Rebuilding a government

The Times of India feature, “Belt-tightening on the anvil” (July 1, 2016), covers details of the white paper by the Kerala finance minister, T M Thomas Isaac.

The report says, “The inefficiency to mobilize taxes and corruption in tax administration department and at check posts contributed to the decline in revenue. It came down to 13.1 during the UDF rule. Now Isac says he will raise the tax collection at the rate of 25 per cent. It is a huge challenge especially because he will have to overhaul the whole system and bring e-governance and more accountability,” said Mary George, chairman of Public review Expenditure review committee.

Based on the problems identified in the white paper, “overhauling the whole system” is too little. What is required is rebuilding the entire Kerala government processes and systems.

Here are some highlights from the “White Paper on State Finances,” some of which are astounding.

  • “The finances of Kerala are in dire straits.”
  • “The entire borrowing ceiling now permitted by the Central Government is just sufficient to meet the day to day expenditure of the State Government. Consequently, my Government is faced with the stark reality that there are no funds left for capital expenditure like construction of roads, bridges and other major infrastructure projects,” said Justice P. Sathasivam [2], Kerala Governor, in his address to the Legislative Assembly on June 24, 2016.
  • “For the last three years, budgets placed before the State Legislature have not had much of reality with either the resources to finance them or with the actual expenditure incurred at the end of the year. Schemes and projects were announced without the funds to back them up.”
  • “Budgets have lost their sanctity and budget speeches have become exercises in conjuring up unachievable visions of schemes and projects. The divergence between the reality and what is professed, has reduced the annual budgets to a ritual of proclaiming a slew of real or imagined dreams and intentions. Thus unfortunately, the State has been living on a financial lie.”
  • “The vital tax collection machinery, be it in commercial taxes, or excise was pawned away for private gains ignoring public interest.”
  • “Imprudent financial management has had an opportunity cost of nearly Rs.3000 cr. ($450m) per annum – money that could have been ploughed into the much needed capital expenditure in the State.”
  • “Unless, special efforts are demonstrably made evident to investors, this negative image may hamper the borrowing program of the State in the future. If the image of the State Exchequer is not restored in public minds, then it will detrimentally affect resource generation to finance the major policy initiatives and capital projects of the State”
  • “The State will have now to wait longer for catching up with advanced States and that the effort will now cost us more.”
  • “The State Own Non Tax Revenue in Kerala arises largely from lotteries and services rendered in Government Departments and account for on an average about nine percent of the total receipts of revenue.”
  • “Commercial Taxes constitute the major share of the revenues of Kerala, yielding approximately 50% of the State’s total Revenue Receipts. For a fiscally constrained State like Kerala, Commercial Taxes is the mainstay for Government. Any slackening of the mobilization efforts on this front immediately plunges the State into a crisis.”
  • “The Government in 2006-2011 had built up a robust, well-oiled and effective tax collection machinery.”
  • “The crisis itself was due to the lack of cohesiveness in Government during 2011-2016, with one arm in Government doing things without the other arms being aware of it.”
  • “The general lackadaisical directions of governance and indiscipline might well have seeped in to the tax administrative machinery in various departments, paving the way for easy subversion of administrative systems in place in these departments.”
  • Corruption and nepotism in the tax administrative apparatus was quietly allowed to grow strangely.”
  • “Sheer indifference to updating technological systems that should have been the foundation of scientific data analysis needed for effective tax collection.”
  • “Even when the finances of the State continued to remain stressed and on the verge of a breaking point, concessions were lavishly handed out on taxes.”
  • “It is also a tragedy that the appeal process often becomes steeped in corruption with the Deputy Commissioners (Appeals) remanding ripe cases overlooking even judicial pronouncements. Those who resisted the pressures found themselves helpless. There is a case where a Deputy Commissioner (Appeal) was changed three times till a pliant officer was found who would oblige the vested interests.”
  • “The report of the Comptroller and Auditor General on KVATIS in 2015 has documented in detail, how addition of simple validation procedures could have avoided significant leakages. The truth of the matter is that there was no attempt to update the systems since its introduction in 2008. Even the computer server capacity was not expanded, so much so that it became very difficult for taxpayers to access the database for even remitting their tax.”
  • “Significant tax concessions were given even through budgetary announcements even at the peril of a collapse of the treasury which was already starved for funds.”
  • “All caution was thrown to the winds in announcing new schemes without matching budget provisions in the hope that tomorrow would take care of itself!”
  • “Concessions offered to benefit certain groups of tax payers which amounted to sacrifice of revenues already being received.”
  • “Unwritten reluctance in certain cases to ensure that legally mandated revenue generation measures are implemented.”
  • “Failure to implement technology support in the major tax collection departments to give advanced data analytics support for tax collection and monitoring.”
  • “The immediate concerns as a State economy is the risk of our foreign NRI (Non-Resident Indian) remittances dwindling.”
  • “The decline in the rubber and price of other commercial crops has had a deleterious impact on the regional economy.”

