Sunday, 7 August 2016

Government of India borrows to pay interest on public debt

 Finance Minister with Budget papers

Budget papers being carried inside Parliament

The annual budget is the time when the government reviews the impact of its previous fiscal policies and gives short-term and medium-term roadmap. The biggest challenge is how to restrict chronic fiscal deficit (difference between total expenditure, revenue as well as capital excluding borrowings, and receipts, tax revenue as well as non-tax revenue). The 2015-16 budget estimate of   fiscal deficit was Rs. 5.56 lakh cr.  and of public debt burden Rs. 56 .58 lakh cr. (about 40% of the GDP). In his budget speech Finance Minister Arun Jaitely declared that “we will meet the challenging fiscal deficit target of 4.1% of GDP that we have inherited…to reduce and eliminate poverty” to: 3.9%, in 2015-16,  3.5% in 2016-17 and, 3.0% in 2017-18.

The purpose of this article is to analyse the causes of fiscal deficit and find out the best strategy to reduce it.

Causes nature and magnitude of fiscal deficit

Economists give several reasons for fiscal deficit: welfare measures; deliberate expansionary fiscal policy to boost aggregate demand, output and employment (known as Keynesian fiscal deficit); subsidy to boost agricultural and industrial production; wide disparity in income and wealth (resulting in reduced number of taxpayers); tax evasion and avoidance; inefficiency and corruption in government; etc. In our country, finance ministers have generally attributed rising fiscal deficits to the subsidies and  need for higher investment for socio-economic development, poverty removal and other welfare measures.  

The problems started with the 1973-74 budget, known as ‘Black Budget’ of India which projected fiscal deficit of Rs. 550 crore. Even then the situation was not that bad. Till 1978-79, the revenue account used to have some surplus available for meeting part of capital expenditure. From 1979-80 the revenue account also started showing deficit and the government had to resort to borrowing to meet part of the revenue expenditure as well. By 2005-06, the public debt had increased to 42.1% of GDP.  For 2015-16 it is estimated to be more than 43%. Table  below gives an idea of the nature and magnitude of the present problem
                                                                                                                         Rs. in cr.

2015-16 (Budget Estimate)
Total  Revenue & Capital receipts (excluding borrowings & other liabilities)
862140 (239.69%)
Total Expenditure (revenue & capital)
1271354 (251.19%)
Interest payment out of above
323515 (243.92%)
Fiscal Deficit (2-1) met through borrowings and other liabilities
409214 (279.45%)
Interest payment as % of tax revenue  (Centre’s share)

Interest payment as % of total expenditure

Interest payment as % of Fiscal Deficit

Fiscal deficit as % of GDP

Interest payment as % of GDP

Total debt burden (including external debt)
6073320 (on Oct 31, 2015)

It may be seen that the government is facing serious debt crisis. The major part of borrowings is needed for payment of interest on past debts, not for infrastructure development or social welfare. Interest payment alone accounts for more than 25% of total expenditure and a little less than 50% of the Centre’s share in tax collection. More than 50% of debt (estimated in 2015-16 budget) is on account of interest liabilities of the past 10 years alone. In 2015-16 budget interest liability accounts for 3.28% of GDP. Unless there is a drastic reduction in government expenditure – admittedly scope is limited – or there is very significant increase in tax revenue to enable debt repayment, government will go continue to borrow to pay interest and that would go on adding to the debt burden and interest liability, year after year and finance ministers will continue to make promises to bring down fiscal deficit, a very convenient way of hiding a major weakness of the government, its inability to check tax evasion and seize black money.

