Negotiating Freebies

IN JULY, PRIME MINISTER Narendra Modi set the cat among the pigeons by stating that the culture of revdi (freebies) could be dangerous for India's development. "Today, in our country, attempts are being made to collect votes by distributing free revdis. This revdi culture is very dangerous for the development of the country… People of revdi culture will not build expressways, airports or defence corridors for you," Modi said.

The Prime Minister's comments, which came during the launch of the Bundelkhand expressway in U.P., triggered a war of words since luring the voter with grand promises of freebies before elections has been a time-tested strategy of Indian politicians.

The first to react was Arvind Kejriwal, Aam Aadmi Party leader and Delhi chief minister, who saw it as an attack on his policies of offering free health and education, in addition to free electricity and drinking water, as well as his promises to the voters of Gujarat, the state set to go to polls later this year. "We will give freebies. You give your ministers freebies, we give to the public," Kejriwal had said. His response was enough to provoke finance minister Nirmala Sitharaman into saying that health and education are not considered as "freebies" and no government can deny those services to its citizens. Making provisions for freebies without understanding a state's financial status will burden future generations, she said.

Sitharaman's statement was rebutted by former finance minister of Kerala T.M. Thomas Isaac, who argued that states have been fiscally responsible while the Union government has behaved imprudently. Tamil Nadu finance minister Palanivel Thiaga Rajan, too, joined the debate, and said it was the prerogative of the elected government to distribute the money in a manner it deemed fit.

The list of state and Central ministers, former bureaucrats, economists, and others who have joined the freebie debate, is long. In fact, responses have been so intense that, within three months, the Supreme Court admitted a bunch of civil writ petitions on the issue. At least one petitioner has made the ruling BJP, the Opposition Congress, and 55 other political parties of India, the Union Government and the Election Commission respondents in the case.

The petitions before the apex court and the ongoing debates raise two pertinent, but distinct questions. First, can the practice of promising freebies in election manifestos to influence voters be restricted? If so, then how? The second question is about the quality of freebies that are promised and delivered irrespective of elections. Is there a need to define a desirable freebie? Also, if some freebies are neither welfare measures nor developmental in nature, but mere drain on public resources, should they be curbed?

The first question is more political in nature, and the Election Commission is already trying to introduce a fresh set of disclosures that political parties will have to make in relation to the promises in election manifestos. The only problem is that the EC had tried to enforce this before through the election manifesto guidelines of 2014, but without much success.

The second one is an issue that economists and public finance experts have been raising for years now. In fact, one of the tasks before the 15th Finance Commission, which submitted its report for 2021-26 two years back, was to suggest measurable performance-based incentives for states to make them reduce expenditure on populist measures. Hardly a month before Modi flagged the problem of freebies, the Reserve Bank of India's monthly bulletin (June 2022) had highlighted the increase in non-merit freebies offered by state governments and its direct linkage to fiscal pressure. In not so recent past, some three decades ago, a paper published by the National Institute of Public Finance and Policy (NIPFP) on Central and state government subsidies had tried to categorise goods and services offered by governments into non-merit and merit offerings and argued that non-merit freebies (also referred to as undesirable freebies in today's context) do not deserve those subsidies.

There is an elephant in the room, but is that a matter of concern? Unfortunately yes, and herein lies the significance of the ongoing debate.

The Age-old Debate

In 1991, eminent economists Sudipto Mundle and M. Govinda Rao estimated that the total volume of explicit and implicit budget subsidies for the Central and state governments was 14.4% of GDP in 1987-88. In November 2019, responding to demands for replicating the original Mundle-Rao estimate for the purpose of comparison, Mundle and Satadru Sikdar, a faculty at the NIPFP, came out with estimates for 2011-12 and 2015-16. A comparative study found that almost 30 years later, subsidies still accounted for over 10% of GDP. More than half of it belonged to the category of ‘non-merit’ subsidies. The analysis carried out by Mundle and Sikdar suggested that rationalising these subsidies, along with other fiscal reform measures, would free up considerable fiscal space (about 6% of GDP).

From a policy perspective, it is important to compare merit subsidies and unwarranted or non-merit subsidies. Mundle and Rao had strictly limited the definition of merit subsidies to four items — food, primary and secondary education, health and water supply and sanitation. They considered all other subsidies as unwarranted or non-merit. The follow-up analysis published in 2019 found that the share of merit subsidies had increased from around 36% in 1987-88 to over 44% in 2015-16, which meant that non-merit subsidies still accounted for 56% of total subsidies. Researchers also pointed out that merit subsidies, mainly for social services, were mostly provided by states. However, the share of merit subsidies is slightly lower than non-merit subsidies for states because a major portion of it, i.e. food subsidy, is provided by the Central government.

