The
National Common Minimum Programme of the UPA government
promised many things, and on some of the more crucial
issues (such as on the Employment Guarantee ACT) the
current central government has shown itself to be
less than enthusiastic in terms of fulfilling the
true spirit of its promise. But on other matters which
are more in tune with the basic neo-liberal economic
policy paradigm which the government continues to
uphold, it has acted with alacrity.
The
most recent example is in terms of the debate on subsidies
provided by the central government. The NCMP had promised
that ''All subsidies will be targeted sharply at the
poor and the truly needy like small and marginal farmers,
farm labour and urban poor.'' However, the actual
analysis provided by the Finance Ministry in its recent
Report prepared with assistance from the National
Institute of Public Finance and Policy (''Central
government subsidies in India: A report'', December
2004) suggests that this is to be used as a justification
for overall cutbacks in subsidies, regardless of their
effects on the poor and needy.
This discussion is not new, of course: the period
since 1991 has been characterised by a generalised
distaste for subsidies among policy makers, who have
tended to blame them for virtually all fiscal problems,
and have used this smokescreen to divert attention
from the inability to raise tax revenues. And so declarations
by the government as well as explicit attempts to
reduce direct subsidies on food and fertiliser have
been important parts of the economic reform programme
since 1991.
All this has been despite the fact that direct subsidies
paid by the central government amounted to a very
small proportion of GDP over this entire period. Chart
1 shows that since 1991, central government subsidies
have never crossed 2 per cent of GDP. Indeed, the
ratio of all direct subsidies paid by the central
government to GDP has actually fallen from around
1.85 per cent in the triennium beginning 1990-91 to
1.6 per cent in the triennium ending 2003-04.
Chart
1 >> Click
to Enlarge
This is really a trivial amount not only in terms
of the past, but also in relation to international
experience. In countries of western Europe, for example,
direct subsidies in the form of unemployment benefits
and social security can make up as much as half of
the current spending of governments.
Because direct subsidies are so low, the obsession
with reducing them has also necessarily required that
the attention be shifted from direct to ''indirect''
or implicit subsidies, calculated on the basis of
working out the excess of expenditure over receipts
for all major items of government expenditure. As
early as 1997, a similar Discussion Paper released
by the then government (which contained many of the
faces that are so prominent today) concluded that
total subsidies (including these implicit subsidies
reflecting low or non-existing user charges for public
services) in India were not only four to five times
higher than explicit subsidies, but constituted an
unacceptable 14.4 per cent of GDP.
This estimate was arrived at from budget documents
simply by calculating the shortfall in public revenues
(or "recovery" of expenditure through charges)
relative to the actual public expenditure incurred.
Using the notion of ''merit'' and ''non-merit'' subsidies,
(that is, those on goods and services with significant
externalities in which private and social valuations
would therefore differ significantly, and those without
large externalities) it was argued that subsidies
accounting for 10.7 per cent of GDP were unwarranted.
It was posited that the distributive consequences
of subsidies were adverse since they were not properly
targeted, quite obviously in cases where the subsidy
was administered through inputs (fertiliser, electricity,
diesel, irrigation, etc.) and even in cases where
they applied to a final good (food). As a result,
it was proposed that most of these subsidies were
best done away with, and that the best way to do so
was "through phased increases in recovery charges".
Thus the 1997 paper argued that there was a strong
case for an almost across-the-board increase in user
charges for services provided by the central and state
governments. This was then used to justify the increase
in fertiliser prices which had negative effects not
only on fertiliser consumption and farm productivity,
but also on the viability of cultivation. It was used
to explain the completely ham-handed and ultimately
counterproductive attempt to reduce the food subsidy
by raising issue prices of food grain and ''targeting''
the poor. This led to reduced offtake and not only
a paradox of large publicly held food stocks in midst
of hunger, but also an actual increase in subsidies
on holding of stocks, which were then exported at
prices even lower than earlier denied to the domestic
poor.
Several critiques of that paper comprehensively established
that the basic methodology of this exercise was invalid.
The classification of merit and non-merit subsidies
emerged as being very subjective and often bizarre.
The principal failure of this methodology was that
it recognised only one reason (the presence of externalities)
why the private valuation of benefits could deviate
from their social value to society. But subsidies
are essentially no more than negative taxes, so externalities
cannot be the only reason why societies choose to
subsidise particular activities, just as there are
basic socio-political and income-distributional decisions
which determine the pattern of taxation. In fact,
there can be many cases where the fact that public
expenditure exceeds cost recovery need not be a problem
but could in fact be socially desirable.
