ASSIGNMENT

FISCAL CAPACITY, FISCAL HEALTH, AND GOVERNMENT BORROWING.

SUBMITTED TO- Dr DEEPIKA

ASSISTANT PROFESSOR OF LAW, H.P. NATIONAL LAW UNIVERSITY

SUBMITTED BY-

SAUMYA RAJPAL

2ND YEAR BBA LLB

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TABLE OF CONTENT

TABLE OF CONTENT ............................................................................................................. 2

ACKNOWLEDGEMENT ......................................................................................................... 3

DECLARATION BY CANDIDIATE ........................................................................................ 4

FISCAL CAPACITY ................................................................................................................. 5

FISCAL CAPACITY IN INDIA ............................................................................................ 6

FISCAL HEALTH ..................................................................................................................... 9

FISCAL HEALTH IN INDIA .................................................................................................. 10

Ways to Improve Fiscal Health in India ............................................................................... 10

GOVERNMENT BORROWINGS .......................................................................................... 13

CONTROLS ON GOVERNMENT BORROWING ........................................................... 14

CONCLUSION ........................................................................................................................ 19

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ACKNOWLEDGEMENT

The completion of the assignment required the assistance and guidance of many people and I
fortunately received them in abundance. Mere words will fall short to extend my thankfulness
to those without which the fruition of the project would not have been possible, their dedication,
sincerity, trust and helping me by providing all necessary information and advice were essential
for the completion of the project and I would thank them for their guidance and assistance all
along.

I, Saumya Rajpal would firstly like to thank my university, Himachal Pradesh National Law
University for endowing their trust and faith in me by giving me the opportunity of doing such
an interesting project and providing all necessary help and guidelines.

I would also like to extend my thanks to my project guide and mentor Dr. Deepika who helped
me by giving valuable insights into the problem and helping me with all necessary information
and guiding me through the project.

Also, I would like to thank my family and friends for their kind support and patience.

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DECLARATION BY CANDIDIATE

I, Saumya Rajpal solemnly declare that the project report is solely based on my own work
carried out with due care and diligence during the course of study under the supervision of Dr
Ambika. I truly assert that the statements made and the conclusions drawn are hereby an
outcome of my research work. I further certify that-

I. The work contained in the report is original and has been done by me under the general
supervision of my professor.
II. The work has not been submitted to any other Institution for any
degree/diploma/certificate in this university or any other University of India or abroad.
III. The guidelines provided by the university were followed in writing the report.
IV. Whenever any material was used like data, theoretical analysis, text or other materials
from other sources, due credit has been to the same in the text along with furnishing
their details for further references.

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FISCAL CAPACITY

Fiscal capacity is the ability of the country to collect income to provide public goods and
perform certain functions of the country in the sense of an administrative,
fiscal accounting structure. In economics and political science, fiscal capacity can be referred
to as tax capacity, extractive capacity or tax power since taxes are the main sources of public
revenue. However, while tax revenues are important to fiscal flexibility, taxes may not be the
only source of revenue for the government. The other sources of revenue include foreign aid
and natural resources.

In addition to the amount of public revenue derived from state extracts, fiscal flexibility is the
country's expenditure in the country structures, including supervision, administration, and
enforcement through the training of tax inspectors and the efficient operation of the revenue
service. Finally, provided that tax-funded public goods include the construction of
infrastructure, health, education, military and social insurance, a country's fiscal capacity is
essential to its economic growth and development.

In simple terms, it is the ability of government, groups, institutions, etc. to generate revenue.
The fiscal capacity of governments depends on a variety of factors including those that
contribute to the tax base; the government’s ability to efficiently tax; compensating behaviour
among taxed individuals, markets, and asset prices; and access to other non-tax forms of
revenue. In order to fund basic operations, provide public goods, and achieve other policy
objectives, governments need revenue, which they can raise by imposing taxes, selling assets
or resources, or receiving transfer payments from other outside governments or other entities.
Fiscal capacity is the degree to which a government is able to raise such revenues.

When governments develop their fiscal policy, determining fiscal capacity is an important
step. Identifying fiscal capacity gives governments a good idea of the different programs and
services that they will be able to provide to their citizens. The theory behind fiscal capacity
can also be used by other groups, such as school districts, who need to determine what they
will be able to provide to their students.

