Political Economy of Fiscal Responsibility

Context: Amidst the fiscal concerns, there is a need for a fiscal responsibility framework.

Binaries developed by multilateral institutions in guiding fiscal policy: International Monetary Fund and the Organisation for Economic Cooperation and Development. (acting as a cookie-cutter)

• Expansionary fiscal policy: should be followed when the “business cycle” is on the downturn.
• Debt Sustainability: should be adhered and the Government should reduce borrowings if a “debt sustainability analysis” shows that the debt-GDP ratio is increasing continuously.
• These guidelines are utilized by nations to justify their respective fiscal stance; leading to arbitrariness in government power to tax, borrow and spend.

Factors necessitating checks and balances on the Government’s powers to tax, borrow and spend:

• Fiscal policy is an instrument of coercive power: similar to military and police where the Government can fine, raid and jail a person for not paying taxes. 
  • Government has first claim over domestic savings for borrowing and freedom to decide to spend.
• Fiscal choices may increase inequality:
  • Government spending on infrastructure by borrowing (from rich) will increase inequality as the lender (rich) will earn from interest on the debt.
  • Governments disinvestment also aggravates inequality - as only rich can invest.
• Delayed and bad quality of shared economic information: which is available with a two-year lag in India and may have deleterious consequences:
  • E.g. In 2019, India went for off-budget borrowing due to wrong information and fiscal crisis and was unable to use expansionary fiscal policy to address the disastrous fallout of the pandemic.
  • Police excesses, military misadventures, and fiscal stress all arise when information is incompetently, or maliciously, used.

Way Forward:

• Develop a framework of rule and regulations: checking the government power to tax, borrow and spend in various circumstances.
• Checking inequality: by adopting the “golden rule,” which states that governments must finance consumption expenditure out of revenue receipts and borrow only for investment.
• Ensure the free flow of information: Responsible fiscal policy requires that the information used to assess and predict the revenues, borrowing and expenditure of governments is accurate and comprehensive.