For decades now, ‘Kerala’s fiscal crisis’ has been a hot topic of discussion at seminars. In fact, the ‘crisis’ has become a new normal for the State. What is the real state of the State’s public finances? Can Kerala propel a new growth path through higher capital spending even as it continues to spend for social welfare, which are the twin goals dear to policy-makers of Kerala?
When Kerala’s economic growth was much lower than that of the national level (during 1960-1990), the State had not only surpassed rest of India in human development indicators, but also had the highest Own Tax–Gross Domestic Product (GSDP) ratio among the States in India. In fact, Kerala was collecting more revenue than other States from a thin base. Kerala’s long term average of tax buoyancy (which is the ratio of increase in tax revenues to the increase in GSDP) during 1960-1990 was 1.3. This implied that the State’s revenues were growing faster than the growth in output.
Since 1991, the State’s GSDP started growing faster than the all-India rates. Paradoxically, since this period, Kerala’s own tax buoyancy started falling markedly. It fell to 0.91 during the period 1990-91 to 2001-02. The pertinent question that arises here is why own tax revenues fell when per capita incomes grew. During this period, Kerala also became the State with the highest Private Final Consumption Expenditure (PFCE) in India as per NSSO surveys.
Remittances, whose impact is not fully captured in GSDP, also soared high. Three reasons have been attributed to this fall in Own Tax Revenue: (a) the growing resistance from the trader community to intrusive action by tax officials, (b) the State’s economic growth being mainly dependent on the services sector, and (c) the complicated tax structure resulting in poor compliance, tax avoidance and evasion.
Fall in tax collection
During this period, the State’s share of Central taxes started falling (till it rose in 2015-16 after the 14th Finance Commission Award). Kerala became a high per capita income State, courtesy the inflow of remittances, but the State’s expenditure commitments grew for three reasons. First, as a result of higher spending in social sectors of education and health (which are personnel oriented) in the past, with higher pension commitments.
Second, higher salary commitments in social and economic sectors. Third, higher cost of borrowed funds which affected all the States, including Kerala, in the 1990s. When faced with falling revenues from Own and Central sources, the inflexible expenditure commitments resulted in not only higher borrowings but also a large share of it going to meet the committed recurring (or revenue) expenditure, leaving only a little for capital spending and infrastructural development.
However, even so, one should not forget that during 2006-07 to 2010-11, State’s Own Tax revenue growth picked up and its buoyancy again reached 1.26, implying a higher tax effort. Implementation of Value Added Tax (VAT) and the positive governance interventions saw a higher growth of Own Tax Revenue. But this slipped to lower levels later.
Though the final figures for 2016-17 are not available, the slippage in Own Tax Revenue growth has continued, exacerbated by demonetisation, which was an unexpected bolt from the blue.
Trilemma
Being a consumer State, GST implementation should have been a welcome development, but Kerala is faced with a trilemma here: (a) GST rates have fallen vis-a-vis old VAT rates, (b) check-posts have been closed down, but the e-way bill system to track down commodity movements is still not in place, and (c) revenue from inter-State trade, which is substantial for Kerala, is coming in trickles from the Centre, and is disproportionate to the output tax paid on actual sales. While three quarters of the commodities were taxed at 14.5% under VAT regime, now they are taxed at 9% (50% of 18%), implying lower revenues due to 5.5% reduction in rates. The shut down of check-posts has made tax evasion more rampant.
The liquidity crunch faced by the State in the recent period is due to these three issues in GST implementation at the national level. On top of it, remittances to India are slowing down and the Kerala economy seems to be in for a lower GSDP growth than the last decade. Due to expenditure commitments, which remain around 15% of GSDP, the State is faced with rising deficits.
In this scenario, bold initiatives for off-budget spending may also hit a roadblock. The State’s ideal goal is a revenue-led fiscal consolidation with larger capital and social sector spending. But certain impediments seem to have appeared on the way. If economic growth does not look up and remittances move in a downward slide, the State’s revenues would not grow at the expected 20% rate. At this juncture, re-prioritising revenue expenditure, without breaking safety nets for the poor would become the immediate priority and this needs a political consensus. Clouds of crisis can dissipate if GST implementation stabilises and the 15th Finance Commission takes forward the policy of its predecessor.
In an alternative scenario, Kerala may need a political consensus on its expenditure priorities to stem the gathering clouds of crisis.
(The author is an expert in State finances)
