Public Finance Newsletter - PwC
Public FinanceNewsletterIssue XIISeptember 2016In this issue3Feature article9 Pick of the quarter 15Round the cornerDear readers,In his book Public Finance andPublic Policy (2004), DrJonathan Gruber definedpublic finance in very simpleterms as ‘the study of the roleof the government in theeconomy.’ Public finance is animportant branch of economics as the governmentplays a crucial role in the economy by bringing inthe potential for efficiency improvement where themarket economy does not lead to the requiredefficiency—maximising outcome (market failure)and redistributing resources to establish equity andequality in society.Given the importance of public finance and publicpolicy in an economy, I am pleased to shareknowledge and updates in the public financedomain through the 12th edition of our PublicFinance Newsletter.The feature article in this issue examines some ofthe key estimates of the Government of India’sbudget for FY 2016–17. The article assesses theestimates through a comparison of the budget andactual expenditure/revenues of the centralgovernment for the last five years. In the ‘Pick of thequarter’ section, the author analyses this year’s‘State Finances: A Study of Budgets’, which is anannual report published by the Reserve Bank ofIndia.‘Round the corner’ provides news updates in thearea of government finances and policies across theglobe and key paper releases in the public finance19Potpourri24 PwC updatesdomain during the recent months, along withreference links. The ‘Our work’ section presents anoverview of the Systematic Review Programme forSouth Asia, which aims to provide policymakers inSouth Asia with a robust assessment of the evidencebase to help in policymaking and programmedesign.You may read this newsletter on the go bydownloading the PwC 365 app on your iOS andAndroid devices. The app is available on iTunesand Google Play. For more about PwC 365 ,please visit https://www.pwc.in/publications/pwc-365-app.htmlI would like to thank you for your overwhelmingsupport and response. Your contributions havehelped in making this newsletter an effectivemedium for sharing information.We would like to invite you to contribute and shareyour experiences in the public sector andgovernance space with us. Do write to me atranen.banerjee@in.pwc.comHappy reading!Sincerely,Ranen BanerjeePartnerPublic Sector and Governance
2PwC
Feature articleUnion Budget 2016–17: How realistic are the estimates?The budget is the most important policy document of a government and can be construed as a vehicle for driving thedevelopment of an economy. Implementing the budget as planned is an important factor in a government’s ability to deliverthe public services for the year as expressed in policy statements. Similarly, an accurate revenue forecast is important forefficient expenditure planning. An optimistic revenue forecast can result in expenditure exceeding the available resources,thereby leading to either borrowings or expenditure adjustments during the financial year and impacting allocativeefficiency. On the other hand, a pessimistic revenue forecast may result in surplus resources which can potentially beused for spending that is not subject to the scrutiny of the budget process.Considering the debate on the reliability of the numbers presented in a budget and the importance of realisticallydetermining budget estimates (BE), this article analyses the reliability of some of the key estimates of the Governmentof India’s budget for FY 2016–17.To begin with, we have compared the actual receipts and expenditure of the central government with the budgetaryestimates for the last five financial years (Table 1). As per the internationally accepted methodology for assessing publicfinancial management practices (Public Expenditure and Financial Accountability Framework, 2011), a deviation of /- 5%is given the best rating, i.e. ‘A’ (taking into consideration the outliers such as large expenditure required during drought).1Table 1: Budget vs actual analysis for the last five 6*Total receipts (excluding loans)-6.7%-5.8%-5.9%-8.8%2.3%Revenue receipts5.0%-6.0%-3.9%-7.4%5.7%(i) Tax revenue (net to centre)-5.2%-3.8%-7.7%-7.5%3.0%(ii) Non-tax revenue-3.0%-16.6%15.5%-6.9%16.6%Capital .3%0.4%(i) Non-plan expenditure9.3%2.8%-0.3%-1.5%-0.3%(ii) Plan expenditure-6.6%-20.6%-18.4%-19.5%2.6%(a) Revenue expenditure4.4%-3.3%-4.5%-6.4%0.8%(b) Capital expenditure-1.2%-18.5%-18.1%-13.3%-1.5%Revenue sideExpenditure