Source: IDEAS AND INSTITUTIONS | ISSUE #47
Analysis
Fiscal Choices Before the 2024 Election
Later this month, the Union Government will present its eleventh Union Budget. The 2023–24 budget had been built on reasonable assumptions and modest targets. The revenue receipts were projected to grow by 10.4 percent over the actual receipts for 2022–23, which is a little less than the growth rate of 10.5 percent for the nominal GDP that was projected in the budget documents. The government also aimed at a gradual climbdown from the high levels of deficit it had reached during the two years when the pandemic and the policy response to it had a major impact on the public finances by placing considerable downwards pressure on revenues and raising demands for expenditure. In 2023–24, the fiscal deficit is aimed at 5.9 percent of GDP, which was only a small moderation from 6.4 percent of GDP in 2022–23 and 6.8 percent in 2021–22. This was not surprising given that this is the last fiscal year before the 2024 general election.
The numbers available so far seem to suggest that the government is on track to meet the targets it had set. According to the Controller General of Accounts, in the eight months from April to November 2023, the government collected 64.3 percent of its budgeted receipts (excluding borrowings and other liabilities). Since the expenditure till November was 58.9 percent of the budgeted expenditure, the fiscal deficit was only 50.7 percent of the budgeted fiscal deficit. So, if the receipts continue apace, there is room for the government to make important fiscal choices in this quarter. Will the government choose to restrict the fiscal deficit, or will it accelerate the expenditure in the last few months of the year?
It could be instructive to look at 2021–22, when the government was in a similar situation. By November 2021, the fiscal deficit was only about 46.2 percent of the budgeted deficit. This was because even though, by that time, about 70 percent of the budgeted revenue receipts had been collected, only about 60 percent of the budgeted expenditure had been incurred. So, the government had some flexibility to choose between staying the course on the deficit, which would have meant accelerating the expenditure, or aiming at a lower fiscal deficit. What course did the government choose to take?
The year 2021–22 ended with the same fiscal deficit to GDP ratio as budgeted—6.8 percent of GDP. This number should be seen in light of two additional facts. First, while the budget documents had projected a growth of 14.4 percent in the nominal GDP, the actual growth rate was 18.4 percent. This meant that the denominator for the deficit to GDP ratio was much larger than expected, and if the actual deficit had been kept at the budgeted level in rupee terms, it would have been lower as a percentage of GDP—around 6.4 percent. Second, the receipts (excluding the borrowings and other liabilities) turned out to be 11.7 percent higher than what was budgeted. Accounting for this, if the expenditure had been kept at the budgeted level, the deficit would have been 5.4 percent of GDP. So, the fiscal deficit of 6.8 percent of GDP allowed for much larger expenditure than what was budgeted. The same fiscal deficit to GDP ratio amounted to more than INR 3 trillion in additional expenditure even over what had been budgeted for the year.
This meant that the average monthly expenditure during the last four months of the fiscal year was 66 percent higher than that during the first eight months of the fiscal year. While at the beginning of the fiscal year, the government may not have expected the higher-than-budgeted growth in nominal GDP and revenue receipts, around November 2021, it must have got a sense that it had a choice. It seems that it chose to accelerate the expenditure rather than restrict the fiscal deficit even as the GDP, and thereby non-debt receipts, grew at a rate that was faster than what was expected.
One way of looking at this choice is in terms of its political context, specifically that of electoral politics. There had been no state legislative elections between April 2021 and January 2022, and then, in February and March 2022, there were elections in Goa, Uttarakhand, Punjab, Manipur, and Uttar Pradesh. It might have been a consideration on the part of the government that additional expenditure between December 2021 and March 2022 might be useful electorally. So, it might have used the flexibility it had at that point to choose the path of additional expenditure rather than one of fiscal consolidation.
An incumbent party has many instruments at its disposal that it can use for its benefit in the elections. But a government may not always find itself in a position where it has much flexibility to use these instruments at will. It may then adapt in other ways to keep with the logic of political survival. Consider the fiscal situation before the 2019 general election. In both 2017-18 and 2018–19, there had been a shortfall in receipts, which limited the government’s fiscal space. The receipts were falling short of budget expectations, despite the government deploying unorthodox methods, such as selling one public sector enterprise to another to generate resources for itself, raising cesses and surcharges, and so on. The shortfall was large, even as the government felt the need to spend in a slowing economy. So, in both 2017–18 and 2018–19, the government “addressed” the situation by moving a significant part of the borrowing to public enterprises for purposes toward which the government used to borrow on its own books. It may be seen as an off-budget fiscal stimulus.
