To define is to limit, said Oscar Wilde, which is perhaps the problem with freebies — for a low-income economy, it is difficult to limit the number of goods and services that need to be provided free or below cost.
But even rich countries provide freebies mainly to address inequalities — 70 per cent of all government spending in the US is on subsidies and transfer payments, in India it is at 44 per cent. The current controversy therefore seems more about political mileage. The tipping point seems to have been the electricity dues of Discoms to power utilities which amount to a staggering ₹1.3 trillion.
Provision of freebies is difficult to challenge since welfare is the goal of any elected government. Peter Drucker propounded 50 years ago that there was no established economic theory of what governments can do but that has not stopped them from trying; if they could not deliver growth, they would deliver the fruits of growth — cash, goods and services. Getting rid of subsidies will require a multi-fold increase in incomes and more equitable growth. A per capita income at around $2,000 constrains us in many ways even though our GDP is the fourth largest.
First, it hugely restricts the direct tax base — income tax limits start at ₹2.5 lakh, well above the average per capita income which means the government has to depend on indirect taxes for as much as 50 per cent of all revenue. And even this is dependent on a few commodities like petroleum, alcohol which limits the capacity to tax.
Second, low incomes limit the ability of many to pay market prices for essential public goods — water, electricity, roads, transportation, education, health, requiring greater government subsidies. So, the political compulsions or the economic justification are hard to ignore.
Sustainability issue
The major criticism over freebies has been on grounds of sustainability. Governments cannot borrow infinitely without something giving. But the issues are more nuanced — first, sustainability is not about the probability of default, because governments service debt through rollovers and fresh borrowings, given that they have few cash flows other than borrowings and taxes.
This is not to understate the sustainability issue or support a free run on borrowing, but only to point out the larger perspective that sustainability should be a test of every government programme, not just freebies and subsidies, especially since outcomes are hard to establish. Finally, there is also the criticism that subsidies lead to under-recovery of costs and distort market prices. This would be true if all the costs were properly benchmarked but simply adding on the costs of inefficiencies, policy flip-flops and time over-runs cannot also be justified. This is evident in the pricing of public goods such as electricity, water, roads and highways, sanitation.
Many market experiments such as BOT, PPP did not work as expected, posing the classic social infrastructure problem — the failure of government to provide them (either for reasons of efficiency or funds) pushed them to markets, but market failure, for various reasons, have put the ball back to the government’s court. Our PSUs have not exactly been models of efficiency, the power sector being an example.
A large part of the blame lies with the government. At the heart of the problem is an overestimation of power demand and a reckless asset creation between FY2010 and FY2017, thermal generation capacity expanded at an annual average rate of 11.4 per cent while annual power demand grew by less than 5 per cent. Saddled with excess capacity and muted offtake, discoms preferred to buy power through short-term contracts or from the open market often defaulting on their long-term PPAs, adversely impacting the generating utilities. The government’s earlier policy of favouring state-owned utilities by protecting them from the bidding process also led to a pre-emption of PPAs in favour of utilities like NTPC, leaving private power producers stranded, a fact that RBI had also pointed out.
The costs of inefficiencies, delays, cost overruns would always lead to under recoveries as these often cannot be passed on. There was ambiguity over taxation — multiple taxes on coal (which account for 50 per cent of all generation) including GST but with electricity itself being outside GST led to input taxes being passed on to consumers. Clearly multiple reforms on many fronts are required, not just the scrapping of free power.
The writer is an independent financial consultant