sideTotal expenditureSource: Union Budget Documents, 2012-13 to 2016-17, *compared against revised estimates (the deviation is calculated as{(actual-budgeted)/budgeted]As per the framework, a country should be assigned an ‘A’ rating (which is the best) on expenditure out-turn if ‘in no more than one out of the last three years hasthe actual expenditure deviated from budgeted expenditure by an amount equivalent to more than 5% of budgeted expenditure’.2Throughout the document, the source is Union Budget Documents published annually, unless specified otherwise. Additionally, it should be noted that wherever2015–16 figures are compared, these relate to revised estimates since actuals are not available.1Public Finance Newsletter3
As can be seen from Table 1, the actual total receipts as well as actual total expenditure have been lower than budgetaryestimates for most of the last five-year period. For FY 2015–16, the revised estimates (RE) indicate that the Government ofIndia’s actual receipts and actual expenditure will be more aligned to budgetary estimates relative to performance in thepreceding four years. However, it can be observed that only RE are available till now, which are generally upwardly biased.For the last four years (FY 2011–12 to FY 2014–15), the actual revenue/expenditure has generally been lower thanthe RE (Table 2).Table 2: Actual vs RE, 2011–12 to %0.85%-1.41%-2.20%Revenue receiptsTotal expenditure-1.09%-1.43%-1.95%-1.04%(i) Plan expenditure-3.3%-3.6%-4.7%-1.1%(ii) Non-plan expenditure0.0%-0.5%-0.8%-1.0%Source: Union Budget Documents, 2012-13 to 2015-16, (-) denotes under-collection/spending, ( ) denotes over-collections/overspendingIn the subsequent sections, we have analysed the BE vis- à-vis trends and underlying assumptions for FY 2016–17 in depth.Revenue sideTax revenueThe Government of India’s projected tax revenue of nearly16 lakh crore INR in 2016–17 is fairly distributed across fivemajor sources—that is, corporate income tax (CIT), 30%;personal income tax (PIT), 22%; customs, 14%; union exciseduties, 20%; and service tax, 14%, with the remainingcoming from taxes in union territories (UTs).Figure 1: Tax revenue composition, 2016-17 BEUnion ExciseDuties , 20%Customs, 14%CorporateIncome Tax, 30%Tax Composition,2016 -17Personal IncomeTax, 22%Corporate income tax (30% share)The tax is levied on the income of companies under theIncome-tax Act, 1961. The CIT rates applicable on Indiancompanies are proposed to be reduced from the present30% (plus surcharge, education cess, and secondary andhigher education cess) level to 25% over the next four yearsin a phased manner, starting from FY 2016–17. Foreigncompanies (i.e. companies which are operating in Indiabut are registered under the laws of a country other thanIndia) are taxed at 40% (plus surcharge, education cess, andsecondary and higher education cess).The government has budgeted for 9% growth in thecollection of CIT in FY 2016–17 vis-à-vis FY 2015–164PwCThe projected growth of 9% appears to be realistic basedon buoyancy estimates calculated for the period after thefinancial crisis (Table 3) (9% 0.8 CIT buoyancy * 11%of annual GDP growth rate).Table 3: Buoyancy of CIT since 1998Taxes of UnionTerritories , 0%Service Tax, 14%(RE). Nominal GDP is estimated to register an annualgrowth of 11% in FY 2016–17 as per the Union Budget ofFY 2016–17.Buoyancy of CIT (in relation to nominal GDP)1998–20072008–20162.070.8However, it may be noted that expecting 9% growth inCIT collection on a base of generally optimistic REs of FY2015–16 may lead to an upward bias in the projections,particularly given the experience of under-collections forCIT during the last five years relative to BE. The actual CITcollections were 10%, 5%, 6%, 5% and 4% lower than theBE in the last five years (FY 2011–12 actuals to FY 2015–16RE), respectively.Additionally, it is noteworthy that cumulative arrears underCIT as on the reporting period of 2014–15 were nearly 62%of the revenues collected in FY 2014–15. It is understandablethat arrears recovery in dispute cases may take time.However, nearly 16% of the total arrears are undisputed.The Government of India has proposed a new DisputeResolution Scheme, under which the taxpayer with apending appeal before the Commissioner can settle her/hiscase by paying the disputed tax and interest up to the date ofthe assessment. Hence, if such tax arrears are collected, theexpected growth in CIT collections will move upwardin FY 2016–17.
