Yesterday evening, a friend from school WhatsApped a doubt he had. He wanted to know if petrol and diesel prices were high because the Narendra Modi government had to repay oil bonds, which had been issued by United Progressive Alliance (UPA) government more than a decade back.
To repay these oil bonds, money is needed. This has led to significantly higher central government taxes on petrol and diesel, which has in turn led to higher pump prices.
However convincing the argument may sound, it’s wrong. 100% wrong. And I have been saying this for a few years now.
Of course, my saying this hardly makes a difference, given that every time petrol and diesel prices rise, WhatsApp starts buzzing all over again with forwards blaming oil bonds issued by the UPA for high petrol and diesel prices. Currently, the price of petrol is more than Rs 100 per litre in several parts of the country.
This high price is on account of a higher excise duty collected by the central government in order to compensate for a fall in corporate tax collections. In that sense, you and I are bearing the cost of lower corporate taxes, in the form of a higher price of petrol and diesel.
Let’s try and understand the issue of high petrol and diesel prices, and why things are the way they are, in some detail.
1)Crude oil prices have risen between last year and now. In June 2020, the average price of the Indian basket of crude oil was at $40.63 per barrel. As of June 16, 2021, the price was at $73.18 per barrel. Clearly, this is one reason behind the rise in petrol and diesel prices, but this isn’t the only reason, and not even the main one.
2) Before getting into any other detail, let’s understand what oil bonds are. These bonds were issued by the UPA government to the oil marketing companies (Indian Oil, Bharat Petroleum, Hindustan Petroleum), for the under-recoveries (the difference between the administrative price and the cost) they suffered when selling petrol, diesel, kerosene and domestic cooking gas, below their cost. This happened up until 2009-2010. Officially, these bonds are referred to as special securities issued to oil marketing companies in lieu of cash subsidy.
Instead of compensating companies immediately for the subsidy offered by them, by giving them money, the government gave them oil bonds, which would pay annual interest and mature a few years down the line. By doing this, the government expenditure during those years didn’t go up. This helped control the fiscal deficit in those years, when oil bonds were issued. Fiscal deficit is the difference between what a government earns and what it spends.
3) Of course, these bonds would mature over the years and the government of the day would have to repay them. And that would need money. So what is the value of these bonds which the government still needs to repay? In a question raised in the Rajya Sabha in December 2018, the government had said: “The current outstanding balance on account of Government of India (GoI) Special Bonds issued to the Public Sector Oil Marketing Companies (OMCs) in lieu of cash subsidy is about Rs 1.30 lakh crore.”
So, two and a half years back, the value of the outstanding oil bonds had stood at around Rs 1.30 lakh crore. What’s the latest number? Take a look at the following table. It has been sourced from the latest government budget. It lists out the different oil bonds that are still to be repaid, with their maturity dates.
What does this table tell us? It tells us that as of March 2021, the total outstanding oil bonds issued by the government stood at Rs 1,30,923 crore. Or the same as what the government had told the Rajya Sabha in December 2018.
4)In fact, the amount of outstanding oil bonds has barely changed during Modi government’s tenure. Look at the following tabled sourced from the 2014-15 budget, presented in July 2014, after Narendra Modi became prime minister.
As of March 2014, the total outstanding oil bonds stood at Rs 1,34,423 crore. Two different oil bonds with maturity amounts of Rs 1,750 crore each, matured in 2014-15, on March 7, 2015, and March 23, 2015, respectively. This brought down to the total outstanding oil bonds to Rs 1,30,923 crore, and which is the current outstanding amount as well.
The point being that the government hasn’t had to repay any outstanding oil bonds since March 2015. Of course, it has had to pay an interest on these oil bonds, like it does on all other bonds.
How much is this interest? As the government told the Rajya Sabha in December 2018: “The annual aggregated amount of Rs 9,989.96 crore was paid every year during 2015-16 to 2017-18 and the similar amount is required to be paid in the current financial year.”
Given that, the outstanding amount of oil bonds didn’t change through 2018-19, 2019-20 and 2020-21, the government would have paid the same amount as interest in each of these years, as it did during 2015-16 to 2017-18.
How does the situation look in 2021-22, the current financial year? As can be seen from both the tables (I know the tables are not very clear. If you really want to verify the data, the source of the tables is available just below them. All you need to do is click), Rs 5,000 crore of bonds are due to be repaid on October 16 and November 28, respectively, later this year. This amounts to Rs 10,000 crore in total.
Over and above this, interest needs to be repaid on the outstanding bonds. Given that Rs 10,000 crore worth of bonds of the total Rs 1,30,923 crore of oil bonds, will be repaid during this financial year, the interest to be paid on the remaining bonds will be less than Rs 9,989.96 crore that the government has been paying year on year. A back of the envelope calculation tells us that the interest to be paid this year should amount to around Rs 9,500 crore.
Hence, in total, the government needs Rs 19,500 crore to repay oil bonds as well as pay interest on them during 2021-22. When it comes to government finances, this is small change.
5)If we look at the excise duty collected on petroleum products over the years, data from Petroleum Planning and Analysis Cell tells us that it stood at Rs 99,068 crore in 2014-15, the financial year in which Narendra Modi was sworn in as prime minister.
The number reached Rs 2,23,057 crore in 2019-20. It touched Rs 2,35,811 crore between April and December 2020, the first nine months of 2020-21. Given this, it would have crossed Rs 3,00,000 crore during 2020-21.
In 2021-22, the central government expects to collect more than Rs 3,00,000 crore through excise duties on petroleum products. A look at this year’s budget tells us that the government hopes to collect Rs 74,350 crore on special additional duty of excise on motor spirit(petrol) and Rs 1,98,000 crore through duty of excise on motor spirit and high-speed diesel oil (road and infrastructure cess). Just this adds to close to Rs 2.75 lakh crore.
Over and above this, one needs to pay a basic excise duty on every litre of petrol and diesel purchased, and there is an agriculture infrastructure and development cess to be paid as well. Clearly, this year, the government will earn more than Rs 3 lakh crore from different kinds of excise duties on petroleum products.
From February 2, 2021, the total excise duty on petrol and diesel has stood at Rs 32.90 per litre and Rs 31.80 per litre, respectively. The total central excise duties on petrol and diesel have been rising since 2014. They had stood at Rs 10.38 per litre and Rs 4.52 per litre in March 2014.
In fact, even in April 2020, they had stood at Rs 22.98 per litre and Rs 18.83 per litre, respectively.