Since the pandemic, such creativity has not been necessary, as the expectations around deficits seem to have changed. So, a silver lining of the recent years has been that we have seen fewer such tricks, and the off-budget borrowing has mostly been brought onto the government’s books. Still, the larger issue of reestablishing the norms of fiscal prudence remain. There seems to be a lack of clarity on what the debt and deficit norms are, and we need much more debate on these issues, more so because much of the debt is placed with domestic, government-owned institutions that are hardly in a position to hold the government accountable for fiscal discipline.
Coming to the present moment, we are in a similar situation—it is noteworthy that the government seems to have a choice, again. If the experience of two years ago is anything to go by, chances are that it is already accelerating expenditure in view of the upcoming general elections.
—By Suyash Rai
Review
Understanding Institutional Change and the use of Policy Instruments for Infrastructure Development in Cities
How do cities meet serious infrastructural challenges, and how do institutions adapt to meet these challenges? In India, this has been a regular issue of deliberation and research. Even as India urbanizes, the quality of urbanization remains problematic. Basic infrastructural issues pertaining to roads, transport, sewage, and water supply constrain the capacity of our cities to function more productively.
One persuasive argument that attacks these problems is that the use of better policy instruments in planning and infrastructure development can help overcome existing difficulties. However, existing institutions, ideas, and interests, it is argued, often come in the way of using these instruments. This line of argument presupposes institutional change before better policy instruments are put into practice.
Simon van Zoest and Tom A Daamen examine the dynamics of institutional change and the use of novel policy instruments in urban infrastructure policy across three different cities. They study the use of value capture mechanisms for financing metro infrastructure in London, New York, and Copenhagen. Their paper titled “Explaining Value Capture Implementation in New York, London, and Copenhagen: Negotiating Distributional Effects” (2024) studies how institutions, broadly defined, changed in response to the need to develop this infrastructure.
One of the main claims the authors make is that the shift to a value capture mechanism or instrument is not just about the novelty of the mechanism. It also reflects a process of institutional change. Studying value capture from this perspective, the authors argue, is useful in understanding the politics of implementing a novel mechanism in local contexts. In order to do so, the authors deploy Elinor Ostrom and Douglas North’s conceptions of institutions “as the rules and prescriptions shaping and influencing the behavior of individuals and their decisions. These institutions can be both formal and informal.”
The authors argue that in understanding the adoption of value capture mechanisms, there was a process of gradual institutional change observed in each of the cases they studied, with respect to both the formal instruments and rules as well as the informal institutions. Through their case studies, the authors also challenge the winner-loser perspective on institutional change, according to which the losers of existing institutions support change, while the winners oppose it. They argue that “short-term behaviors do not always match long-term strategies, and institutional change does not necessarily emerge from actors with transformational motives.”
To flesh this argument out, they detail three cases of metro rail development where value capture instruments were used. These are summarised below.
London's Business Rate Supplement
The Crossrail 1 project is, according to the authors, a pivotal shift in infrastructure financing in London. This new subway line spans 119 kilometres and increases the city's rail capacity by 10 percent. About 28 percent of its funding, approximately 4.1 billion GBP, comes from existing commercial property owners through the Business Rate Supplement (BRS).
UK’s infrastructure projects traditionally relied heavily on national government funding. However, the enormous investment required for Crossrail 1 necessitated a different approach. Given the project's significant financial demand and political resistance, especially from outside London, the government sought to engage local beneficiaries in its funding.
Implementing the BRS required companies to contribute directly to a specific infrastructure project. This method, though politically and financially impactful, garnered support due to the anticipated economic growth and improved connectivity. Businesses, particularly those near the proposed line, perceived the project as crucial for maintaining London's competitiveness in the global market. The route's extension to include Canary Wharf and Heathrow Airport further solidified this support.
However, securing these funds involved more than goodwill. Local authorities actively engaged with the business community, conducted workshops, and developed transportation models to showcase the project's benefits. This strategy reframed the funding narrative, indicating that the project's realization depended on local contributions. A significant development in this process was the active lobbying for VC legislation by some of the major beneficiaries, recognizing that it would ensure a broader financial contribution base, including their competitors.