Personal income tax (21% share)In India, ordinary residents are taxed on their worldwideincome. Non-resident Indians (NRIs) are taxed onlyon income that is received or deemed to be received inIndia, or which accrues or arises or is deemed to accrueor arise in India. A person who is a resident but notordinary resident (RNOR) is taxed like an NRI, exceptthat such a person is also liable to pay tax on incomeaccruing abroad, if it arises from a business controlled, ora profession set up, in India.The government has budgeted for 18% growth in PITcollections in FY2016–17 vis-à-vis FY2015–16 (RE).The projected growth is close to the long-term averagegrowth of 17.4% (FY 1988–89 to FY 2015–16 [RE]). Incomparison with CIT collections, the performance underPIT in terms of credibility of budgetary estimates hasbeen better in the last five years (Table 4).Table 4: Actual income tax collection vis-à-vis budgetaryestimates in the last five years, FY 2011–12 to FY 2015–16 (RE)education cess at 1%, (iv) an additional duty of customs(ADC)—to countervail state taxes, and VAT of 4% is chargedin addition to the above duties on imports, subject to certainexceptions. ADC is calculated on the aggregate of theassessable value of the imported goods, the total customsduties (i.e. BCD and CVD), and the applicable educationcess and secondary and higher education cess. In the budgetfor FY 2016–17, the finance minister has abolished sectorspecific duties such as duty on motor spirits and high-speeddiesel oil. However, levies/cesses on imported goods that areearmarked for specific purposes—namely education cess andsecondary and higher education cess—continue.Figure 2: Relationship between trade growth and customs revenuegrowth (1989–2014)60%50%40%30%20%10%YearActual 99-002004-052009-10-20%Customs Revenue GrowthAlthough projections for a majority of the PIT headsseem to be relatively realistic (more than 90%), onehead, namely ‘surcharge’, merits further consideration.The Government of India, in its budget for FY 2016–17,increased the surcharge from 12% to 15% on persons otherthan companies, firms and cooperative societies havingan annual income above 1 crore INR. The governmenthas increased its budgetary estimate under this head to7,650 crore INR from 7,500 crore INR in FY2015–16 (RE),amounting to a 2% percentage increase only. This seems anunderestimation unless there are policy changes proposedoutside the budget document. Given that the surchargerate has been increased by 25% (i.e. 12% to 15%), thecollections under the surcharge can go down only whenincome tax collections from individuals earning more than1 crore INR are expected to decline significantly, whichis not very likely. Hence, projections for collections undersurcharge may turn out to be underestimated.Customs duty (14.1% share)Customs duty is levied by the central government ongoods imported into, and exported from, India. Hence, thecollection is expected to be linked to trends in India’s tradewith the world. The rate of customs duty applicable to aproduct imported or exported depends on its classificationunder the Customs Tariff Act, 1975. Customs duty is leviedon the transaction value of the imported or exported goods.The customs duty applicable to any product is composedof a number of components—that is, (i) basic customsduty (BCD), (ii) additional customs duty in lieu of exciseduty, (iii) education cess at 2% and secondary and higher2014-15Trade GrowthThe government has projected an increase of nearly 10%growth in customs duty collections in FY 2016–17 from FY2015–16 (RE). The projected increase is not significantlydifferent from the long-term average growth rate (11% fornearly three decades); however, the risk from declining tradegrowth in the recent past remains. Analysis of trade andcustoms growth since 1989 shows that the two growth ratesare highly correlated (Figure 2). Since 2011–12, the annualtrade growth rate has been declining. In 2014–15, trade grewonly by 0.3%. Hence, there are downward risks in collectionsfrom custom duties.Union excise duties (20% share)Union excise duty is levied as per the rates specified in theFirst and Second Schedules of the Central Excise Tariff Act,1985. In FY 2015–16, the Government of India initiated somesteps to strengthen the administration of union excise duty,which included: (i) online central excise registration in twoworking days, (ii) increase in the time limit for central valueadded tax (CENVAT) credit on inputs and input services fromsix months to one year, and a (iii) facility to digitally signinvoices and maintain electronic records.With the fall in global oil prices, the government increasedexcise duty on petrol and diesel during the precedingfinancial year (FY 2015–16). Hence, collection under exciseon motor spirit and high-speed diesel oil was 72% and 68%more than that budgeted in 2015–16 respectively. Suchwindfall gains from oil may not be repeated in the comingfinancial year. The government has therefore brought downgrowth in the overall excise duty to 12% (from 24% in FY2015–16 [RE]), which is close to its long-term average growthrate (11.2% between FY 1989–90 to FY 2015–16 [RE]).Public Finance Newsletter5