Between April last year and now, the petrol price is higher by close to Rs 10 per litre just because of higher central government taxes on it. When it comes to diesel, it is higher by close to Rs 13 per litre because of this.
6) There is another small reason for higher prices as well. The state government taxes on petrol and diesel are ad valorem, that is they are a certain percentage of the price charged to dealers plus the excise duty of the central government plus the dealer commission on every litre of petrol and diesel sold.
Take a look at the following table, which has the detail for petrol sold in Delhi.
The price of petrol charged to dealers in Delhi by Bharat Petroleum was at Rs 37.68 per litre as on June 16. On this there was an excise duty charged by the central government of Rs 32.90 per litre along with a dealer commission of Rs 3.80 per litre. This adds up to Rs 74.38 per litre.
On this, the Delhi government charges a value added tax of 30%, which amounts to Rs 22.32 per litre. This leads to a retail selling price of Rs 96.70 per litre (Rs 74.38 plus Rs 22.32) in Delhi.
Like, the Delhi government, other state governments also charge a value added tax or a sales tax on petrol and diesel sold in their respective territories. The 30% tax charged by the Delhi government is ad valorem. Hence, if the petrol price charged to dealers goes up as oil price goes up, the tax collected by the Delhi government also goes up.
Over and above this, when the central government increases the excise duty on petrol, the tax collected by the Delhi government (and all other governments) goes up because the state government charges a value added tax on dealer price plus excise duty plus dealer commission.
Hence, every time you and I buy petrol or diesel, we are paying a tax on tax. This is an anomaly that needs to be set right. And state governments need to charge a sales tax just on the dealer price and commission, and not on the central government excise duty as well.
7)A major reason for the central government implementing a high excise duty on petrol and diesel, lies in the fact that the government’s tax revenues as a proportion of the size of the Indian economy, measured by the gross domestic product (GDP), has been falling over the years.
Look at the following chart. It plots the ratio of gross tax revenue earned by the central government as a proportion of the GDP.
Source: Centre for Monitoring Indian Economy and Controller General of Accounts.
What does this chart show? It shows that the gross tax revenue as a percentage of the GDP reached an all-time high of 12.11% in 2007-08. The gross tax revenue was at 11.22% of the GDP in 2017-18 and fell to 10.25% of the GDP in 2020-21.
The recent fall has been more because of a fall in corporate tax collections. In 2017-18, the corporate tax collections amounted to a total of 3.34% of the GDP and fell to 2.32% of the GDP in 2020-21. This was despite the listed companies registering bumper profits during the financial year.
Corporate taxes have come down primarily on account of the base tax rate being cut from 30% to 22% in September 2019 and to 15% from the earlier 25% for new manufacturing companies.
In absolute terms, the total corporate tax collected in 2019-20 had stood at Rs 5.57 lakh crore. It fell to Rs 4.57 lakh crore in 2020-21, thanks to lower tax rates. The collections of the goods and services tax have also not gone along expected lines.
To compensate for this to some extent, the government has had to increase the excise duty on petroleum products. Hence, it is only fair to say that the cost of lower corporate tax rates for the government, is being borne by citizens in the form of higher petrol and diesel prices. There is no free lunch, as I keep reminding.
To conclude, while the revenue earned by the government can vary, its expenditure doesn’t. It usually goes up year on year. In 2017-18, the total expenditure to GDP ratio stood at 12.53%. This jumped to 17.47% in 2020-21. Of course, 2020-21, could very well be an anomaly given that the size of the economy (GDP) contracted.
Nevertheless, the expenditure in 2019-20 had also stood at a higher 13.20% of the GDP, while the gross tax collections fell. And someone had to pay for this.
Note: Detailed analysis takes time. Like this piece took three weeks to write. Hence, please continue supporting this effort. Every rupee helps.
Chintan Patel and Vivek Kaul
The devil, as they say, is always in the detail.
Nevertheless, in an era of instant digital journalism, where you, dear reader, are constantly bombarded with information, the real story, or should we say stories, often get buried under numerous headlines, lazy journalism, government press releases and the false news that is the flavour of the day.
But if one is willing to do some basic number-crunching, like we are, some interesting details and narratives can emerge.
This is one such story of the central government taking both the states and the common man, for a ride and that too in broad day light. At the risk of stretching the metaphor a bit too far, the scene of the crime is the petrol pump and the motive, the dire state of the economy.
But to do this story full justice, we need to set up the background with some dry, academic points as well as digress into some adjacent details.
So, kindly bear with us. While sensational things might get you excited and help us get a few more clicks, but as we said at the beginning, the devil is in the detail.
And here’s presenting the detail.
What’s the point?
Over the years, the central government has been sharing less and less of the overall taxes that it collects, with the state governments. This is the main point we make in this piece.
The annual budget of the central government is presented in February ever year. The budget is analysed by the media in minute detail.
However, amidst all the analyses, one subject that is often ignored is the financial relationship between the central government and the state governments. After all, much of the services that the government provides are in fact delivered by local and state governments.
It is worth remembering that while the central government collects the bulk of the taxes in the country, it’s the states that the taxes ultimately come from. And given that, this money in one way or another needs to go back to the states.
But does it? The short answer is no. And there is a longer answer which explains the reasons, has some nuance and which forms the heart of this piece.
This piece is divided into three sections. The first section provides a background on how tax revenue is transferred from the central government to the state governments and the role of the Finance Commission.
The second section focuses on a special tax category – cess and surcharge, their increased prominence in recent times, and how that raises prices of petrol and diesel.
The third and final section examines the trend of total transfer of funds from the central government to the state governments.
This is an opportune time for such an analysis, since this year’s Union budget was accompanied by the unveiling of the 15th Finance Commission’s report for the period 2021-22 to 2025-26.
So, read on, to find out.
Who Gets How Much?
The Constitution stipulates how taxes are collected and split between the central government and the state governments. It empowers the central government as well as the state governments to raise revenues from different sources of taxation.
The central government gets to collect more taxes while the state governments end up with the bigger portion of the expenditure, leading to a mismatch. This mismatch of money that is earned through taxes and other routes and money that needs to be spent, is referred to as a “vertical imbalance”.
Take a look at Figure 1. In 2018-19, the Union Government raised 62.7 per cent of the aggregate resources raised by both the Union and states, whereas the states spent 62.4 per cent of the combined aggregate expenditure. While Figure 1 shares data for just one financial year, what’s true for 2018-19 has also been true for other financial years.
Figure 1: Vertical imbalance (2018-19)
Source: 15th Finance Commission Report.