There is no official data about the magnitude of black money. According to a World Bank report India’s shadow economy in 2006 was 25.1 per cent of GDP, against 22.9 per cent in 1999. But that is only part of the story. According to an IMF study (2010), Indian residents sent around $ 88 billion abroad over the 1971-97 period, i.e. 20% of external debt raised by the country during that period.   In February 2012, the then CBI director had claimed ‘around $ 500 billion (more than Rs. 33 lakh cr. at the current exchange rate) of illegal money deposited by Indians in tax havens abroad.’  The Global Financial Integrity report (December 2015) claims that during the period 2004-13, Indians sent $ 510 billion (more than Rs. 34 lakh cr. at the current exchange rate) of black money abroad. The untaxed money smuggled out is brought back for investment as foreign investment. A 2011 study on foreign direct investments in India estimated that up to half the investments could be result of round-tripping.

We have a tradition of ignoring revenue services  but  demanding more public expenditure. In The Discovery of India (1945) Jawaharlal Nehru writes that Kautilya’s Arthashastra deals with almost every aspect of the theory and practice of government including taxation and revenue but it seems his interest was only academic. As Prime Minister he ignored Kautilya’s advice that ‘KOSH MULO HI DAND' i.e. ‘revenue is the backbone of administration’. The Nehruvian model of economic development was shortsighted as well as contradictory. The state was required to be the domain investor but Nehru did not pay any particular attention to have a strong  revenue service. He ignored the advice of famous economist Prof Nicholas Kaldor, who at the invitation of the government, had prepared a report on Indian tax reform (1956) and had suggested that since ‘revenue secures means for the rest’, the country needed a strong revenue service.  Nehru also ignored similar recommendations of other expert bodies. To Indira Gandhi socialism meant very high tax rates and interest rate.  She rejected recommendations of the Justice Wanchoo Committee on black money (December 1971) that ‘where efficiency means more money, outlay on personal should rightly be considered as an investment and not expenditure.’ The result of  high tax regime and neglect of revenue services was rapid growth in generation of black money.

When the government failed to anything, the IRS Association   started pleading the case before the Central Pay Commission (CPC). The first such effort was made before the fourth CPC which did not pay any attention. The fifth CPC suggested some minor improvements. The process of strengthening the revenue services remained slow. Ultimately the cadre structure recommended by a committee set up on the direction of the sixth CPC and implemented in 2013-14 made a major breakthrough, perhaps because of rapid increase in collection of direct taxes, far more than direct taxes, the main source of revenue till 2006-07. Since assessment year  2013-14, the water mark printed on the income tax acknowledgement form (ITR V)  states in Hindi ‘KOSH MULO DAND‘. 

Meanwhile, the generation of black money has been increasing. In 1956, Kaldor had estimated that it was about 6% of the GDP. Today, the combined value of black money in India and abroad is not less than 50% of the GDP. The sources of black money can be divided into two broad categories: (a) income from legal activities but not disclosed to the tax authorities, (b) income from illegal activities such as smuggling, trafficking in drugs, illegal mining, illegal felling of forests, illicit liquor trade, illegal trade in arms, money laundering, contract killing, kidnapping, human trafficking, robbery, theft, bank frauds, bribery, etc. etc. In several otherwise legal business where transactions are done partly or mainly in cash e.g. real estate, jewelry, retail stores, fees to professionals, donations, etc. generation of black money is very common. Thanks to the development of technology, information technology in particular, criminals are inventing new techniques and often seem to be ahead of investigating agencies. The latest is the use of Bitcoins (digital currency) for money laundering and tax evasion; the anonymous nature of transactions suits the offenders.

Existing legal and institutional arrangements for detecting black money

There are several government agencies.

·          Intelligence agencies such as Central Economic Intelligence Bureau (CEIB) to gather information about economic offences to be used by other law enforcing agencies.

·          Investigating agencies such as CBI and Enforcement Directorate (ED) which share  information with other agencies like income tax Department but use primarily for in-house action.

·           State governments’ anti-corruption bureaus, vigilance officers in government departments and PSUs.

·           Lokayuktas.

·           In-house agencies investigating agencies such as Directorate of Revenue Intelligence to gather information to for the Central Excise and Customs authorities and Directorate General of Income Tax (Investigation) and Directorate General of Income Tax (Intelligence and Criminal Investigation) to gather information for use by the income tax authorities.