Service tax (14.2% share)Figure 4: Interest income from states and UTs (crore INR)Non-tax revenueFigure 3: NTR composition, 2016–17Interest incomefrom dends fromPSEs17%Non - tax revenuecompositionPetroleum4%Dividend fromRBI, FIs22%Power4%Non-tax revenue (NTR) constitutes 16% of the centralgovernment’s total receipts (FY 2016–17 [BE]). Majorcomponents of NTR include dividends from public sectorenterprises (PSEs) and other investments (17%), dividendsfrom the Reserve Bank of India (RBI) and other financialinstitutions (22%), revenue from the power sector (5%),revenue from the petroleum sector (4%), revenue from othercommunication services (31%) and others (20%) (Figure 3).Interest receipts from statesThe government has budgeted for a 6% increase in interestreceipts on the central government’s loans to states in FY2016–17 vis-à-vis FY 2015–16 (RE). The expected increasecould be seen as a reversal of the declining trend since2007–08 (Figure 4). However, this can be attributed tounder-collections in FY 2015–16 (by 6.3%). Further, thecomparison of interest receipts expected in FY 2016–17 (BE)with FY 2015–16 (BE) shows a decline by 0.2%.6PwC15500Interest Receipts (INR Crore)The government has projected an increase in service taxcollections in FY 2016–17 by 5.3% vis-à-vis FY 2015–16(RE). In the budget for FY 2016–17, it has introduced theKrishi Kalyan Cess @ 0.5% on all taxable services, theproceeds of which will be exclusively used for financingactivities relating to the improvement of agriculture andwelfare of farmers. The cess came into force from 1 June2016. The government had introduced a similar cess forSwachh Bharat initiatives in November 2015 @ 0.5% onall taxable services. It should be mentioned here that whilethe base as well as the rate is the same for the two cesses,the budgetary estimates for FY 2016–17 are different. Thegovernment intends to collect 10,000 crore INR under theSwachh Bharat Cess and 5,000 crore INR under the KrishiKalyan Cess. Possible explanations for the difference can be:(i) credit of Krishi Kalyan Cess paid on the input side willbe available as credit for payment of the cess on the outputside. On the other hand, the Swachh Bharat Cess is a costand non-creditable, and (ii) while the Swachh Bharat Cesswill be levied during the entire financial year, the KrishiKalyan Cess will be levied only post 1 June 2016. Hence, theprojected collections appear to be 7 2008 2009 2010 2011 2012 2013 2014 2015 2016-08-09-12-13-14-15-16-17-10-11(RE) (BE)Dividends from central PSEs and on otherinvestments, RBI and financial institutionsDividend income from PSEs and on other investments isprojected to increase by 21% in FY 2016–17 vis-à-vis FY2015–16 (RE). Dividend income from RBI and other financialinstitutions such as nationalised banks and insurancecompanies (e.g. Life Insurance Corporation of India) is, on theother hand, budgeted to decline by 5% as compared with FY2015–16 (RE). Given the currently stressed financial situationof financial institutions, it is expected that the dividendincome of the government would be adversely affected.Revenue from power sector, petroleum and othercommunication servicesRevenue from the power sector relates to the fee receiptsof the Central Electricity Authority under the Electricity(Supply) Act, 2001. In FY 2015–16, NTR (RE) under this headwas 346% of BE. This was primarily due to 10,000 crore INRrevenue receipts from the Central Electricity Authority. Thegovernment has projected the revenue for FY 2016–17 togrow by 1% since no such windfall receipts are expected in FY2016–17. The projection of 1% growth in FY 2016–17 appearsto be realistic.Revenue from petroleum includes royalty on variouspetroleum resources, profits shared with the contractor on theproduction of petroleum, production-level payment, licensefees for exploration and petroleum mining leasing fees. In FY2015–16, collection under this head as per the RE was 23%lower than budgeted, which can be partially attributed tofalling oil prices. The government has, therefore, projected15% growth in revenue from petroleum for FY 2016–17, withthe expectation that crude oil prices will grow in the ensuingfinancial year.Revenue from other communication services includes onetime charges on auctioning of spectrum. Apart from this,it includes recurring license fees collected from telecomoperators and a one-time entry fee for new operators. Thegovernment expects a growth of 73% in FY2016–17 and aimsto collect about 98,994 crore INR from this head. This is dueto the expected spectrum auction starting from July 2016,and the expected collection of deferred payments of auctionsin the past will depend on the success of the auctions.
Expenditure sideOver the last three decades, the central governmentexpenditure as a percentage of GDP has gone down from18.7% in FY 1989–90 to 13.13% in FY 2016–17 (Figure5). This can be attributed to increasing expenditureresponsibilities at the state government/local governmentlevel (73rd and 74th constitutional amendments). Further,over time, the government has leveraged the strengths ofthe private sector in delivering services to the public.Budgeting for the 7th Pay CommissionrecommendationsTable 5 shows a comparison of pension expenditure asprojected by the 7th Pay Commission and provisions madein Budget 2016–17.Table 5: Pension expenditure 2016–17 (crore INR)As per the 7th 8-52,932Source: 7th Pay Comm
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