Editorial Notes

[Editorial Notes] A blueprint to finance higher Public Spending

The implication of lockdown in the country has led to fall in the revenues, which in turn is causing a huge challenge for the government to finance higher public spending.
By IASToppers
May 04, 2020

Contents

  • Introduction
  • Options Available
  • Key principles of public finance
  • Implementable Ideas
  • Role of state government
  • Conclusion

A blueprint to finance higher Public Spending

For IASToppers’ Editorial Simplified Archive, click here

Introduction:

It is evident that the lockdown imposed in the country to contain COVID-19 is creating enormous stress on every part of the economy, including public finances. The need for public expenditure to address the crisis has increased, but the revenues are down. This has caused a huge challenge for the government to finance higher public spending.

Options Available:

  • There are broadly four options before the government:
    • Cut other expenditure
    • Increase revenues
    • Increase borrowing
    • Print money to monetise debt.
  • All these options are difficult choices for the government and costly in their own way.

Key principles of public finance:

  • The costs of each of the options may increase non-linearly, and so the optimal approach may be a judicious combination of all four options.
  • To minimise frictions across tiers of national, state, and local governments and take a consolidated view on the best policy actions.
  • To ensure that short-term actions do not jeopardise longer-term fundamentals and also enable structural reforms that will put the country on a stronger economic trajectory.
  • To not let financing concerns impede essential investments to support public health and the economy.

Implementable ideas:

1. Principle of variable pay:

  • On expenditure, one simple idea is to change the structure of public employee pay so that all allowances other than basic pay are linked to government tax revenues.
  • In good times, public employee pay will be higher, and in difficult times, the reduced payroll provides an automatic macro-fiscal stabiliser.
  • It may also create an important symbolic link between public employee pay and state and national economic performance, which is missing right now.
  • Over time, once the principle of variable pay for public employees is in place, it may be possible to link it to measures of department and individual performance which has been shown to meaningfully increase effort and productivity of public employees.

2. Increase property Taxes:

  • On revenues, there is substantial scope to increase property tax rates and collections by local bodies.
  • The central government can incentivise these payments by making property taxes deductible from taxable income.
  • The property taxes are less likely to dampen economic activity since they are based on immovable investments.
  • Urban areas contribute the most to GDP and tax revenue, but have been hit hardest by the pandemic and lockdown.
  • This then becomes a form of central government support that disproportionately benefits urban areas.
  • It does not cost the central government much (since property tax collections are very low) but makes the extent of benefits to states and local governments conditional on implementing overdue property tax reforms.

3. Finance productive investments:

  • Third, the government should issue debt with a commitment that these funds will be used primarily to invest in strengthening health systems.
  • Increasing debt per se is not a problem if used to finance a public investment that has a positive net present social rate of return.
  • The problem is that bond markets do not trust that governments will finance productive investments.
  • Consequently, breaching deficit targets and borrowing more is often penalised with higher interest rates.
  • Ring-fencing any additional Covid-19-related debt to focus primarily on health systems investment will reduce the likelihood of a bond market interest penalty.
  • According to one estimate, each week of the full lockdown has cost nearly Rs 2 lakh crore.
  • Thus, the public returns to health investments that enable even a partial release of the lockdown are likely to be very high.

4. Avoid monetising the debt:

  • It is best to avoid discussion of monetising the debt.
  • Even discussion on debt monetisation will raise inflationary expectations, divert domestic savings to unproductive assets like gold, raise bond yields, and jeopardise India’s hard-won inflation credibility in recent years.
  • At this point, we do not know if the crisis will be deflationary (through demand contraction) or inflationary (through supply chain disruptions).
  • So it is best to wait. Importantly, this does not preclude the Reserve Bank of India from directly purchasing government debt.
  • As long as there is a commitment from the government to paying it back (and markets believe that the debt can be paid back), this approach allows fiscal stimulus without jeopardising inflation credibility.
  • If inflation stays very low, then a modest amount of monetisation of debt may make sense over time.

Role of state government:

  • It is critical to recognise that states are at the frontline of the battle against the virus, both for securing public health and for protecting the vulnerable.
  • But they simply do not have the policy instruments needed to respond fully.
  • Consistent with the first principle of public finance, the central government should lead on financing this war, and state governments should lead on-field implementation (including designing locally appropriate mitigation measures).

Conclusion:

It is the need of the hour for the central government to clearly communicate not just the policies, but also the economic principles behind the pandemic response. These uncertain times demand greater clarity on policy to minimise the economic and health costs of this crisis.

Topics
Mains 2020 Editorial Notes
Tags

IT on Facebook

Facebook Pagelike Widget

Comments

My Favourite Articles

  • Your favorites will be here.

Calendar Archive

May 2020
M T W T F S S
« Apr    
 123
45678910
11121314151617
18192021222324
25262728293031