Analysis of the white paper points to the following causes for the financial crisis in Kerala.

  • Irresponsible government
  • Corruption at different levels of the government
  • Lack of a balanced, sustainable economy
  • Inefficient tax administration systems and support processes
  • Fantasy budget and financial planning processes
  • Lack of inter-department coordination and collaboration
  • Lack of effective planning, coordination, collaboration and data management infrastructure and processes for the government
  • Lack of a coherent vision for the state economy

During the previous LDF (Left Democratic Front) government (2006-2011), responsible financial management resulted in:
     a) High growth rate (24%) of commercial taxes
     b) High year-end treasury cash balances.

During the last UDF (United Democratic Front) government (2011-2016) financial mismanagement, corruption and unfunded project expenses resulted in:
     a) Lower growth (10.13%) of commercial taxes
     b) Negative year-end treasury cash balance.

Tax revenue is highly volatile and point to an unbalanced economy. Major part of the tax revenue is from commercial taxes, resulting from consumption. Therefore, the first level dependence is on economic activity (consumption). The second level dependence is on the bureaucratic tax collection system (“vital tax collection machinery”), which is prone to political interference and manipulations.

A large portion of the tax revenue is derived from state lottery and alcohol sales. And the income tax share is nonexistent. This makes the tax system extremely regressive. A necessary goal for real economic development is shifting a significant share of state taxes to income tax, which will necessarily mean creating good jobs in the state, and will provide many supplementary economic benefits.

Implementation of a state-wide effective IT infrastructure capable of administrative support, financial and project management is a critical need.

The problems highlighted in the white paper also point to many governance deficiencies. Here are the critical ones.

1. Meaning of democracy

A common belief among political parties and leaders in India is that if they win elections, they can run the government as they please. The is a misconception. India is a “constitutional democracy” [2, 3]. That means political parties, political party members and leaders, government ministers, officials and employees have to behave and act within the provisions of the constitution and the laws derived from it. In addition to the constitution and laws consistent with it, there are sensible norms and customs that need to be followed by all for a functioning democracy.

Democracy matters because “it is the best system we’ve invented for distributing wealth, maintaining peace, and preventing one portion of society from falling beneath the yoke of another.”

2. Purpose of government

Kerala government formulation itself is based on outdated concepts, manifested by its tendency to arrogate to itself various activities in the economy. In fact, Kerala government may be a quintessential example of a malfunctioning government Peter Drucker [2, 3, 4, 5] describes: “There is mounting evidence that government is big rather than strong; that it is flat and flabby rather than powerful; that it costs a great deal but does not achieve much.”

Drucker defines the role of government: “The purpose of government is to make fundamental decisions, and to make them effectively.. The purpose of government, in other words, is to govern. This, as we have learned in other institutions, is incompatible with ‘doing’ … If this lesson were applied to government, the other institutions of society would then rightly become the ‘doers’ … It would rather be a systematic policy of using the nongovernmental institutions of the society – the hospital as well as the university, business as well as labor unions – for the actual ‘doing.'”

OECD (Organisation for Economic Co-operation and Development) has expanded on Drucker’s ideas and developed concepts for “public management” using “leveraged government,” More details available in the OECD publication: “Government at a Glance“.

Kerala government should focus on governance and divest itself from all other activities, automatically reducing its financial burden.

3. Tax administration

Kerala government tax administration, also known as “vital tax collection machinery,” is a misguided organization. Currently, based on the inclination of the political party in power, the “machine” whirls into action, collecting taxes. If the inclination of the party in power is lower taxes, the “machine” goes slow, and tax collection decreases. This type of thinking is an outdated vestige of the colonial days.

“The promotion of voluntary compliance should be a primary concern of revenue authorities,” OECD recommends in “Principles of Good Tax Administration.” And OECD adds, “Voluntary compliance is promoted not only by an awareness of rights and expectations of a fair and efficient treatment but also by clear, simple and ‘user-friendly’ administrative systems and procedures. Voluntary compliance is enhanced when it is easier for taxpayers to do so. Voluntary compliance is maximized when revenue authorities are aware of major developments and trends in the business and legislative environment, and are responsive to their implications on tax administration and compliance.”

The measure used for the effectiveness of taxation, rate of growth of commercial taxes collected is unscientific. A better method for estimating potential taxes is to benchmark with Tax revenue to GDP ratios. EU Tax revenue statistics may be a helpful guide for estimating tax potential in Kerala.

The solution to the current financial crisis in Kerala is a comprehensive economic development program — not increasing the rate of commercial tax collection.

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