Raw fiscal capacity starts with a government’s available tax base. The famous American bank
robber, Willie Sutton, when asked why he robbed banks is reputed to have replied, “Because
that’s where the money is.” A government’s fiscal policy fundamentally starts in the same

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way: by assessing where the various sources of wealth and income in its community lie. The
valuable real estate, profitable businesses, and personal incomes of its citizens and subjects,
and those with whom they transact business, from which a government can extract revenue
make up the tax base. The wealthier and more productive the available population of potential
taxpayers that a government has access to, the larger the tax base and the base fiscal capacity.

FISCAL CAPACITY IN INDIA

Fiscal capacity is key to long run economic development. Taxation is not just about financing
spending; it is the economic glue that binds citizens to the state in a two-way accountability
relationship. Against this background, we assess India’s fiscal capacity. Simple tax-GDP and
spending-GDP ratios suggest that India under-taxes and under-spends relative to comparable
countries. But, controlling for the level of economic development, India neither under-taxes
nor under-spends. India does tax and spend less than other politically developed nations, but
given that most other democracies took time to strengthen tax capacity, perhaps India is not an
outlier on this dimension, either. India does stand out in the number of individual income
taxpayers, currently about 4 percent, far from our desirable estimate of about 23 percent.
Building long-run fiscal capacity is vital. One low hanging fruit would be to refrain from
raising exemption thresholds for the personal income tax, allowing natural growth in income
to increase the number of taxpayers. Beyond that, building fiscal capacity is also about creating
legitimacy in the state. This can be acquired by prioritizing improved delivery of essential
services that all citizens consume.

The Indian tax system is about to witness dramatic changes. Consider first the GST.
Implementing a new tax, encompassing both goods and services, to be implemented by the
Centre, 28 States and 7 Union Territories, in a large federal system, via a constitutional
amendment requiring broad political consensus, affecting potentially 2-2.5 million excise and
service taxpayers, and marshalling the latest technology to radically improve collection
efficiency, is a reform perhaps unprecedented in modern global tax history. Take next corporate
taxes. The rate is scheduled to come down from 30 percent to 25 percent and a wide range of
exemptions will be phased out in an orderly manner. In addition, the legacy of contentious,
adversarial tax issues from the past is being cleaned up. Tax administration is being improved:
now around 95 per cent of filings are electronic, tax refunds are now being issued in a record
7-8 days, and a new Tax Policy Council and Tax Research Unit are being created.

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Questions are often raised as to how can India move from its current situation to one of
increasing taxes and government spending as part of the process of building state capacity?
There have been various researches and studies where the findings are nuanced but striking.

i. A simple comparison of aggregates with other countries indicates that India under-taxes
and under-spends.
ii. Controlling for the level of economic development, India neither under-taxes nor under-
spends.
iii. India does tax and spend less than other politically developed nations, but given that
most other democracies took a long time to strengthen tax capacity, perhaps it is not an
outlier on this dimension, either.
iv. Where India does stand out is in the number of individual income taxpayers. The ratio
of taxpayers to voters is only about 4 percent, whereas it should be closer to 23 percent.

Taxation is key to long run political and economic development. If spending is about the
entitlements of citizenship in a democracy, taxation is about the obligations of citizenship.
Taxation and military service (or some other form of compulsory national service) are two core
elements of modern citizenship. India has chosen taxation as the key obligation that it can
demand of its citizens. The obligations of citizenship are the foundations of nation building and
democracy. Bringing more and more people into the tax net via some form of direct taxation,
will help in realizing the promise of Indian democracy. Democracy is a contract between the
state and its citizens. This contract has a vital economic dimension: the state's role is to create
the conditions for prosperity for all by providing essential services and protecting the less well-
off via redistribution. The citizen's part of the contract is to hold the state accountable when it
fails to honour the contract (Besley and Persson [2013].