The collaboration of local business leaders, the Mayor of London, and the national government was crucial in advocating for and implementing the BRS. This collective effort underscored the project's significance for London's economic and transport development and the national economy.
New York's Subway Extension
The authors describe New York City's approach to funding the 2.4 km extension of the No. 7 subway line as very different from that to London's Crossrail project. This smaller-scale infrastructure project was crucial for developing Manhattan's West Side and was entirely funded through future property tax income.
In New York, public transportation projects are usually funded by the Metropolitan Transportation Authority (MTA) or the federal government. The No. 7 line extension was not prioritized by either. This left the city to shoulder the financial responsibility for the extension. This development was facilitated by a zoning change allowing for high-density construction, leading to the creation of the Hudson Yards, a significant high-rise area.
The authors state that the city’s innovative financing involved creating a designated financial district around Hudson Yards. For a period of twenty to sixty-four years, all property taxes collected in this area would be specifically allocated to fund the subway extension and related public works.
The implementation process in New York differed significantly from London's Crossrail project. In New York, the city administration itself was the main beneficiary of the funding strategy. The decision to earmark its own property taxes deviated from the norm of state-funded infrastructure projects. This shift was driven by the city’s broader strategy to foster economic growth and maintain Manhattan’s status as an economic center. The subway access to Hudson Yards was seen as a critical condition for the area's development.
The authors, however, point out that despite the success of this venture, the city administration is cautious about broadly applying such strategies, preferring only to consider them on a case-by-case basis.
The authors argue that the institutional change represented by the No. 7 subway line's funding approach was primarily a means to an end for the city administration. While the New York State supports such institutional changes, NYC’s veto power in using such schemes indicates that this approach remains a one-off strategy rather than a systemic shift in funding infrastructure projects.
Land Transfer in Copenhagen
Copenhagen's approach to financing its first two metro lines is a third variant of using value capture for infrastructure funding. Beginning in 1996, these lines, extending 20.4 km and costing 1.64 billion euros, were entirely funded through land development, a significant deviation from Denmark's traditional reliance on national government funding for such projects.
The authors argue that the financial and political context in Denmark at the time made traditional funding methods untenable. This situation necessitated an alternative funding approach, for which a 310-hectare site west of Copenhagen's city centre was identified. The site was owned jointly by the state and the municipality. This underused land presented an opportunity for large-scale area development, with the potential revenue earmarked for funding the metro lines.
To capitalize on this opportunity, the state and the municipality established By & Havn, a public development company. They transferred their land to this entity at no cost, and By & Havn commenced the construction of the subway lines using government loans. The subsequent rise in land value due to the construction of the metro lines and a change in zoning regulations enabled By & Havn to repay these loans through the sale of the developed land.
This innovative funding approach required a significant departure from existing arrangements. It demanded close collaboration between the state and the municipality, despite their strained relations, and an entrepreneurial, risk-embracing mindset. This shift was driven by Copenhagen's economic decline in the 1980s, the municipality's near bankruptcy, and the pressing need to revitalize the city's infrastructure to foster economic growth.
Satisfied with this model, subsequent infrastructure projects in Copenhagen also deployed land development for funding—the inner-city metro ring and its branch lines were also funded through similar arrangements. The authors also suggest that this value capture strategy involving land transfers to a separate legal entity has become a preferred method for funding new subway lines in Copenhagen.
The authors present a few interesting insights based on these case studies. First, they find that the new value capture mechanisms actually required “displacement” or a significant shift from existing practices or rules. Each of the instruments adopted was a significant departure from existing practice and, in the cases of London and New York, required new legislation. Second, they find that contrary to intuition, beneficiaries of existing institutional frameworks supported and advocated for the value capture instruments, sometimes in collaboration with other stakeholders. Third, the stakeholders viewed the changes in financing mechanisms as a means to pursue strategic goals, rather than seeking institutional change for its own sake. Higher levels of government in each of these cases also considered the success of value capture mechanisms instrumentally. They considered the benefits of value capture as a strategy for freeing up funds for other expenditures. These instrumental considerations drove institutional change, rather than the other way round. Fourth, the authors find that the support of beneficiaries is critical to the adoption of value capture mechanisms.
In conclusion, each of these cases speaks to the issue of the relative prioritization of institutional change over the adoption of better policy instruments. Sometimes, as the paper discussed here argues, the adoption of novel policy instruments is achieved organically through a process of institutional change, which in turn drives institutional change in favour of the novel policy instruments.
—By Anirudh Burman