SUBSIDIES IN THE FEDERAL BUDGET

SUBSIDIES IN THE FEDERAL BUDGET Subsidies, like taxes, have been considered legitimate tools of government intervention. Before the 1990s, Indian government intervention over a wide spectrum of private decisions about production and consumption brought extensive use of tax subsidies, designed to achieve given objectives of its socialist approach to economic development. These subsidies took various forms, including: standard consumer subsidies, for example food subsidies; interest or credit subsidies on priority sector lending by public sector banks; tax subsidies or tax "expenditures"; free public supply of certain services, like primary education and some health services; procurement subsidies for food grains and some other agricultural products; and regulatory subsidies arising from administered prices pegged below market prices, as for iron and steel.

Rationale

All subsidies add to public expenditure and must be financed from general revenues. In a balanced budget framework, this requires an equivalent rise in taxes or other sources of income whenever subsidies are given. Under normal circumstances, subsidies must be justified in specific benefits, and comparison of these benefits with the costs, both private and social, associated with such revenues is implied.

The basic economic rationale for subsidies is to bridge the gap between private returns and social returns of goods and services that have large externalities. Examples would include inoculation against communicable diseases, elementary education, social forestry and water conservation. In India, however, government subsidization has gone well beyond this primary reason, and widespread subsidies have been justified on several grounds, including self-sufficiency in production, supporting infant industries, poverty alleviation, or sometimes for distributional reasons (e.g., food subsidies).

The main problem with the subsidy regime in India is that much of it is nontransparent because subsidies are given in the form of unrecovered costs. As such, they are not really mandated by the empowered legislature, nor are their costs fully appreciated in general. The explicit subsidies are large but form only a fraction of the total amount of subsidies. Large implicit and explicit subsidies have been responsible to a considerable extent for the high fiscal deficits now observed at all levels of government in India. This has resulted in absorption of nongovernment savings to finance the deficits, leading to high interest rates, lower private investment, and consequent adverse effects on growth. Subsidies also change relative prices, and the resultant price distortions have led to resource misallocation.

Estimates

In India, official figures of subsidies either relate to only explicit subsidies or those including a small part of the implicit ones. After more comprehensive estimates of subsidies were unofficially made and widely accepted, official acceptance also followed. An official white paper on the subject that used the wider concept and its methodology for estimation of subsidies has tried to take

into account the justification for various kinds of subsidies by classifying subsidized services into merit and non-merit goods based on subjective judgments regarding the degree of externalities involved (see Table 1). There are several difficult problems encountered in measuring this concept on the basis of available information. The stock of accumulated capital is given in nominal terms at heterogeneous prices that vitiate the computation of depreciation. The life of the assets concerned is also not uniform, and therefore the rates of economic depreciation. There is also the problem of change in value of some of the assets, particularly land, which cannot be taken into account, but which are extremely important for understanding the opportunity costs involved.

Another important problem relates to the issue of efficiency costs as opposed to actual costs, and the conceptual need to eliminate the excess of actual over efficiency costs from the estimate of subsidies. This is an intractable problem that has not yet been tackled. There is also the problem of lags between investment and the generation of service flow, and hence the need to abstract from the associated capital costs during this lag, but the informational requirements for this are not readily available.

Table 2 presents the four discrete estimates of aggregate budgetary subsidies, all of which put the total at around 12 percent of the gross domestic produce (GDP) or more. About one-third of these constitute the share of the central government, the rest being provided at the state level. The state governments provide the bulk of the subsidies, mostly in the areas of education, medical and public health, agriculture and allied services, energy,

irrigation, and transport. At the central level, about a third of the total subsidies are explicit, the rest given through low or nonrecovery costs of public services. In fact, the overwhelming bulk of explicit subsidies are at the central level. Aggregate estimates of subsidies rose as a ratio of revenue receipts, but fell as a ratio of fiscal deficits. The implication is that subsidies are being financed less by current income of the government, and more by borrowed resources that push up the fiscal deficit, which creates problems of sustainability.

Table 3 shows the growth of explicit subsidies given by the central government, and the clear deceleration in growth during the 1990s. The deceleration would have been much larger had the trends suddenly not reversed direction in the second half of the 1990s, possibly caused by the increase in current costs of service provision due to upward wage revisions.

Assessment

The targeting of subsidies leaves much to be desired, due to design faults as well as implementation problems. Food subsidies, through the public distribution system, are good examples. Most input-based subsidies (like fertilizer or power subsidies) are ill-designed, so that they are not properly targeted and are often regressive. Subsidies at the intermediate stage of production always carry the risk of getting dispersed to all consumers simply in proportion to their consumption.

In the long-term perspective, unnecessary subsidies, coupled with persistent deficits in the public sectors, can actually have the opposite effect of that intended. Provision of many basic services by the government is now facing this paradox, since large subsidies divorce price and output decisions and breed indifference to cost recovery. With growing pressure of population increase and no built-in controls on costs, implicit subsidies keep rising until they hit a budget constraint, and the subsequent adjustments affect both quality and quantity. Poor quality confers an inferior status on such services.

Reforms

A reform that is gradually gaining ground is that of reestablishing the link between price and supply of services, by allowing some autonomy to service units in user charges and allowing use of the proceeds at the same unit for improving the quality of the services concerned. Another reform that is becoming popular concerns collection of charges for irrigation. Water user associations are being set up in some states to take care of distribution of water and collection of appropriate user charges. But proper pricing for piped water supply, particularly in urban areas, still awaits effective reform. Similarly, problems of major power theft raise the issue of who exactly benefits from the huge subsidies in this area.

Several products actually receive unmerited subsidies, as does jute, long subsidized despite a clear worldwide trend of lower demand. This distorts cropping patterns and prevents market orientation of agriculture.

Tapas K. Sen

BIBLIOGRAPHY

Mundle, Sudipto, and M. Govinda Rao. "The Volume and Composition of Government Subsidies in India." Economic and Political Weekly (4 May 1991): 1157–1172.

Rao, M. Govinda, and Sudipto Mundle. "An Analysis of Changes in State Government Subsidies: 1977–1987." In State Finances in India, edited by A. Bagchi, J. L. Bajaj, and W. A. Byrd. New Delhi: National Institute of Public Finance and Policy, 1992.

Srivastava, D. K., et al. Government Subsidies in India. New Delhi: National Institute of Public Finance and Policy, 1997.

Srivastava, D. K., C. Bhujanga Rao, Pinaki Chakraborty, and T. S. Rangamannar. Budgetary Subsidies in India. New Delhi: National Institute of Public Finance and Policy, 2003.

Tiwari, A. C. Volume and Composition of Subsidies in the Government: 1992–1993. New Delhi: ICRIER, 1996.