But a citizen's stake in exercising accountability diminishes if he does not pay in a visible and
direct way for the services the state commits to providing. If a citizen does not pay - through
taxes or user fees - he either becomes a free rider (using the service without paying) or exits
(not using the service at all). Both reduce the accountability of the state. Hence the expression:
no representation without taxation. Taxation is not just about financing public spending; it is
the economic glue that binds citizens to the state in a necessary two-way relationship. One can
think of tax paying and political participation as two important accountability mechanisms
wielded by citizens. The precocious India phenomenon is that economic development lags
political development. One can hypothesize that this difference in taxpaying and voting might
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explain the phenomenon in India of there being reasonably effective episodic accountability as
opposed to ongoing accountability. Independent India has averted famines but chronic
malnutrition is still a challenge. The Indian state can organize mega-events but routine safety
for women has turned out to be more difficult to achieve. The Indian state responds effectively
to floods and tsunamis but finds water and power metering more challenging.

Consider next the challenge of moving to a better equilibrium. There are no real low hanging
fruit here because of two reasons: first, India is not really an outlier, contrary to much popular
perception, in terms of its overall level of taxation and spending—facts that we establish
unambiguously. It is easy to exhort the government to, say, increase spending on health and
education or remove exemptions on the tax side. But it must be remembered that the ability to
spend and tax is in part endogenous to the perceived legitimacy of the state. Citizens will be
willing to pay their dues as taxes only if they feel that the state is adhering to its side of the
contract by delivering essential services. In other words, tax and spending policy are related to
actions by the state to increase its legitimacy. State and tax capacity are as much about state
legitimacy as they are about technical details relating the design of policy and its
implementation.

In conclusion, Fiscal capacity in India can be dealt with keeping in the mind the following two
things. First, the government’s spending priorities must include essential services that all
citizens consume: public infrastructure, law and order, less pollution and congestion, etc.
Second, reducing corruption— fiendishly difficult as it is—must be a high priority not just
because of its economic costs but also because it undermines legitimacy. The more citizens
believe that public resources are not wasted, the greater their willingness to pay taxes. In that
sense, the government’s efforts to improve transparency through transparent and efficient
auctioning of public assets will help create legitimacy, and over ti,me strengthen fiscal capacity.

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FISCAL HEALTH

Financial health is a term used to describe the state of one's personal monetary affairs. There
are many dimensions to financial health, including the amount of savings you have, how much
you’re putting away for retirement, and how much of your income you are spending on fixed
or non-discretionary expenses. Financial experts have devised rough guidelines for each
indicator of financial health, but each person's situation is different. For this reason, it is
worthwhile to spend time developing your own financial plan to ensure that you are on track
to reach your goals and that you’re not putting yourself at undue financial risk if the
unexpected occurs.

Fiscal health is an elusive concept with many definitions. It can be defined as the ability to
continue current service levels for the foreseeable future without jeopardizing the financial
stability of the organization or suddenly increasing the price of government. In other words,
fiscal health is about maintaining or increasing outputs without significantly increasing inputs.

An individual’s financial health can be measured in a number of ways. A person’s savings and
overall net worth represent the monetary resources at their disposal for current or future use.
These can be affected by debt, such as credit cards, mortgages, and auto and student
loans. Financial health is not a static figure. It changes based on an individual’s liquidity and
assets, as well as the fluctuation of the price of goods and services.

Typical signs of strong financial health include a steady flow of income, rare changes in
expenses, strong returns on investments that have been made, and a cash balance that is
growing and is on track to continue to grow. To improve your financial health, one must first
take a hard, realistic look at where you’re currently at. Calculate your net worth and figure out
where you stand. This includes taking everything you own, such as retirement accounts,
vehicles, and other assets and subtracting any and all debts.

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FISCAL HEALTH IN INDIA

In its report, titled State Finances: A Study of Budgets of 2022-23, RBI said improved fiscal
health also helped boost revenue collections and the states’ gross fiscal deficit is now budgeted
to narrow from 4.1% of gross domestic product in FY21 to 3.4% in FY23 within the indicative
target of 4% set by the centre. While states’ debt is budgeted to ease to 29.5% of GDP in FY23
as against 31.1% in FY21, it is still higher than the 20% recommended by the FRBM Review
Committee, 2018, under the chairmanship of N.K. Singh, warranting prioritisation of debt
consolidation, RBI said in its annual report that provides information, analysis and an
assessment of the finances of state governments for FY23 against the backdrop of actual and
revised/provisional accounts for FY21 and FY22, respectively.