To offset this imbalance, the Constitution provides mechanisms for intergovernmental transfers – the transfer of funds from the central government to the state governments. A key player of this setup is the Finance Commission.
The Finance Commission (FC) is an advisory body that is appointed by the President every five years and which evaluates the state of finances of the central as well as the state governments, and determines how taxes collected by the central government are to be distributed between the central government and the state governments, and among the state governments.
Over and above this, the FC also recommends grants to states based on revenue needs, grants for local governments and grants for specific purposes e.g. health sector grants etc. Thus, there are two broad channels of transfer of funds under the FC umbrella – i) devolution of taxes, and ii) grants.
At the heart of the idea of intergovernmental transfers and tax devolution is the concept of ‘divisible pool’. The divisible pool is the portion of the taxes (technically referred to as the gross tax revenue) collected by the central government, which is distributed between it and the state governments. What this means is that all the taxes collected by the central government aren’t shareable with the state governments.
Till the tenth FC which tabled its report in 1995, only union excise duties and personal income taxes made up the divisible pool. Under this arrangement, 85% of the personal income taxes and 40-45% of excise duties were shared with the state governments.
In 2000, the tenth FC recommended a constitutional amendment to expand the divisible pool to all central taxes. The central government accepted this recommendation and the 80th Amendment was passed making a certain portion of central government taxes shareable with the state governments, effective retrospectively from April 1, 1996.
Further, the portion of the divisible pool that is shared with the states is referred to as the devolution of taxes and is determined by the FC. Before the14th FC which came into effect from April 2015, 32% of the divisible pool was shared with the states.
The 14th FC increased the share of the state governments in the divisible pool to 42%. At the same time, the sector-specific grants were eliminated. This decision was primarily in response to grievances expressed by the state governments. State governments prefer funding through devolution since such transfers are unconditional.
Other transfers of money, whether they are through FC grants, or through channels outside the FC (like schemes from central government ministries) impose policy priorities set by the central government over the state governments, compromising the latter’s fiscal flexibility or the ability to spend money as the state government deems fit.
To give an example, a FC health-sector grant can only be used for health spending by the states, or funds transferred to the states under Pradhan Mantri Gram Sadak Yojana can only be used to make roads.
When state governments have more flexibility in allocating funds for various initiatives, they can craft policy that is more responsive to the needs on the ground than having to blindly follow policy that is framed in New Delhi.
The 14th FC recognised this and increased the state share of the divisible pool from 32% to 42%. The intent behind this increase was not to increase the amount of transfers but rather change the composition of the transfers – from diverting conditional funds to diverting unconditional funds, to state governments.
The 15th FC tabled in 2021 lowered the divisible pool marginally to 41%, from the earlier 42%. The is because Jammu and Kashmir is no longer a state and the money allocated to it has not been counted as transfer to a state government. Given this, the 15th FC has kept the divisible pool distribution unchanged.
And now we come to the most important point of this write up. A key detail in this entire discussion is that the only tax revenue that is excluded from the shared divisible pool are different kinds of surcharges and cess.
As we shall see next, this exclusion has proved to be the back door that the central government has been using to divert funds from the states governments’ kitty to its own.
A Tale of Two Taxes
Before we get into the details, let’s first try and understand what surcharge and cess actually are.
A cess is tax on a tax imposed by the central government attached to a specific purpose. For example, an education cess collected should be utilised only for financing education and not for any other purpose. It is worth remembering here that the education cess is imposed on the total income tax and not on the total taxable income.
Hence, as explained earlier, it is a tax on a tax. Examples include infrastructure cess on petrol and diesel, krishi kalyan cess, health and education cess on Income Tax, etc.
In theory, money collected under a cess is to be spent on the specific purpose for which it is collected but that’s not always the case.
A Comptroller and Auditor General (CAG) report for 2018-19 indicates that only Rs 1.64 lakh crore of the Rs 2.74 lakh crore or around 60% of the amount collected from cess and surcharge during 2018-19 had been transferred to their respective funds. Around 40% was still retained in the Consolidated Fund of India, which is the general-purpose fund of the Indian government.
The provision of levying a cess was intended to be used for shorter specific purposes. So, the procedure for introducing a cess is comparatively simpler than introducing new taxes, which usually require change in the law.
Coming to surcharges, a surcharge is also a tax on a tax, but is not tied to a specific purpose like a cess is. Let’s take the example of the surcharge on income tax. It is an added tax on the taxpayers having a higher taxable income during a particular financial year. So, an individual having a taxable income between Rs 50 Lakhs and Rs 1 crore pays an income tax surcharge of 10%.
Further, an individual with a taxable income between Rs 1 crore and Rs 2 crore, pays an income tax surcharge of 15%, and so on.
Note that this surcharge is only on the base income tax, not on the income itself. So, if an individual earning Rs 1 crore in a year needs to pay an income tax of Rs 20 lakhs, the applicable surcharge would be Rs 2 lakhs (10% of 20 lakhs).
A surcharge can be utilised for any purpose of the government, without having to bend the rules, like they do sometimes for cess collections.
In the last few years, these surcharges and cess, which do not need to be shared with the state governments, have become the central government’s go-to tools to address the tax revenue shortfall.
Take a look at Figure 2a, which basically plots the total amount of surcharges and cess collected by the central government over the years, along with the surcharge and cess it hopes to collect during 2021-22, the current financial year.
Figure 2a: Total cess and surcharge revenue (in Rs crore).
Source: Union budget documents.
Figure 2a clearly shows that the general trend is upwards, with small blips in 2017-18 and 2018-19. The government expects to collect total surcharges and cess of Rs 4,45,822 crore (revised estimate) in 2020-21.
This is surprising given that overall tax collection during the year is expected to come down. In comparison to the years before 2020-21, the collections for 2021-22 are also expected to be at a very high Rs 4,48,821 crore.
The collections of cess and surcharge surged from Rs 2,53,540 crore in 2019-20 to Rs 4,48,822 crore (RE) in 2020-21, an increase of a whopping 77%. This huge increase is almost entirely due to increased cess and surcharge on petrol and diesel – in particular, the road and infrastructure cess and the additional duty of excise on motor spirit (which is a surcharge), which increased by Rs 1,92,792 crore. Motor spirit is the technical term for petrol.
The increased reliance on cess and surcharge is also seen in Figure 2b below, which plots the total cess and surcharge earned by the central government as a proportion of the Indian gross domestic product (GDP). This is done in order to take the size of the Indian economy into account as well.
