subsequent growth rebound and stronger micro foundations for growth. In other words, it has taken some 12 years for the economic benefits from the post-1991 reforms to emerge.

But sustaining these benefits and the high growth will require continuing fiscal reform, not least to address the growing infrastructure constraint, which remains a major challenge for the public finances. One way to close the infrastructure gap is simply to borrow and spend on related projects; after all, infrastructure will pay for itself through faster growth and higher taxes. We caution against such reasoning because of the potential size of the investments involved and the risks this would pose in conjunction with the prevailing high indebtedness and the poor performance record of existing infrastructure investments, captured by the egregious power sector losses. Further, a significant agenda of reform remains in the areas of revenue mobilization and subsidies, which when implemented will generate significant space for infrastructure. For example, Ninth Plan period outcomes might have been softened by more aggressive implementation of tax reform, especially on direct taxes and the state-level VAT, which was finally introduced in 2005 in 24 out of 29 states and union territories after a 10-year delay (Poirson (2006)). Subsidy reform (electricity, food, fertilizer) is another area in which more could have been done. These reforms plus a clearer strategy for addressing the infrastructure problem (by dealing with pricing and regulation) might have led to smaller cuts in government capital expenditure and a bigger private sector role in providing infrastructure services.

It is a matter of debate why the preceding combination of low taxes, inefficient subsidies and bad infrastructure was not remedied during the Ninth Plan; however, the chances of successfully implementing the necessary reforms now may be higher if they are seen as creating a stronger environment for supporting the rapid growth and accompanying euphoria which have emerged after the stagnation of the Ninth Plan period. In the next section, we address two transitions that are going on, both critical for reining in indebtedness and strengthening the links between the public finances and growth: (i) in revenues, completing the move away from trade, excise and financial repression taxes to a broad-based VAT and income taxes; and (ii) at the state level, a major fiscal adjustment in line with the 2004 Twelfth Finance Commission (TFC) report. It culminates in a discussion of the options for addressing the infrastructure gap.

# **3. Towards Sustained High Growth and Lower Indebtedness**

This section discusses two major remaining challenges facing the public finances: further revenue reform; and the significant progress with the states’ fiscal adjustment. It closes by discussing the infrastructure gap.

# 3.1 India’s Revenue Adjustment

Table 5 shows the big decline in revenues after 1991, which has only been restored to pre-crisis levels very recently. We focus on a few main ideas in this section, as several good surveys exist.<sup>29</sup> As alluded to above, there has been a major shift in the tax structure post-1991, and a fall in indirect taxes has been a major factor in lower revenues after 1991. Figure 6 shows that compared to 6.3 percent of GDP in the second half of the 1980s, customs and excise had fallen to 3.8 percent of GDP in recent years.

> 29 Acharya (2006, chapter 5), Muhleisen (1998) and Shome (2004), for example.

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