Ways to Improve Fiscal Health in India

1. Responsible Budgeting

The annual budget is the one tool with the singular ability to promote fiscal health or destroy
it. Overestimating revenues, under-budgeting and depleting surplus reserves automatically
build problems into future budgets and steadily erode fiscal stability. Responsible budgeting
promotes revenue stability, realistic spending and long-term thinking. Revenue estimates
should be conservative. Only recurring revenues should be used to fund ongoing expenditures.
One-time revenues, or temporary spikes in recurring revenues, should be used for one-time
expenditures, or not at all. User fees should be regularly reviewed. The revenue base should be
diversified with a solid foundation of inelastic revenues and minimal reliance on external
funding sources over which there is little control. All known expenses should be budgeted
because delaying necessary expenditures, such as equipment maintenance, will lead to
higher costs in the future. Expense budgets should be realistic. Managers that consistently
over-budget can cause other service areas to be under-funded or eliminated. Those that
consistently under-budget can create a great deal of fiscal stress toward the end of the budget
period.

2. Sufficient Reserves

We all know that surplus is necessary for cash flow purposes, and to provide for unforeseen
events. Surplus also provides us with the necessary liquidity to pay our bills. It is important to

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analyze cash flow needs and assess risks to establish a baseline amount of surplus to be
maintained. All stakeholders should understand that reducing this amount can have negative
consequences. The link between responsible budgeting and surplus funds cannot be ignored.
Limit the use of surplus as a revenue source to fund ongoing expenses, and avoid the necessity
of constantly making withdrawals from the savings account to pay bills. Conservative revenue
estimates and prudent spending plans promote superior operating performance – which
replenishes and builds surplus reserves. One or two years of poor operating performance can
jeopardize surplus reserves, making it difficult to match the amount needed for the budget from
year to year, reducing the amount of funds available for emergencies and restricting cash flow.
Maintaining these reserves to avoid the need for emergency appropriations and to eliminate
significant fluctuations in the budget from one period to the next.

3. Information Systems

Accurate and timely data is needed to make informed, intelligent decisions. The most
sophisticated planning and analysis methods are useless if the data they use is stale or
inaccurate. Identifying the most useful data, and using the most effective analysis methods
doesn’t necessarily require a large investment in technology. The incremental benefits realized
from the additional time and expense of implementing new tools are cost effective only if those
changes make us more efficient and better informed. The best technology solutions help us to
narrow down the amount of data necessary to produce reasonably reliable and accurate analyses
using the simplest methods possible. With all of the focus on technology and automation, we
have to remember that data analysis, and fiscal health, begins at a much more fundamental
level. Reliable information systems require proper internal controls.

4. Analysis and Planning

To effectively gauge our performance, and the state of our fiscal health, we need to monitor
our progress and engage in constant analysis and planning. A trend analysis will help explain
how we got to where we are, and in what direction we’re going. Taking a critical look at
our strengths and weaknesses, and evaluating potential threats to our financial stability are vital
elements of a comprehensive planning process. Financial projections show us where we’re
likely to arrive at a point in the future, and highlight the gaps between where we want to be and
where we’re actually heading. It is not essential to analyze our history to the nth degree, or to
forecast our financial position with pinpoint accuracy. The most essential goal of the process

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is to stimulate thinking. By involving the governing body and other members of the
management team, we can create a pervasive focus on long-term planning that becomes infused
into all financial decisions.

5. Financial Policies

Financial policies are “rules of thumb” that establish acceptable and unacceptable courses of
action for daily operations and annual budget decisions. Policies are often the result of the
analysis and planning process – distilling all of the analysis and all of the plans into a set of
guidelines that, if followed, will take us in the direction we need to go. No one could
successfully argue that judiciously using surplus as a budget revenue, increasing budget
flexibility by reducing fixed costs, and prudently investing our money are bad things to do. So
why not just start doing them – whether or not they are part of a more formal process? Financial
policies won’t work unless they are actually followed. The most effective policies are specific
and written. They should be formalized, adopted by the governing body and shared throughout
the organization. Then they need to be followed – day to day and year to year.