Figure 2b: Cess and surcharge revenue expressed as a proportion of the GDP (in %).
Source: Union budget documents.
The above figure makes for very interesting reading. The total amount of cess and surcharges earned by the central government went up from 1.25% of the GDP in 2019-20 to 2.29% of the GDP in 2020-21, a massive jump of 104 basis points. Some of this jump was obviously because the size of the economy or the GDP is expected to contract in 2020-21. Nevertheless, the fact that cess and surcharges collected by the government went up in a year when the economy contracted, does come as a surprise.
In Figure 3, let us look at the breakdown between cess and surcharges earned by the central government over the years. Looking at the below figure it is evident that cess collections form the bulk of the total revenue.
Figure 3: Cess and surcharge breakdown (in Rs crore).
Source: Union budget documents.
Clearly, cess is bringing in more money for the central government, though the contribution of surcharges has also jumped up since 2019-20.
Now let’s try and understand, why has the central government increasingly become more dependent on earning money through cess and surcharges, and in the process it is sharing lesser proportion of taxes with the state governments.
This increased reliance on cess and surcharges in the last two years can be understood when one looks at what is happening with the total tax revenue. Figure 4 plots the total taxes earned by the central government or gross tax revenue as a proportion of the GDP.
Figure 4: Gross tax revenue as a proportion of GDP (in %).
Source: Union budget documents
While the negative economic impact of the covid pandemic has been a telling blow, the downward trajectory in tax collections of the central government had started as far as back as 2018-19. The twin economic debacles of PM Modi’s first term – demonetisation and a shaky GST implementation – meant the economy was already tottering before the covid pandemic hit.
An obvious casualty of this slowdown has been a declining tax revenue as a proportion of the GDP. In the normal scheme of things, this would have meant that the central government would have ended up with lesser taxes for itself, after sharing with the state governments.
But this fall has been cushioned with the central government earning a higher amount of taxes through cess and surcharges (as can be seen from Figure 5).
Figure 5: Cess and surcharge as a proportion of total central government taxes.
Source: Union budget Documents RE = Revised Estimate BE = Budget Estimate
In 2019-20, the total taxes earned by the government or the gross tax revenue had stood at Rs 20.1 lakh crore. In 2020-21, it is expected to fall by 5.5% to Rs 19 lakh crore. The net tax revenue of the central government (what remains after sharing taxes with the state governments) in 2019-20 was at Rs 13.59 lakh core.
This is expected to fall to Rs 13.45 lakh crore in 2020-21, a fall of 0.9%, which is much lower than the 5.5% fall in gross tax revenue. While, the total gross tax revenue is expected to fall by Rs 1.1 lakh crore (Rs 20.1 lakh crore minus Rs 19 lakh crore), the net tax revenue is expected to fall by just Rs 14,000 crore (Rs 13.59 lakh crore minus Rs 13.45 lakh crore).
In percentage terms, in 2019-20, the central government kept 67.6% of the taxes for itself in 2019-20. This shot up to 70.8% in 2020-21.
Clearly, the state governments have been short-changed here, with their share of taxes falling from Rs 6.51 lakh crore in 2019-20 to Rs 5.5 lakh crore in 2020-21, a fall of a little over Rs 1 lakh crore or 15.5%, in such economically difficult times.
This is primarily because the share of cess and surcharge in total taxes collected by the central government has jumped from 12.67% in 2019-20 to 23.46% in 2020-21. Do remember that cess and surcharges are outside the divisible pool.
So, when the inflow of these taxes increases, the central government gets to keep all the revenue, as opposed to sharing 41% (15th FC guideline) with the state governments. So, it is far more efficient for the central government to increase cess and surcharge when it needs to increase tax collection.
This overuse of cess and surcharges by the central government has not gone unnoticed. In fact, the chairman of the 15th FC, NK Singh has talked about introducing a constitutional amendment to include them in the divisible pool.
“I see no viable solution except a constitutional amendment. If that constitutional amendment is introduced, recognizing some proportion of cess and surcharge to the divisible pool, it will certainly allow greater flexibility to the successive Finance Commissions subsequently to be able to calibrate a framework.”
Ultimately, as we said at the very beginning, whatever might be the term used, a tax, or a cess or a surcharge for that matter, it is being paid by people. And hence, the money thus collected should be shared with the state governments.
How does all this affect you, dear reader?
If you have managed to make it thus far, many of you by now would be like how much gyan are these guys going to give. Why can’t they tell me straightaway how does all this impact me or the world at large or the aam aadmi?
Well, sometimes it is important to take a look at the bigger picture first and then arrive at how it impacts all of us.
The government’s increased reliance primarily on cess actually has had a direct impact on most citizens – in the form of increased prices at the petrol pump.
The biggest contributor to the spike in cess collection over the last two years has been cess collected on the sale of petroleum products. The figure below charts the total cess collected on petroleum products (crude oil, petrol and diesel) over the last five years. While the cess on petrol formed at least 50% of total cess each year, it was as high as 69% of the total cess revenue in financial years 2019-20 and 2020-21.
Figure 6 clearly shows that the government has resorted to taxing petrol and diesel to make up for revenue shortfalls. This conclusion is hardly a revelation to anyone paying attention to prices at the pump, but the numbers help understand the government’s motivation.
Figure 6: Total cess on petroleum products (in Rs crore).
Source: Union budget documents
There is another way of looking at the cess on petrol and diesel. Table 1 below gives a breakdown of the union taxes on petrol and diesel for 2020-21 and 2021-22. Note that the table below only analyses central excise tax and excludes customs duty. There are technical complications in figuring out the per litre customs duty.
Table 1: Central government tax breakdown on petrol and diesel.
The total union excise duty on petrol and diesel, in 2021-22 are Rs 32.90 per litre and Rs 31.80 per litre, respectively, which are marginally lower than the previous year. All taxes other than basic excise duty, including special additional excise duty, which is a surcharge, are exempt from the divisible pool.
1)For 2021-22, only ~5% of the excise taxes on petrol and diesel will go to the divisible pool. The rest (~95%) will be kept by the central government. In 2020-21, this portion was at around 91% for petrol and 85% for diesel. Clearly, the government is keeping a greater share of petrol and diesel taxes for itself.
2)The above point does not clearly bring out the gravity of the situation. Let’s do a simple calculation to show that. In 2021-22, the total excise duty on petrol stands at Rs 32.90 per litre. Of this, the basic excise duty of Rs 1.4 per litre is the only part which is a part of the divisible pool and hence, will be shared with the states. It is worth remembering only 41% of this or around 57 paisa per litre needs to be shared with the state governments.
