Deception of fiscal deficit

The right measure of good governance is making expenditures according to income and the quality of government expenditures.

 

In this budget season, like the previous ones, there exists a consensus among economists that controlling fiscal deficit is of paramount importance. This is deceptive. It allows the present government to overspend by liquidation the assets received by past generations as bequeathal.

Every business has two accounts: the capital, and revenue accounts. Income from salary or from the shop and expenditures on food, petrol and staff salaries are reflected in the revenue account. A “healthy” businessman earns in the revenue account and invests in a plot of land. On the other hand, a “weak” businessman is unable to meet his expenses from the earnings from the shop. He sells a plot bequeathed by his forefathers and uses the money to meet his daily expenditures. The healthy businessman uses the surplus in revenue account to invest in capital account.

This same classification applies to government finances. The government earns monies from taxes and makes expenditures on salaries, maintenance of roads, printing of currency and other such items of day to day expenditures in the revenue account. If income is greater than expenditure, then the government creates a revenue surplus. This surplus can be used to make investments like setting up Public Sector Undertakings (PSUs). If revenue income is less, then the government has to raise funds from another source to meet the expenditures.

There are two ways these funds can be raised. The government can liquidate the assets bequeathed by the earlier generations or it may borrow and transfer the liability to future generations. Presently, the government is trying hard to liquidate assets bequeathed by previous generations. Previous generations invested their hard earned income in these PSUs. Now, the government is on the fast track to sell shares of these PSUs to raise monies to meet its expenditures. This is considered a “good” way of meeting the revenue deficit in mainstream economic thinking.

The other way to raise funds for meeting day to day expenditures is to take loans and pass off the liability to future generations. This mode of raising money is considered “bad” by mainstream economists. The anomaly in this thinking is that fiscal deficit ignores the eating of past bequeathals and focuses on future loans.

The government can incur huge revenue expenditures in paying salaries to the government servants or in welcoming US President Barack Obama and yet pass the test of good governance if it only eats into income of past generations. This imprudence is fine as long as it relates to past generations. The only correct measure of good governance is revenue deficit. That is, unfortunately, hardly talked about by finance ministers.

Investment in PSUs

Taking loan is actually good if the money is used for creating assets of greater value. Previous governments, especially that of the Nehru-Indira period, borrowed indeed but used the money for investment in PSUs. They created assets of Rs 20 crore from the borrowing of Rs 10 crore. So, they passed on to huge assets in the form of PSUs to the future generations. On the other hand, present government is borrowing to meet its current expenditures, it is taking loans to pay salaries to the government servants.

Borrowing money and using it for payment of salaries is as much a folly as not borrowing and not establishing steel plants. The correct question is whether the money raised from past or future generations is used to create assets or used for meeting current consumption. It is the quality of expenditures that matters, not the quantity. Large borrowings, and a large fiscal deficit to make investments in PSUs, highways and space research is good while even small borrowing to pay salaries to government servants is bad.

There is a mad rush in most government departments to spend the budget before the financial year ends on March 31. The measure of “efficiency” is whether one can spend. Making expenditures to first dig a pond; and making further expenditures to fill it up is “efficient.” To leave the money idle and in the bank and to earn interest on the same is “inefficient.” This anomaly arises because the government does not undertake performance audit of the expenditures.

I had done a study for some NGOs in Rajasthan. It was found that the saplings had already been planted on double the total land area of the district over the years. Yet, there were few forests to be seen. Positive impact of the afforestation programme could not be seen even though the money had been spent, “efficiently,” so to say. The correct measure of good governance is impact assessment; not incurring of expenditures.

The focus on fiscal deficit is misplaced. Fiscal deficit does not disclose whether monies have been raised from tax incomes or from liquidating assets bequeathed by previous generations. Large fiscal deficit also is not necessarily bad. But in the current budget management, there is no way of knowing whether borrowing is good or bad because there is no system of impact assessment. The correct measure of good governance is making expenditures according to income and the quality of government expenditures. Alas! both are missing from the present dialogue on the budget.