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GOVERNMENT BORROWINGS

The Union Budget is the most important executive document published by the government of India
each year. The Budget lays down the status of the government’s financials and also provides
information about what areas it will be focusing on. But it also showcases the health of the
government treasury, exactly how much the government is bringing against its expenses. One of the
important ways that the government meets its expenses is through government borrowing. Most
nations in modern times choose to take on debt for a variety of reasons, like economic stimulation
and stabilisation, accelerating capital expenditure etc. Since the national economy often grows faster
than the interest on the debt, most governments don’t increase their debt obligation when borrowing
money.

The government borrows money in the form of debt. The government issues government securities
called G-secs and Treasury Bills. Investors, financial institutions, companies, and even other
governments in some cases can purchase these securities. This initial purchase gives the government
the money that it seeks to borrow. But like any other debt, the government is also on the hook for
paying for the public debt with interest. The government promises to pay the initial principal along
with interest upon the maturity of the security, though some securities also offer a periodic coupon
or interest payments. Just like other securities, rating agencies also rate these government borrowing
instruments. These payments often form a significant portion of the government’s fiscal deficit--the
deficit between the government’s expenditure and revenue in a year. This information can be found
under the Capital Receipts within the budget document.

Governments try to keep their fiscal deficit in check by consolidating their past debt obligations,
which itself is often referenced in terms of a percentage of the national GDP to understand its real
scale. Government borrowings plays an important role in government's finances to meet its
spending requirements. Government borrows through issue of government securities called G-
secs and Treasury Bills. Borrowing is a loan taken by the government and falls under capital
receipts in the Budget document. It is essentially the total amount of money that the central
government borrows to fund its spending on public services and benefits. As the tax and non-
tax revenue fall short in financing government's spending programme, the government
announces an annual borrowing programme in the Budget.

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The government's decision to stick to its borrowing programme has largely kept the bond yields
in check. But the risk of raising finances at a time when the gross tax revenue collection is
already under pressure could constrain spending which is key to economic revival. Bulk of
government's fiscal deficit comes from its interest obligation on past debt. If the government
resorts to larger borrowings, more than what it has projected, then its interest costs also go up
risking higher fiscal deficit. That hurts government's finances.

CONTROLS ON GOVERNMENT BORROWING

India has a complex system of intergovernmental fiscal relations. This complexity has its roots
in a number of factors, including substantial ethnic, social, and economic disparities among
regions, as well as the long-Standing vertical imbalance between the expenditure and revenue-
raising responsibilities of the state governments. This imbalance is in part covered by revenue-
sharing arrangements. States also receive a variety of grants from the centre, but even then
states run deficits. Despite the formal absence of independent borrowing powers, states borrow
both from the central government and state-owned commercial banks, with attendant
macroeconomic risks. For these reasons, and because of the clear trends toward structural
transformation of the economy—away from central planning—and increased claims of the
states for fiscal autonomy, a comprehensive reform of centre-state fiscal relations is needed.

The current Indian federal structure has its origins in the Government of India Act of 1935 and,
following independence, in the Indian Constitution of 1950. India is not a federation but a union
state, with a higher degree of centralization than found in most federations. The central (or
union) government is empowered to limit the rights of the 25 state governments (and 7 union
territories), and even to take over completely their administration in emergencies (including
financial emergencies). Until 1993, the Constitution did not discuss local governments. The
authority of local governments—encompassing a variety of urban and rural local bodies—is
still determined by the individual states and it can always be revoked. There is wide variation
in expenditure and tax assignments, and transfer arrangements across local governments. A
1993 amendment to the Constitution provided for the formation of state finance commissions
to review and recommend changes to fiscal relations between the states and local governments.

The Constitution specifies the expenditure responsibilities of different levels of government in

three lists defining central powers, state powers, and concurrent powers where both levels of
government can exercise authority, although the central government is granted supremacy. It

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also specifies the taxation powers of the central government and the state governments, and the
principles governing the sharing of revenue and certain other resources. A Finance
Commission, which is appointed every five years, recommends how the proceeds of taxes
should be shared between the central government and states, how the share of states should be
divided among them, and how to distribute grants-in-aid to the states. The Planning
Commission plays the lead role in deciding the distribution of development grants from the
centre to the states.