What this means is that just 1.7% of the total excise duty earned by the central government per litre of petrol will be shared with the state governments. It was at 3.8% in 2020-21.
3)Now let’s carry out the same exercise for diesel. The total excise duty earned by the central government on the sale of one litre of diesel will be Rs 31.80 during 2021-22. Of this only Rs 1.8 per litre will be shareable with state governments. 41% of this amounts to around 74 paisa per litre.
This amounts to around 2.3% of the total excise duty of Rs 31.8 per litre earned by the central government per litre of diesel. It was at 6.4% in 2020-21.
4)In 2021-22, a new agriculture infra cess has been introduced. It amounts to Rs 2.5 per litre on petrol and Rs 4 per litre on diesel. This has led to the reduction of basic excise duty on petrol from Rs 2.98 per litre to Rs 1.4 per litre and that on diesel from Rs 4.83 per litre to Rs 1.8 litre. As mentioned earlier, only the basic excise duty needs to be shared with the state governments.
Hence, by introducing a new agriculture infra cess, the central government has ensured that state governments get an even lower share of taxes from petrol and diesel in 2021-22.
The general public is quite sensitive to price rise at the petrol pump since it is a highly visible and recurrent cost. That the government has still resorted to this strategy for increasing revenue, speaks to the lack of better options – a fact that is a direct consequence of the tepid economic scenario even before the pandemic began. Of course, the covid pandemic has only made things more difficult for the government on tax front.
Nonetheless, things are even more difficult for state governments, which don’t have many avenues to raise tax. Clearly, this amounts to the centre shortchanging the state governments during difficult economic times.
Oh wait, there is more – Total intergovernmental transfers
Other than the divisible pool of taxes, there are other channels of intergovernmental transfers between the central government and the state governments. So, to get the complete picture on the flow of money from the central government to the state governments, it is instructive to examine the total intergovernmental funds transferred in more detail.
Before diving into those details, a brief overview of intergovernmental transfers would be useful. Figure 7 below is a good graphical representation of all the ways in which the central government can transfer funds to the state governments.
Broadly speaking there are two instruments of fund transfers.
1)Finance Commission funds: As discussed earlier, this includes the 41% of the divisible pool revenue, general-purpose grants for states with weak revenue raising capacity and specific purpose grants for funding local governments (panchayats and municipalities) and funding certain specific initiatives (eg. health-sector grants by the 15th FC). Most of the funds provided via the FC channel are not conditional and don’t require state government contributions.
2)Funds from central ministries: In addition to the FC funds, the central government also gives specific purpose grants through the respective ministries. These funds are transferred either through centrally sponsored schemes or central sector schemes. Central sector schemes are entirely funded by the central government. Some examples include the free LPG connections provided to poor households, crop insurance scheme etc.
The centrally sponsored schemes require a matching component from the state governments i.e. they have to fund a portion of the scheme. Examples of this include the Pradhan Mantri Gram Sadak Yojana, the Swachh Bharat Mission etc.
As Figure 7 shows, the mechanism of intergovernmental transfer underwent a major transformation in 2015. Two things led to this. Firstly, the 14th FC gave its recommendations for increasing the devolution share of state governments from 32% to 42% and eliminating a host of specific purpose grants. The underlying rationale was to change the composition of state transfers to increase the “no-strings-attached” outlays and reduce conditional grants to give state governments more financial headroom.
Secondly, the newly elected NDA government disbanded the Planning Commission and replaced it with the NITI Aayog. While the NITI Aayog has some shades of resemblance with the Planning Commission, the five-year plans, which was the responsibility of the Planning Commission, were scrapped.
The five-year plans would have their own grants for states in the annual budget of the central government. The establishment of the NITI Aayog and the approval of the 14th FC recommendations were two initiatives that formed the basis the oft-cited “cooperative federalism” mantra of the NDA government, especially in the early years.
The argument put forth to claim this catchphrase was that the Modi-led administration was reversing the centralising tendencies of earlier governments and ushering in an environment where states had greater fiscal autonomy.
Does the data corroborate these claims? Let us examine. Figure 8 below charts the tax devolution to states as a portion of the gross tax revenue.
Figure 8: Tax Devolution vs Gross Tax Revenue (in %).
Source: Union budget documents
Some interesting observations can be made from Figure 8.
1)The first few years after the 14th FC came to effect (April 2015) saw a significant increase in the portion of taxes devolved to the states.
2) This increasing trend of devolution peaked in 2018-19 when the devolution was 36.6%. The last three years have seen this number come down, with the 2020-21 figure (~29%) close to the pre-2015 levels. So, all the talk about cooperative federalism has gone for a toss, in the last few years.
3) Note that these numbers don’t reflect the 32% (pre-2015) or 42% (post-2015) devolution share prescribed by the FC since cess and surcharge revenue is not devolved. This also explains why the devolution percentage has dipped sharply in the last two years, a period when cess revenue has had a corresponding increase (as shown earlier in Figure 5).
While the 14th FC may have been the catalyst, the Modi government can rightfully claim credit for strengthening fiscal federalism, at least in its first term. However, most of these gains have been reversed in their second term. This justifies N.K Singh’s lament:
“ It should not be a cat and mouse game that every finance commission raises the devolution number and it then neutralised simultaneously by an increase in cess and surcharge leaving the states where they were, nor the opposite way.”
Next, in Figure 9, let us look at the total transfers made to state governments in recent years, not just tax devolution. The total transfers to states includes tax devolution, finance commission grants, centrally sponsored schemes, central sector schemes and other miscellaneous items listed as state transfers in the union budget.
The figure below charts the total transfers made to states as a percent of the total expenditure of the Union government.
Figure 9: Portion of total expenditure of central government transferred to state governments (in %).
Source: Union budget documents
There are two caveats on the chart above.
1)Starting 2014-15 there was a change in how expenditure for central schemes was routed to the states. The figures for 2013-14 have been adjusted to make the comparisons with the subsequent years correctly.
2) We have excluded loans made to states from the total transfer amounts and only included grants and devolution, since loans do need to be repaid.
That said, these figures also lead to similar observations made from Figure 8. The period from 2015-16 to 2018-19 (roughly co-incident with NDA’s first term) had a significant increase in funding to the state governments.
