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No pain now for gains in 2014
Bharat Jhunjhunwala on why subsidies must be replaced by direct cash transfers
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Illustration: Tanmaya Tyagi |
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WHAT IS the basic philosophy behind the recent budget? Increase in basic rate of excise duty and service tax will lead to an all-round increase in prices but the opposite may happen in the long run: increase in tax would lead to higher revenue collection and reduced fiscal deficit. The Reserve Bank will have to bankroll fiscal deficit to a lesser extent. This will lead to less monetary expansion and control in prices.
The finance minister’s strategy is to face an immediate increase in prices but control the same in the long run. Perhaps the finance minister has his eyes on the 2014 general elections. He might have assessed that people will soon forget this increase in tax rates and make it possible for him to introduce populist schemes in the coming budget of 2013 and help the UPA win the ensuing elections.
A similar strategy seems to be working with respect to the growth rates. The increase in rates of excise duty and service tax will lead to pressure upon the corporate sector. Companies will find it difficult to sell their goods. But this is in the short run. The impact may be the opposite in the long run. Increase in revenues would lead to lower fiscal deficit, stabilisation of the currency, increased confidence of foreign investors, inflow of foreign capital and higher growth rates. The short-run decrease in growth rate may thus translate into long-term increase in the same. Economic growth rate may be higher for two more reasons. It has been made easier for companies working in the infrastructure sector to access external commercial borrowings. Select infrastructure companies have been allowed to issue tax-free bonds totaling Rs 60,000 crore in the coming year against Rs 30,000 crore in the past year. These measures will buoy growth rates in the infrastructure sector and have an all-round multiplier effect.
There is danger in this strategy, however. The fiscal deficit may not reduce despite the increase in taxes. The burden of subsidies continues to rise. There is some effort to improve delivery system of the subsidies but this is unlikely to lead to reduction in total outlays. There will be compulsion for the government to enhance these subsidies in view of the impending general elections in 2014. The government has no courage to dismantle this massive leakage-prone expenditure. There is no indication of reduction in government consumption. No action has been taken to improve the functioning of the bureaucracy. The UPA government is under pressure from allies. It may have to buy support from Mamata Banerjee and Akhilesh Yadav. These increased expenditures may eat up the increased collection of revenues. The government will be doubly hit under such circumstance. The short-run increase in prices and decline in growth rate may persist in the long run. The finance minister’s gamble is that such a scenario will not unfold.
The two major drains on government revenues are salaries and pensions of government servants and expenditures on subsidies. The UPA government is philosophically oriented towards bureaucracy-led welfare of the people. This is based on the belief is that people are uneducated fools and government servants will prod them in the right direction. Therefore, there is no will to rein in government consumption.
That leaves the question of subsidies. Here the Finance Minister has made some moves in the direction of streamlining distribution. The subsidies are at present being grabbed by the upper sections of society. The Food Corporation of India and upper sections of the society, not the poor people, are the main beneficiaries of food subsidies; manufacturing companies who show inflated cost of production are the main beneficiaries of fertiliser subsidies; and upper sections who buy more goods from the market are beneficiaries of the subsidy on diesel. The government has initiated IT-based pilot schemes to reach some of these subsidies directly to the people. IT-based verification of ration cards is taking place in Jharkhand, which will make it possible to identify and eliminate bogus cards. A pilot project to transfer subsidy on LPG gas directly to the bank accounts of the beneficiaries has been implemented in Mysore. Another pilot project to transfer kerosene subsidy directly in cash to the beneficiaries has been implemented in Alwar district of Rajasthan. The finance minister intends to expand these direct transfers to beneficiaries in 50 districts in the coming six months. These direct transfers may lead to reduced financial burden on the government revenues and reaching subsidies in cash may provide political mileage to the ruling party.
AN EFFORT is being made to track movement of fertiliser from manufacturer to retailer through an IT-enabled system. It is proposed to extend it to tracking the movement up to the farmer in due course. It is believed that this will help prevent diversion. I am not sure of this benefit. Ultimately, the fertiliser is consumed by some farmer. It is not like diversion of kerosene for adulteration of petroleum products. Therefore, tracking of movement may not reduce the burden of subsidy.
The government’s efforts to streamline delivery systems are welcome. However, more aggressive actions could be taken. Instead of streamlining delivery of each subsidy separately, all subsidies may be scrapped in one go and the amount saved may be transferred to the bank accounts of all the citizens of the country. The increased burden upon the farmer can be neutralised by an increase in price of food products, which would have been already neutralised by cash transfers to the middle class. The increased burden on people due to increase in price of food, fertiliser, LPG, kerosene and diesel will be more than compensated by the cash transfers. Additionally, the people will be empowered to use the cash transfers for purposes close to their hearts. In fact, the cash transfers should be extended to include health and education services. Back-of-the-envelope calculations show that every family in the country can get an amount of Rs 2,500 per month from redistribution of present budgets on these heads. This amount is sufficient to enable a family to keep its body and soul together.
The budget has taken some small steps in the right direction— within the limitation of burgeoning government consumption. It was necessary to increase excise duty and service tax to reduce fiscal deficit in view of increasing government expenditures. The movement towards cash transfers of subsidies is a step in the right direction. But there is no mention of reducing the number of government servants and capping their salaries. The danger is that increased government consumption may derail the whole strategy: Fiscal deficit may not be controlled despite increase in taxes, private investment may not increase despite control of fiscal deficit; and jobs may not be created despite increased private investment. This will be disastrous for the government as well as the economy.
Bharat Jhunjhunwala is a former economics professor at IIM Bengaluru.
bharatjj@gmail.com
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