1. Expenditure Assignment

Consolidated government expenditure has been in the range of 27–30 percent of GDP during
the 1990s. The Constitution assigns a wide range of government functions to the states. In
particular, most spending related to agriculture and social policies is included in the state list.
Although the concurrent list admits wider responsibilities for the states in the economic field,
most major industries, even if not on the union list, are controlled by the central government.

2. Tax Assignment

One objective of the Constitution is to prevent overlapping tax powers, which translates into a
requirement that one type of tax can be levied only by one level of the government. The central
government is assigned the most important taxes with economy-wide implications. However,
while some taxes are levied by the centre for its exclusive use, the revenue from other taxes
imposed and collected by the centre is shared with the states. The central government levies a
personal income tax on all sources of income, except that from agriculture and of self-employed
professionals, a corporate profit tax, income tax surcharges, and import duties. State
governments are entitled to raise taxes on agricultural income and the income of self-employed
professionals, but agricultural income is taxed in only a few states.

The authority to levy taxes on property, wealth, estates, and capital transactions is split between
the centre and the states according to whether they are related to agricultural or non-agricultural
property. This appears to be consistent with the principle that lower-tier governments should
be assigned taxes from relatively immobile tax bases. In practice, however, agricultural wealth
and property are not taxed in any state. The central government is entitled to raise taxes on non-
agricultural estates. However, because all proceeds from these taxes have to be transferred to
the states, the central government does not have much incentive to levy such taxes. The states

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can levy stamp and registration duties, as well as a tax on urban immovable property. The
central government imposes excise duties at the production stage, except on alcohol and
narcotics, which are taxed by the states. A sales tax on a fairly wide range of goods is the states’
main source of revenue.

3. Revenue Sharing

The gap between states’ revenue and expenditure is bridged in part by revenue sharing. The
Constitution provides that the sharing of non-agricultural, noncorporate income tax revenue is
mandatory, while excise duty revenue may be shared with the states if parliament so decides.
The central government retains corporate profit tax, import duty, and income tax surcharge
revenue for its exclusive use. Revenue shares are not specified in the Constitution, but are
recommended for a five-year period by finance commissions. While the Constitution limits
finance commissions to making recommendations, its recommendations have almost always
been ratified.

4. Grants

Revenue sharing notwithstanding, vertical imbalances remain, which are filled through grants.
The central government provides many types of grant to the state governments. Grants-in-aid—
which represent only about 7 percent of transfers from the centre to the states—are also
recommended by finance commissions and are intended to close residual deficits on the state
governments’ nonplan revenue accounts. Gap filling has in most cases been determined by
projecting historical trends in revenue and expenditure. However, the Ninth Finance
Commission (1990–95) introduced a controversial normative element into its approach, taking
account of the special needs of each state.

In addition to funds allocated on the preceding basis, states can receive specific purpose grants
at the discretion of the Planning Commission, such as assistance for hill area development,
tribal area development, and matching grants for foreign aid projects. These have accounted
for an increasing share of the grants to states in recent years. One implication of specific
purpose grants is that although expenditure responsibilities have remained basically
unchanged, a growing share of spending is dictated by the central government. Through its
various ministries, the central government gives grants to state governments undertaking
nationally important development or welfare programs. The central government also provides

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discretionary grants for a variety of reasons, most notably in the event of emergencies or to
improve specific services. Not only does the grant system still leave vertical imbalances—
which necessitate borrowing—but it also does not fully address horizontal imbalances among
states. Recognizing that they have weak revenue bases, because of their physical and economic
characteristics, certain states have special category status. Both revenue sharing and grant
formulas are biased in their favour, although not by enough to compensate for their additional
expenditure needs. However, the largest horizontal imbalance remains in respect of poorer
“general category” states.

5. Borrowing

According to the Constitution, only the central government is entitled to borrow abroad. The
states are, in principle, entitled to borrow domestically, but they have to get permission from
the central government if they have any outstanding liabilities to the centre. All state
governments have such liabilities. Market borrowing, in practice mainly from banks, used to
be a captive market under the control of the central government, since the latter defined a
portion of assets that banks had to invest in state securities approved by the central government.
At present, the Reserve Bank of India in effect allocates state securities to commercial banks.
The central government also on lends shares in funds from small savings at post offices to
states; the shares reflect finance commission recommendations.