While the increased devolution of taxes could be attributed to the recommendations of the 14th FC, the increase in total transfer of funds was certainly government policy. The last two years (and the projections for the next year) show a steep decline in the intergovernmental transfers. The huge spike in cess and surcharge collections which are not shared with states and declining tax revenues during this period contributed to this effect.
There are two other conjectures one can make based on the trends seen above. First, when Narendra Modi won in May 2014, he was a sitting chief minister and his perspective on governance was heavily biased towards the challenges of governing a state.
Hence, financial outlays were perhaps favourable to the states. In the second term, he was well-entrenched as a national leader and the instincts were now honed favouring centralisation.
Second, the Bhartiya Janata Party has adopted an increasingly overt approach favouring homogenisation of the country. Whether it is the abrogation of Article 370, the passage of national farm laws, or flirtations with one-nation-one-language, it is evident that impulse is towards uniformity and centralisation. In this context, the trend of holding back funds from states, seems a natural accompaniment.
One suggestion that I see people constantly make on the social media, particularly on Twitter, is that the government should do away with personal/individual income tax. They often say this with a lot of confidence, giving the impression that they have thought through the argument. Over the last one week, since the presentation of the annual budget of the union government, such suggestions seem to have made a comeback.
But the confidence of the people making these suggestions largely comes comes from two things. One is that they haven’t had a look at the government data on taxes, which leads them to believe that barely anyone pays income tax and hence, it should be scrapped. Two, they have no idea as to how most governments operate.
Let’s take a look at a few charts to understand why this logic is all wrong. The following chart plots the individual income tax collected by the government as a proportion of the Indian gross domestic product (GDP), a measure of the size of the economy.
Source: Centre for Monitoring Indian Economy. Revised estimate for 2020-21. Budget estimate for 2021-22.
As can be seen from the above chart, income tax as a proportion of GDP has only gone up over the years. In 2019-20, it peaked at 2.68% of the GDP. In 2020-21, thanks to the economic contraction due to the spread of the covid pandemic and falling incomes, the income tax to GDP ratio is expected to be at 2.36% of the GDP. It is expected to rise again to 2.52% of the GDP in 2021-22.
The typical argument suggesting that the government should do away with income tax, goes somewhat like this. Oh, but very few people pay income tax. Now that is true, but that hardly means that the government will stop collecting income tax.
A slightly more sophisticated argument (at least the person making it, feels it is a sophisticated argument) goes somewhat like this. Oh, but income tax collected forms just a couple of percentage points of the GDP. That’s nothing.
Honestly, I find both these arguments hilarious. Guys making these arguments have no idea about how the data looks and as I said, which is where their confidence comes from.
Let’s look at the following chart, which basically plots corporation tax (income tax paid by corporates on their profits) and personal income tax as a proportion of gross tax revenue, over the years. Gross tax revenue is basically the sum of different taxes (corporation tax, income tax, union excise duty, customs duty, central goods and services tax etc.), earned by the union government.
Source: Centre for Monitoring Indian Economy.
What does the above chart tell us?
1)The corporation tax collected as a proportion of the total taxes collected by the government, has been falling over the years. In 2009-10, corporate taxes formed around two-fifth of the total taxes collected by the government. In 2021-22, the tax is expected to be at around one-fourth of total taxes. There are multiple reasons for this. Corporate revenue growth has slowed down over the years. Along with that corporate tax rates have also come down.
2) The importance of income tax in the overall taxes earned by the government has gone up in the last decade. In 2009-10, they formed around one fifth of total taxes and in 2021-22, they are expected to form around one fourth of the gross tax revenue earned by the union government. In 2019-20, income tax formed around 23.9% of overall taxes.
Hence, all taxes may appear small as a proportion of the GDP, but that does not mean that they are not important for the government. The government isn’t the entire economy as represented by the GDP but only a part of it and the taxes earned are a part of that part.
Now tell me which government in its right mind is going to drop a tax which is likely to bring in one-fourth of the total taxes earned by it. This especially in an environment where corporation tax collections as a proportion of the GDP have been falling over the years.
Another argument that is made is that income taxes should be eliminated and indirect taxes should be raised. So, with no income tax, people will earn more and hence, spend more, and the government will end up collecting more indirect taxes, and these taxes will more than make up for a loss of income tax.
While this sounds good in theory, the trouble is that unlike the physical sciences, in economics you cannot carry out real life experiments. So, no government is going to risk one-fourth of its revenue just because in theory they could do something else. Nah, not going to happen. The whole argument rests on the idea that if income tax is done away with people are likely to spend more. What if they don’t and decide to save more? There is no way of knowing in advance about how people are going to behave.
Actually, a more refined argument can be made here. People who pay a bulk of India’s income taxes already have most things that they need in life. Hence, their marginal propensity to consume will be low. This means that the extra money they earn thanks to lower taxes, they are more likely to save/invest it than spend it.
Hence, the argument that people are likely to spend more because they will earn more thanks to no income tax, doesn’t really hold. One thing that can be said for sure here is that if income tax is done away with, the stock market will go through the roof (not that it isn’t already).
A better way to increase consumption and hence, indirect tax collections is to reduce goods and services tax on mass produced goods. The impact is going to be much greater in this case.
There are other reasons here as well. There is a huge income tax bureaucracy in place. What happens to those people with no income tax? Income tax is also used by politicians in power to harass those in opposition or other people opposing them. Why let go of such an option?
All in all, income taxes are not going anywhere, even though when the BJP was in the opposition, it was pretty vocal on the issue of doing away with them.
But now they need to run the country and the gross tax revenue collected by the government, has come down over the years. The gross tax revenue as a proportion of the GDP peaked at 12.11% in 2007-08. In 2019-20, it was at 10.61%. It is expected to fall to 9.75% of the GDP this year and rise to 9.95% of the GDP next year, still significantly lower than the all-time peak level.
So, next time you want to go shouting on Twitter asking the government to do away with personal income tax, please do remember these points.
At the end of every month, the Controller General of Accounts (CGA) declares the revenue and the expenses of the central government up until the last month. Hence, on September 30, the CGA declared the revenue and the expenses of the central government between April 1 and August 31.
Take a look at the following chart. It plots the decrease in gross tax revenue between April and August 2020 in comparison to the same period in 2019. The major taxes collected by the central government are income tax that you and I pay, corporate tax (income tax paid by corporates), customs duties, central goods and services tax, goods and services tax compensation cess and excise duties.
They all fall down
Source: Centre for Monitoring Indian Economy.