·            Direct and indirect tax authorities detecting black money in normal course.

·            Tax collection machineries of state governments.

 There are serious shortcomings in the existing legal and administrative systems.

Despite so many investigating agencies, every day huge amount of black money is generated, a good part of it is sent outside and then brought back undetected. Detection is the exception rather than the rule and happens very much after the offenders have done their work and that too so cleverly or our investigating agencies are so inefficient or are corrupt or both that investigations go on for years without reaching finality. By the time Hassan Ali attracted attention of the Income Tax Department (in 2007), he had, through hawala, stashed nearly $ 8 billion in Swiss banks. Investigations are still going on. Income tax raiding party reached Yadav Singh, engineer-in-chief of Noida Authority, Greater Noida Authority and Yamuna Expressway Industrial Development Authority (without any degree in engineering) in November 2014 when he had illegally acquired assets worth Rs. 1000 cr. He was suspended in March 2012 for involvement in in a Rs. 954 cr. properties scam but was let off by the State Chief Minister.   Now CBI is breaking walls and floors in search of hidden treasure..

 In recent months many more such cases have surfaced. CBI investigations started much after Rose Valley chit fund Chief (Odisha) had duped people of Rs. 17,000 cr, Pearls Group chief had diverted the 618 crore to Australia and former media baron Peter Mookerjee and his wife  had siphoned off  more than Rs.  900 cr. from media firm. Similarly, ED investigations  started much after NCP leader Chhagan Bhujbal had built a vast empire, former telecom minister Maran and his family had laundered more than Rs.740 crore, former Air Force chief SP Tyagi’s cousins had invested his bribe money (from the Rs. 3586 crore VVIP chopper scam) and Hurriyat leader Ahmad Shah had used money received from Italy for the 26/11 Mumbai terror attack.

Even after an investigating agency completes its work, the matter goes to court of law where proceedings go on for years. The cases often collapse for want of valid proof of link between income/assets and the crime mentioned in the FIR.

All these agencies work under several legal and institutional constraints.

CBI and ED have police powers but they have to file FIRs for completing any investigation and then go to designated courts to seek punishment. CBI has no jurisdiction over state government officials unless permitted by state government or a court. Till recently, CBI could not take action against senior central government officers without government permission

CBI and ED can investigate only specific allegations and quantify illegal income/assets related only to those allegations. Every time the agency receives fresh allegation, it has to go through the same motion to investigate the specific allegation. Very often, a person who makes money from one crime, indulges in several other crimes and the total  illegal income or wealth of such a person may be much more than what CBI or ED investigated but these agencies have neither legal power nor professional expertise to quantify income and assets from all sources, a necessary action to unearth black money.

Income tax department is the only organisation which has the requisite legal authority, training and expertise to assess a person’s total income and assets, legal as well as in legal and bring within tax net all earnings, except those legally exempted. In other words, income tax Department can perform all the functions which CBI, ED and other investigating intelligence agencies do. Last month income tax raids exposed large hoarding, illegal trading and price manipulation of pulses. ED initiated action against Himachal Pradesh CM on the basis of information furnished by IT Department. IT  Department is investigating tax invasion by high profile Tamil Nadu company Vasan Healthcare which in the past enjoyed political backing. The department has unearthed a Rs. 1000 crore hawala racket with which Dawood Ibrahim is believed to be associated. Income tax authorities do not require permission of any external authority to initiate and complete proceedings to collect taxes evaded interest and impose penalties. They have to go to a court only when there is ground for imprisonment of a tax evader.  But the Department is seriously handicapped due to shortages of facilities for investigations. It has to depend on the local police for support to/protection during raids which may not be up to expectation. Theoretically there are arrangements for coordination with other investigating agencies but there is no integrated approach. As a result of constraints during the period 2000-01 to 2014-15, the value of unaccounted assets seized by the Department varied between Rs. 202.28 cr. to Rs. 963.50 cr. which was not even tip of the iceberg.

