One of the most important decisions of Prime Minister Narendra Modi vis-à-vis economic policy making was the disbanding of Planning Commission in India. With the 12th Five Year Plan period getting over in 2017, the 2017 budget is putting an end to the practice of classifying central government spending into plan and non-plan categories. This entails two major changes in the overall budgetary exercise—a shift away from the plan/non-plan classification to a classification focused solely on revenue and capital expenditure, and a change in the way ministries submit demand for grants.

An August 2016 finance ministry note on the issue says that the earlier practice of classifying government spending in plan and non-plan categories will make way for a division on the basis of revenue and capital expenditure. Revenue expenditure refers to routine expenses such as those on salaries and pensions while capital expenditure refers to spending on long-term investments such as infrastructure.

In the planning era, the Planning Commission could decide on the allocation of funds in the plan component of the budget. Now, the finance ministry will be the sole arbiter of funds, and will decide on allocation to ministries. The ministries, in turn, will be expected to submit proposals based on a four-fold classification: central government projects, establishment and obligatory expenditures, expenditure on autonomous bodies/implementing agencies, and expenditure on centrally sponsored schemes.

The practice of classifying expenditure into plan and non-plan categories was based on the idea that the state could direct resources in desired areas (specified in five-year plans) over and above what was necessary for regular expenses (non-plan). In theory, this sounds very close to the idea of the revenue versus capital expenditure classification.

In practice, however, the division was not so clean. Over time, the share of revenue expenditure in plan expenditure increased to around 70%. In fact, decline in capital expenditure component of plan expenditure has been an important reason for declining share of capital expenditure in overall government spending. While the planning process was intended to focus on medium-term target-oriented spending, it ended up funneling resources to fund current expenditures. See Charts 1A and 1B.

The problems with the earlier approach were recognized by a number of government committees. A 2011 report of the High Level Expert Committee (HLEC) on Efficient Management of Public Expenditure under the chairmanship of C. Rangarajan had termed the practice as “dysfunctional and an obstacle in outcome based budgeting".

The shift away from plan-non-plan to revenue-capital classification is expected to improve the efficiency of the budgeting exercise as outcomes depend on total spending, rather than just plan or non-plan expenditure. Also, a focus on revenue versus capital expenditure is expected to help the government follow a golden rule of public finance, which requires revenue expenditure to be financed by revenue receipts, with the government borrowing only for capital expenditure (i.e. only for long-term investments).

One of the risks of the new framework is that it creates a void with regard to the budget planning process, and may encourage ad hoc spending decisions, a 2017 working paper by Pratap Ranjan Jena at the National Institute of Public Finance and Policy (NIPFP) pointed out. To prevent that, Jena argued that the Centre should develop a structured medium-term budgeting framework, possibly co-ordinated by the Niti Aayog and the states should adopt a similar framework in which their respective planning departments take the lead role.

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