As can be seen in the above chart, the collections of all taxes have come down. The gross tax revenue is down 23.7% to Rs 5.04 lakh crore. Only one tax and that is excise duty, has grown during the course of this year. The growth is a huge 32.05% to Rs 1 lakh crore.
Given the economic contraction this year, it is hardly surprising that tax collections have crashed. The question is how has the collection of excise duties increased by almost a third?
This is primarily because of the central government increasing the excise duty it charges on petrol and diesel. This has been done twice in 2020. First in March and then again in May.
The excise duty on petrol stood at Rs 19.98 per litre, when it was increased by Rs 3 per litre in March and then again by Rs 10 per litre in May and now stands at Rs 32.98 per litre. When it comes to diesel, the excise duty on it stood at Rs 15.83 per litre in March. It was increased by Rs 3 per litre in March and Rs 13 per litre in May.
Take a look at the following table. It provides the price build up of petrol in Delhi as of March 1 and as of October 1.
High and low.
Source: Indian Oil Corporation.
This table makes for a very interesting reading. Let’s first understand how the mathematics of this works out using the data as of October 1.
The price charged to dealers is Rs 25.68 per litre. On this, the central government charges an excise duty of Rs 32.98 per litre. There is a dealer commission of Rs 3.69 per litre. Adding the price charged to dealers (Rs 25.98), the excise duty (Rs 32.98) and the dealer commission (Rs 3.69), we get a price of Rs 62.35 per litre. On this the local Delhi government charges a value added tax of 30%. This works out to Rs 18.71 per litre in this case.
Adding the value added tax, we get the retail selling price of Rs 81.06 per litre. The maths for the price as of March 1, works similarly, the difference being in the numbers and the taxes.
In March, the price of Indian basket of crude oil was around $55 per barrel. The latest price of the Indian basket of crude oil is around $41 per barrel. This is reflected in the fact that the price charged to dealers as of October 1, stood at Rs 25.68 per litre, lower than the Rs 32.93 per litre charged in March.
Despite the higher price charged to dealers, the retail selling price of petrol in March was at Rs 71.71 per litre as against Rs 81.06 per litre in October. The price as of today is 13% higher than that in March.
What’s happening here? Let’s take a look at it pointwise.
1) The total excise duty on petrol was at Rs 19.98 per litre in March. It has since gone up to Rs 32.98 per litre, Rs 13 per litre extra. This adds to the retail price.
2) The value added tax charged by the Delhi government has also increased from 27% to 30%. This also adds to the retail price though not as much as the increase in excise duties.
3) As of March 1, taxes amounted to Rs 35.23 per litre (excise duties + value added tax). This was against a price charged to dealers of Rs 32.93 per litre. Taxes amounted to 107% of the price charged to dealers.
As of October 1, taxes amount to Rs 51.69 per litre (excise duties + value added tax). This is against a price charged to dealers of Rs 25.68 per litre. Taxes now amount to 201% of the priced charged to dealers. This explains the higher retail price of petrol, despite the lower price charged to dealers, thanks to a lower oil price.
4) There is another way of looking at this data. In March, the total taxes amounted to around 49% of the retail price. In October, they amount to around 64% of the retail price. There has been a substantial increase in taxes.
5) The reason behind this increase is that the central government needs to meet its expenditure from somewhere. One point that often gets made on the social media is that the central government shares the increase in excise duties with the state governments. This isn’t totally true.
In May, the excise duty on petrol was hiked by Rs 10 per litre. Of this hike, the hike in road and infrastructure cess (additional excise duty) was Rs 8 per litre. Given that this is a cess, it need not be shared with the state governments. Hence, the bulk of the increase has stayed with the central government.
Now let’s take a look at diesel pointwise. In this case, I am taking diesel price in Delhi as of February 12. I couldn’t find the data for March 1. But the logic remains entirely the same.
2) The total excise duty on diesel back then was Rs 15.83 per litre. Currently, it stands at Rs 31.83 per litre. This has added to the price of diesel.
3) As of February 1, the price charged to dealers was Rs 36.98. The excise duty was Rs 15.83 per litre. The value added tax worked out to Rs 9.56 per litre. Hence, total taxes (excise duty + value added tax) worked out to Rs 25.39 per litre or around 69% of the price charged to dealers.
As of October 1, the excise duty is at Rs 31.83 per litre whereas the value added tax works out to Rs 10.37 per litre. Hence, total taxes work out to Rs 42.2 per litre or 164% of the price charged to dealers.
4) Total taxes amounted to 39% of the retail price in February. They now work out to 60%.
5) In May, the excise duty on diesel was hiked by Rs 13 per litre. Of this hike, the hike in road and infrastructure cess (additional excise duty) was Rs 8 per litre. Given that this is a cess, it need not be shared with state governments. Hence, the bulk of the increase has stayed with the central government.
This explains why you and I are paying a higher amount per litre of petrol and diesel, despite oil prices being lower from the time the covid-pandemic struck. Also, it needs to be mentioned here that the consumption of petroleum products has fallen every month between April and August. The following chart plots the same.
The interesting thing here is that thanks to a higher excise duty per litre of petrol and diesel, the collection of excise duties has risen, despite fall in consumption. Also, the other interesting bit here is that the consumption decline was at 8.4% in June. The situation has worsened since then.
In the last six years, the government hasn’t passed on the fall in the price of oil to the end consumer. In May 2014, when Narendra Modi took over as prime minister, the average price of the Indian basket of crude oil during the month was $106.85 per barrel. The following chart plots the average price of the Indian basket of crude oil during a particular year, over the years.
The above chart makes for a very interesting reading. The average price of the Indian basket of crude oil in 2020-21 at $35.74 per barrel, has been the lowest since 2003-04. But that is clearly not reflected in the retail price of petrol and diesel, thanks to higher taxes, particularly higher excise duties.
A May 2020 report by the Press Trust of India points out: “The tax on petrol was Rs 9.48 per litre when the Modi government took office in 2014 and that on diesel was Rs 3.56 a litre.” The Modi government has captured a bulk of the fall in price of oil over the years. This is clearly reflected in the following chart, which plots the excise duty earned by the government from petroleum products.
As can be seen from the above chart, the excise duty earned from petrol and diesel has more than doubled over the years. While, the government has captured a bulk of the fall in oil prices, there are no guarantees that it will protect the consumer, if and when oil prices start to go up again.
Also, this is a very easy way for the government to collect revenue. It allows them to go slow on more difficult ways, like selling stakes in public sector enterprises (PSEs), selling the massive land owned by PSEs, shutting down the badly run PSEs, fixing the badly implemented goods and services tax system, and so on.