This is because market failure does not occur only
at the microeconomic level as is true in the case
of externalities. Even at the macroeconomic level,
government expenditure plays a critical role in maintaining
levels of economic activity, and to characterise much
of this as implicit ''subsidy'' is therefore highly
misleading. In market-based systems where savings
and investment decisions are taken by atomistic decision-makers
based on their guesses and expectations of an uncertain
future and of the decisions to be taken by others,
there is an inherent tendency towards an unemployment
equilibrium. Faced with this prospect, governments
tend to intervene with counter-cyclical demand management
policies aimed at dealing with the prospect of a recession,
and in some cases they attempt to mitigate the adverse
consequences of unemployment through mechanisms such
as unemployment benefit.
In addition, market-based systems tend to be characterised
by an unequal distribution of assets and incomes,
which reduces the ability of some individuals to participate
in the market and adequately finance their basic needs.
It is to deal with these features of the market economy
that the developed industrial nations have created
an elaborate welfare state, which has been dismantled
only partially even in the current "market-friendly"
ideological environment, and why direct subsidies
continue to be such an important part of the expenditure
of such governments.
Given this background, it is disturbing to see the
current Finance Ministry producing almost the same
false arguments of the earlier Paper, and coming to
even more unwarranted conclusions with respect to
policy. The only modification (which is not really
of much signfiicance) is the further segregation of
''merit'' subsidies into two categories based on degree
of merit. The methodology for calculating implicit
subsidies is the same, and yields a figure of 4.18
per cent of GDP for the year 2003-04.
Chart
2 >> Click
to Enlarge
Even the calculations presented in the Paper indicate
that these are mostly spent on critical areas such
as agriculture, industry and education. Chart 2 shows
the break-up of implicit subsidies as described in
the Paper. And these individual implicit subsidies
(which are already worked out on the basis of a problematic
methodology) come to tiny percentages of GDP, so small
that they are barely to be noticed in public finance
terms. Chart 3 provides an estimate of these. In fact,
if social services such as health and education as
well as expendtiure for the development of agriculture
and industry is to be provided in a socially optimal
way and provided to all of those who are poor and/or
deserving, then higher levels of implict subsidy are
called for, not lower ones.
Chart
3 >> Click
to Enlarge
But this faulty calculation (which also throws up
anomalies such as the railways providing a negative
subsidy, that is a net profit, for the government)
is then used to make very sweeping and even alarming
recommendations for cutting all subsidies. Based on
the unjustified axiom that even so-called ''merit''
subsidies should be reduced as much as possible, the
Report makes policy proposals that are not only wrong-headed
but also breathtaking in their insensitivity to the
current economic situation and problems of ordinary
people.
Thus, it calls for reducing Minimum Support Prices
for farmers at a time of widespread agrarian crisis.
It suggests that the present two-tier system of prices
in the Public Distribution System should be done away
with (presumably by revising the lower prices upwards)
along with a system of food coupons for BPL families.
Fertiliser prices should be raised. LPG and kerosene
subsidies, which affect largely middle class and poor
households, are seen as objectionable and requiring
further reduction, notwithstanding the recent price
hikes which have already adversely affected the poor.
Economic services are to be priced to varying degrees,
which essentially means increasing user charges regardless
of the merits and positive externalities of the services
in question. Even social services do not escape the
net: the Report argues that ''while humand development
is a necessary concern of the welfare state. It may
be necessary to reassess policies in this area at
the micro level to temper this concern with the equally
legitimate concern of burgeoning public expenditures.''
(page 22).
The irony is that in fact public expenditures have
not been burgeoning - as a share of GDP, non-interest
public expendiutre has actually been falling in recent
years, and this is part of the economic problem of
the country. This falling share of public expenditure
has been associated with much less infrastructure
development, poor and declining public services, and
a collapse of employment generation. So the economic
agenda should really be to think of ways of increasing
public expenditure, not cutting it further.
The focus on reducing expenditure only comes about
because of the failure to raise tax revenues. And
this has been an integral part of the fiscal strategy
associated with neo-liberal reform. The cuts in indirect
and direct tax rates have been associated with falling
central tax to GDP ratios, but the current Finance
Ministry does not appear to see reversing this trend
as a priority. Instead, it has already simply given
away around Rs. 6,000 crores to stockbrokers as lost
taxes, first by replacing the capital gains tax with
a turnover tax, and then by reducing that proposed
tax to a fraction of the original demand because of
protests on Dalal Street.
All fiscal measures have very strong implications
for income distribution. And they reflect very clearly
the intentions of the government and which sections
of the people and the economy the government serves.
If this Paper is an accurate reflection of the curent
thinking of the government in the matter of subsidies,
then it is bad news not only for the poor and needy
who require such subsidies for survival, but also
for development of the economy in general.