6. Tax Administration

Tax assignment is based in significant measure on the relative efficiency of the central
government and state governments in collecting taxes. Thus, all central taxes are collected by
the central tax authority and all local taxes are collected by state tax authorities. This
arrangement, while sound in principle, raises some problems, particularly in the context of
revenue sharing. The fact that the centre retains different percentages of different taxes—with
the rest being passed on to the states—may provide an incentive to concentrate the collection
effort and resources of the central tax administration on those taxes (such as the corporate
income tax and import duties) it retains in full, or in a higher percentage. The fact that separate
agencies are responsible for income taxation based on the origin of income (agricultural versus
non-agricultural) may create difficulties for the reform of the personal income tax. Similarly,
the fact that the central government is primarily responsible for taxing production, while the

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states are responsible for taxing retail sales, may make it more difficult to reform domestic
consumption taxes.

7. Budget Formulation and Implementation

The Indian fiscal year runs from April to March. The central government budget is formulated
beginning in October. It is presented to parliament by the end of February and approved shortly
thereafter. State budgets are formulated in tandem with the central budget and approved at the
state level usually in March. There are linked, yet separate, budget formulation procedures for
plan and nonplan spending. Even though an integrated budget is presented to each state
parliament, separation of budget-setting procedures causes problems. In particular, the plan
embodies an attempt to reconcile central spending priorities with the attraction to states of
securing central resources to support local projects. In discussions with the Planning
Commission, states overestimate own revenues and underestimate nonplan expenditure, thus
presenting a larger-than-justified absorptive capacity for new capital projects. Discussions with
finance commissions, by contrast, lay more emphasis on the prospect of rising deficits to attract
larger grants.

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CONCLUSION

In conclusion, the concepts of fiscal capacity, fiscal health, and government borrowing are
intricately linked and crucial for understanding the financial stability and sustainability of
governments. Throughout this assignment, we have examined the key elements and interplay
between these factors, shedding light on their impact on public finances and the broader
economy. Fiscal capacity refers to a government's ability to generate revenue through taxation
and other means, reflecting its economic potential and resources. A strong fiscal capacity
enables governments to finance public expenditures, provide essential services, and respond to
economic challenges effectively. It plays a pivotal role in determining a government's ability
to meet its financial obligations and maintain fiscal discipline.

Fiscal health encompasses a broader perspective, considering not only the capacity to generate
revenue but also the management of public expenditure, debt, and deficits. It reflects the overall
state of a government's finances, including the sustainability of its fiscal policies and the long-
term viability of its budgetary framework. A sound fiscal health is crucial for ensuring
economic stability, investor confidence, and sustainable growth. Government borrowing, on
the other hand, refers to the practice of obtaining funds from various sources, such as issuing
bonds or taking loans, to bridge budget deficits or finance public projects. Borrowing can
provide short-term flexibility and support necessary investments; however, excessive reliance
on borrowing can lead to fiscal imbalances, high levels of debt, and increased interest
payments, which can strain the economy and jeopardize fiscal health.

Understanding the interplay between fiscal capacity, fiscal health, and government borrowing
is essential for policymakers and economists to make informed decisions and maintain
sustainable public finances. It requires careful balancing of revenue generation, expenditure
management, and borrowing practices to ensure both short-term fiscal stability and long-term
economic prosperity.

To maintain a healthy fiscal framework, governments should focus on enhancing fiscal

capacity through efficient tax systems, reducing tax evasion, and promoting economic growth.
They should also prioritize prudent fiscal management, including effective budgetary planning,
expenditure control, and debt management strategies. Regular monitoring and assessment of
fiscal indicators can help identify potential risks and enable timely corrective measures.

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Himachal Pradesh National Law University

In conclusion, the concepts of fiscal capacity, fiscal health, and government borrowing are
critical components of public finance management. A robust fiscal capacity, supported by
prudent fiscal policies and responsible borrowing practices, fosters economic stability, enables
effective governance, and contributes to sustainable development. By maintaining a careful
balance between revenue generation, expenditure management, and borrowing, governments
can navigate fiscal challenges and create a foundation for long-term fiscal health and
prosperity.

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