There has been some improvement in the recent past. The new law on black money has provisions for confiscation of income or wealth stashed abroad with penalty of 300% and rigourous imprisonment of 10 years. Under a special amnesty scheme announced before the implementation of the new law, 638 Indians disclosed Rs. 3770 cr. kept by them abroad on which they paid 30% the stacks and 30% as penalty.

 During the last 10 years, collection of direct taxes increased by more than 383%, as against increase of about 227% in indirect taxes. With more than 5.6% of GDP,  direct taxes are now the main sources of revenue, far ahead of indirect taxes which used to be the main source. Considering the magnitude of black money, there is scope for substantial increase in collection of direct taxes.

      The scope for new taxes and for increasing rates of existing taxes is limited. Implementation of Lodha Committee’s recommendation to legalise betting in cricket -there is equally strong case to legalise betting in other sports also - will solve the problem only marginally. 


(1)         We need a central data-bank to which information about all financial transactions above specified limits are automatically transferred by concerned authorities to facilitate quick investigation by tax authorities and other investigating agencies. Information about all economic and other important activities should ultimately be linked to biometric unique multipurpose identification number so that information about every citizen or organisation is available at the click of button.  Had there been such a data-bank, Hassan Ali would have been nabbed when he started sending money abroad. A committee set up by RBI has also suggested linking of all credit accounts to a unique biometric identifier such as Aadhaar. IT Department also plans to map taxpayer details via PAN. According to new rules cash receipts and high-value transactions beyond a certain threshold will have to be reported to the tax authorities online in a prescribed format. It would be much better if wherever feasible transactions are automatically sent to the central data-bank and taxpayers are also required to furnish information in the income tax return to facilitate crosschecking at the time of processing of returns.

(2)         CBI being a police organisation should concentrate on the area of its core competence, namely enquiry of crimes like murders and trapping cases of bribery. Laws should be amended to make investigation of economic offences including cases of disproportionate assets by politicians and public servants the responsibility of the income tax Department assisted by investigating agencies like CBI and ED. The final investigation reports of these agencies should be submitted to the income tax authorities for further action. The income tax authorities will assess income from all sources, legal as well as illegal.

(3)         Income tax assessment order of a person found guilty of indulging in illegal economic activities should be in two parts: one part dealing with income from legal activities, declared voluntarily as well as detected by tax authorities and the other part dealing with income from illegal activities. There are already legal provisions in the income tax act to impose penalties and even initiate prosecution for tax evasion. The income/assets from illegal activities should be completely confiscated and the guilty should face not only penalty but also imprisonment.

(4)         Presently, tax evasion is not considered a very serious offence. Under the Representation of the People (RP) act, 1951, a person on whom fine is imposed for offence of bribery (no minimum amount is mentioned) under the Indian Penal Code is disqualified for contesting elections for six years but a tax evader on whom penalty of crores of rupees is imposed or who is imprisoned for less than two years for tax evasion is not disqualified. The RP Act should be amended to disqualify serious tax offenders from contesting elections. Similarly, laws should be amended to disqualify such persons from holding responsible positions in public or private sector.

(5)         Income tax department needs to be suitably strengthened with more staff, facilities and status to discharge its challenging task efficiently and honestly and create a fear in the minds of tax evaders and economic offenders.

It is quite possible that there would be opposition to giving more teeth to IT Department on the ground that it would lead to harassment of public and more corruption. If such arguments are applied to the police, no power should be given to any police man because there is more misuse of power by the police than by any other agency in the country. A strong and honest vigilance machinery is necessary to keep a check on misuse of power and corruption in any organisation. Throwing baby with bathwater is not the remedy.

The bottom line is that unless the country has strong laws and administration to deal with economic offences and collection of direct taxes improves substantially, fiscal deficit will never end.

Devendra Narain
IRS (Retd.)

January 21, 2016

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