NCAER Calls For Forensic Analysis Of State Finances To Curb Deficits

The think tank suggests conducting forensic analysis to identify revenue shortfalls and excessive expenditures in fiscally weak states. It also emphasizes improving revenue generation through digitalization, broader tax bases, and privatization while redirecting spending towards infrastructure and capacity-building

The prominent think tank National Council of Applied Economic Research (NCAER) has made seven recommendations to strengthen state finances, including forensic analysis, digitization, review of the roles of the Finance Commission and Reserve Bank of India (RBI), and institutional reforms.

In a recent working paper, ‘The State of the States: Federal Finance in India’ by Barry Eichengreen and Poonam Gupta, the NCAER said: “Officials should conduct a forensic analysis identifying the specific revenue shortfalls or expenditure overruns resulting in excessive budget deficits and debt increases in the fiscally worst performing states.”

Second, State governments should improve revenue mobilization through digitalization and administrative streamlining, by broadening the tax base, raising property tax, adopting new taxes, and increasing privatization receipts, while re-orienting spending toward capacity- and infrastructure-enhancing investment that promises to further boost States’ GSDP and revenues.

Third, State governments should acknowledge the risk to the public finances posed by contingent liabilities. These should be addressed by adopting institutional reforms, such as creating self-standing debt management offices at the state level responsible for forecasting contingent liabilities, and more generally for executing the State government’s debt management strategy, assessing the tradeoffs associated with different strategies, and providing advice to governmental decision-makers, the NCAER paper said.

Fourth, to further strengthen institutional capacity, each state could create its own independent fiscal council, whose members would include academics, financial market participants, and other experts.

Fifth, the RBI should review its policies of intervening in the markets to cap spreads on the bonds of heavily indebted states. Limiting such intervention would strengthen market discipline.

Sixth, the role of the Finance Commission should be reconsidered. Finance Commissions have not been asked to consider overall fiscal prudence when recommending allocations. The horizontal devolution of taxes among states does not provide incentives for fiscal rectitude, the paper said.

“Perversely, Finance Commissions are mandated to allocate more resources to states with larger revenue deficits, which is an obvious source of moral hazard and a mechanism through which errant states are subsidized.”

Seventh and finally, there may be room for a fiscal ‘grand bargain,’ where heavily indebted states with the worst prospects receive a modicum of debt relief in return for their conceding additional Central government oversight and even a loss of fiscal autonomy, the NCAER paper said.