"If you want a debate on freebies, let us first recognise the quantum (of freebies). It has to be a general debate. We need a total of all subsidies. For state governments, this will primarily be subsidies for power and road transport sectors. And then we need to decide which of these deserve such a treatment. Philosophically, for everything, we are looking at the Socio Economic Caste Census (SECC) data. So, anyone who is deprived under SECC deserves a subsidy," says Bibek Debroy, chairman, Prime Minister's Economic Advisory Council (PM-EAC). "The last time we systematically quantified all the subsidies — Union, state, production, consumption, implicit, explicit — was the NIPFP study. We have asked NIPFP to update their study," he adds.

Non-merit Subsidy

While the Centre and state governments do not define merit and non-merit subsidies, there is ample data on what it means for state finances. For example, while analysing the budget documents of 2022-23, SBI Research said Telangana committed 35% of the state's revenue receipts to finance several populist schemes. "In terms of percentage of states' own tax revenue it is a whopping 63%. It might be a potential recipe for fiscal disaster going forward," says Soumya Kanti Ghosh, group chief economic adviser, SBI. According to Ghosh, states such as Rajasthan, Chhattisgarh, Andhra Pradesh, Bihar, Jharkhand, West Bengal and Kerala have all committed 5-19% of their revenue receipts towards such schemes in Budget 2022-23.

"In terms of tax revenue, this is as much as 53% for some states. It is imperative for them to rationalise their spending priorities in accordance with revenue receipts," says Ghosh. He has categorised farm loan waivers, return to the old pension system (where government pays pension instead of market-linked National Pension System), etc., as economically unsustainable and, in that sense, non-merit subsidies.

A more comprehensive risk analysis of state finances has been done by seven experts in RBI's monthly bulletin for June 2022. They have categorised subsidies given by state governments as public or merit goods, and non-merit goods. While they consider expenditure on what brings economic benefits, such as public distribution system, employment guarantee schemes, states' support for education and health in the first category, provision of free electricity, free water, free public transportation, waiver of pending utility bills and farm loan waivers come in the second category, which undermine credit culture and distort prices through cross-subsidisation, thereby eroding incentives for private investment and disincentivising work at the current wage rate, leading to a drop in labour force participation. While expenditure on freebies ranges from 0.1% to 2.7% of GSDP for states, freebies have exceeded 2% of GSDP for some of the highly indebted states such as Andhra Pradesh and Punjab.

Major subsidies offered by the Centre — food, fertiliser and petroleum — increased from ₹3.36 lakh crore in BE (Budget Estimate) 2021-22 to ₹4.33 lakh crore in RE (Revised Estimate) 2021-22. The main reason has been the extension of free foodgrain scheme PMGKAY and additional outgo on fertiliser subsidy to protect farmers from the adverse impact of price rise. In Budget 2022-23, allocation towards major subsidies was around ₹3.18 lakh crore, about 1.2% of GDP. Though the current debate veers around freebies offered by states, and not the Centre, a comprehensive analysis is essential for any meaningful outcome.

"The key question is who has been performing in a fiscally responsible manner — the states or the Union? In 2000-01, the combined revenue deficit of the Union and states reached a dangerous level of 6.45% of GDP, the Union's deficit being 3.91% and states' 2.54%. After the FRBM Act was passed, the deficit ratio came down and in 2010-11 it was 3.20%, which was entirely the Union government's contribution. In 2010-11, the Centre's revenue deficit was 3.24% while state governments together had a revenue surplus," says Isaac.

Since then, the average revenue deficit of states and the Centre was 0.05% and 3.15%, respectively, till Covid stuck, says Isaac. "The lesson that can be drawn from these numbers is that states have been fiscally responsible while the Union government has behaved imprudently. This asymmetry between the Union and states is even sharper with respect to fiscal deficit," he adds.

Isaac accuses the Centre of offering freebies to corporates while blaming others for offering it to the poor. "How can the Union government justify its corporate and other tax concessions to the rich while running a continuous revenue deficit? Every year around ₹1 lakh crore in direct taxes are foregone as disclosed in the annexures to the annual budget," he says.

The Future

Even as the blame game continues, the Centre is attempting to discourage non-merit subsidies by all possible means.

According to the terms of reference (ToR) of the 15th Finance Commission notified by the government in 2017, the Commission may consider proposing measurable performance-based incentives for states, at appropriate levels of the government, to control or stop recurring expenditure on populist measures. Three years later, the Commission's report said some states opposed the particular ToR on grounds that the categorisation of schemes into populist and non-populist cannot be done objectively as development requirements differ from state to state.

Incidentally, the SC had in the case of S. Subramaniam Balaji v. State of Tamil Nadu of 2013 issued directions to the Election Commission (EC) to frame guidelines regarding pre-election promises in the absence of any legislative enactment covering the field. On October 4, 2022, the EC proposed to widen the scope of its earlier guidelines. The draft guideline circulated by the EC talks of a mandatory disclosure proforma that explains the scope, financial implications and resource mobilisation plans of the promises made in the election manifesto. Opposition parties are seeing red since the EC ruling will curb their ability to offer promises before elections.

While a consensus among political parties on the freebie issue is unlikely, every stakeholder needs to accept the fact that economic and social inequalities that exist in India make some form of social security in the form of subsidies or freebies essential. Whether it can be better targeted and streamlined is the question.