent to Rs 10.21 trillion in 2023-24, it is also because the share of cesses and surcharges in gross domestic product (GDP) is declining, for the first time in the last three years, to 1.35 per cent.

State finance ministers should also be pleased by the way

^{Illustration: Binay Sinha}

Ms Sitharaman has cut the income tax on the super-rich or those having a taxable income of over Rs 5 crore. Finance ministry officials point out that the tax collection estimate for 2023-24 could not capture the full impact of the income-tax relief as this decision was taken too late for its inclusion in the Budget numbers. Now, the super-rich tax has come down from 42.7 per cent to 39 per cent because the surcharge on it has been slashed from 37 per cent to 25 per cent. The revenue hit on account of this will be borne entirely by the Centre and, therefore, would not affect the amount of tax transfer to the states. Taken together with an increased allocation of capital expenditure advances to the states by 30 per cent to Rs 1.3 trillion, the states have reasons to believe that the Union finance ministry’s overall approach to them has become a little more supportive.

How have the non-tax transfers from the Centre to the states fared? In addition to tax transfers, the states also get assistance from the Centre by way of grants and loans, some of which is mandated by the Finance Commission. Since the pandemic, the total assistance by way of annual grants and loans to the states has seen no increase, staying at around Rs 8 trillion, while it is the tax transfer that has gone up steadily. That trend is likely to be maintained even in 2023-24, and the states have no cause for celebration on this count.

A lot has been written about how the Budget for 2023-24 has been generous with its capital expenditure. But a key feature of this increase is that a large chunk of its capital outlay would be routed through capital support to PSUs. Of the Rs 10 trillion of capital expenditure proposed in 2023-24, more than half is channelled through them by way of the Centre’s budgetary support to their equity and a tiny portion through loans. In 2022-23 also, PSUs accounted for over half of the government’s capital expenditure, up from a share of 42 per cent in 2021-22.

Unfortunately, this has led to a corresponding decline in the share of the PSUs’ own contribution to their total capital outlay on projects. In 2021-22, PSUs would contribute about 64 per cent of their total capital outlay with resources mobilised by them through internal generation of funds or borrowing. But this share plummeted to 52 per cent in 2022-23 and will now go down further to 49 per cent in 2023-24. In other words, PSUs are increasingly becoming more dependent on the Centre to meet their capital expenditure requirements. This is not a healthy sign.

Nothing could illustrate this gradual weakening of the PSUs more than the state of the Indian Railways. In 2023-24, it would be helped by Rs 2.4 trillion of capital support from the Centre, but its overall capital expenditure is just about Rs 2.93 trillion, which means that its own contribution to its capital projects will decline to 18 per cent, down from 38 per cent in each of the previous two years. Not surprisingly, the Indian Railways’ operating ratio, a benchmark of its financial efficiency, is languishing at 98 and the extra budgetary resources it raises would decline from Rs 82,000 crore in 2022-23 to just about Rs 17,000 crore in 2023-24. There are of course other questions of how effectively the huge amount of government resources are being spent on various railway projects.

But the larger point is that the healthy rise in the Centre’s capital expenditure should not hide the worrying decline in the public sector’s own contribution to its capital outlay and, therefore, its lack of accountability in ensuring a decent return on such investment. This trend should be reversed soon. Simultaneously, the government must expedite its plan for asset sale and privatisation, both of which hardly got any mention in the Budget speech for 2023-24. Even the revenues proposed to be raised through this route were modest.