Take a look at the following chart which compares India’s petrol and diesel prices with that of our neighbouring countries.
The Indian high
Source: Websites of oil companies in these different countries. Nepal prices from local newspapers. (I would like to thank Chintan Patel for putting this table together). Prices as of October 1, 2020.
The above chart clearly shows that the petrol and diesel prices are the highest in India. And as they say, there is no free lunch in economics. You and I are paying this higher price, not just when we buy petrol and diesel directly, but also when we pay for almost every product that is produced somewhere and delivered to where we are.
The Controller General of Accounts publishes the state of government finance at the end of every month. This data is published with a gap of one month. Hence, on 31st August, the data as of 31st July, was published.
This data, not surprisingly, doesn’t make for a good reading. The fiscal deficit, the difference between what a government earns and what it spends, for the period April to July 2020 stood at Rs 8.21 lakh crore. The fiscal deficit that the government had plans to achieve during the course of the current financial year (2020-21) stands at Rs 7.96 lakh crore. Hence, at the end of July, the actual fiscal deficit of the government was 103.1% of the budgeted one.
But given the state we are in this is hardly surprising. Nevertheless, there are several reasons to worry. Let’s take a look at it pointwise.
1) Tax collections have collapsed. Between April and July 2020, the gross tax revenue, which brings in a bulk of the money for the central government and which it shares with the state governments, is down 29.5% to Rs 3.8 lakh crore, in comparison to the same period in 2019.
Let’s look at the different taxes collected by the government between April and June this year and the last year.
They all fall down
Source: Controller General of Accounts.
As can be seen from the above chart, the collections of all major taxes are down big time.
Take the case of central goods and services tax. (GST) or the part of GST that ends up with the central government. During April to July 2019, the total collections of the central GST had stood at around Rs 1.41 lakh crore. During the same period this year the collections have fallen by 34% to Rs 92,949 crore. Other taxes have fallen along similar lines.
The fall in GST collections is a reflection of a massive slowdown in consumption. A slowdown in consumption ultimately reflects in a slowdown in income of individuals as well as incomes of companies. Ultimately, one man’s spending is another man’s income.
But there is something that the above chart does not show, the excise duty collections of the central government. They are up year on year by 23.8% to Rs 67,895 crore. This despite the fact that the consumption of petroleum products between April and July is down 22.5% in comparison to 2019.
So, how have excise duty collections gone up? The central government has increased the excise duty on petrol from Rs 22.98 per litre to Rs 32.98 per litre. The excise duty on diesel has been raised from Rs 18.83 per litre to Rs 31.83 per litre. Also, a substantial part of this duty is a cess, leading to a situation where the central government does not have to share the revenue earned through the cess with the state governments.
In the process, the central government has captured a bulk of the fall in oil prices.
2) As mentioned earlier, the central government needs to share a part of the money it earns with state governments. Between April and July it shared Rs 1.76 lakh crore with states, against Rs 2 lakh crore, during the same period last year. This is 12% lower, during a time when the states are at the forefront of fighting the covid-epidemic.
The ability of the state governments to raise taxes, after having become a part of the goods and services tax system, is rather limited. Take the case of petrol and diesel. The central government has raised excise duty by such a huge extent that the state governments aren’t really in a position to raise the value added tax or the sales tax on petrol and diesel, which they are allowed to charge, without having to face political repercussions for it.
3) The central government has more ways of raising money than the states. One such way is disinvestment of its stakes in public sector enterprises. This year the government plans to earn a whopping Rs 2.1 lakh crore through this route. The original plan included the plan to sell Air India. Whether that happens in an environment where the airlines business has been negatively rerated in the aftermath of covid, remains to be seen.
The other big disinvestment plan was that of the government selling its stake in the Life Insurance Corporation of India through an initial public offering. There are one too many regulatory hurdles that need to be removed, before a stake in India’s largest insurance company can be sold to investors. Long story short, it looks highly unlikely that the government will get anywhere near earning Rs 2.1 lakh crore this year, through the disinvestment front.
Having said that, the government can always resort to some accounting shenanigans, like getting one public sector enterprise to buy another, and pocketing that money. This is likely to happen in the second half of the year.
Over and above this, the government earns a lot of money from the dividends that it earns from public sector enterprises as well as banks and financial institutions. The target for this year is around Rs 1.55 lakh crore. Public sector banks will continue to remain on a weak wicket through this year, hence, their ability to pay dividends is rather limited.
The only way the government can make good this target is by raiding the balance sheet of the RBI for money. Also, the government is likely to raid the cash balances of public sector enterprises which have them, by asking them to pay special dividends.
4) The money that gets invested into various small savings schemes, which includes schemes like Post Office Savings Account, National Savings Time Deposits ( 1,2,3 & 5 years), National Savings Recurring Deposits, National Savings Monthly Income Scheme Account, Senior Citizens Savings Scheme, National Savings Certificate ( VIII-Issue), Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account, net of the redemptions, is a revenue entry into the government budget.
This time it has been assumed that the government will get Rs 2.4 lakh crore through this route. Between April and July, Rs 38,413 crore or just 16% of the targeted money has come in. Last year, during the same period, 38% of a much lower target of Rs 1.3 lakh crore had been achieved. Clearly, this target is also going to be missed.
5) Of course, the government understands this and which is why in early May it increased its borrowing target from Rs 7.8 lakh crore to Rs 12 lakh crore, by more than 50%. The government borrows money to finance its fiscal deficit.
What this means is that the government wants to at least keep the fiscal deficit to around Rs 12 lakh crore. The question is will that happen? Gross tax revenues are already down 30%. Of course, as the economy keeps opening up, this number will look better. Having said that, even if tax revenues are down by 15% as of the end of the year, we are looking at a shortfall of Rs 2.5 lakh crore for the central government. The other big entries of disinvestment and the net-revenue from small savings schemes, are also looking extremely optimistic in the current situation.
Even if the government achieves a fiscal deficit of Rs 12 lakh crore and the economy shrinks by around 10% this year, we will be looking at a central government fiscal deficit of 7% against the targeted 3.5%.
In this scenario, it is now more than likely that the RBI will resort to direct financing of government expenditure by printing money and buying government bonds. The government sells bond to finance its fiscal deficit.
This isn’t to say that the RBI hasn’t printed money this year. It has. But it has chosen to operate through the primary dealers. But the mask might come off in in the time to come and the RBI might decide to buy bonds directly from the government.
Winter and money printing are coming to India, in a few months.