While hearing a petition demanding the de-recognition of political parties that promise “irrational freebies” to voters, the Supreme Court recently drew attention to the substantial fiscal cost of freebies. The court noted that a legislation banning freebies is not advisable, but at the same time called for a balance between welfare measures and loss to the public exchequer. The Supreme Court’s observation comes in the backdrop of the clash between the Bharatiya Janata Party and the Aam Aadmi Party on the issue of wasteful spending on freebies. It also takes in the larger public debate on how to differentiate welfare spending from freebies. Reetika Khera and N.R. Bhanumurthy discuss various aspects of the subject in a discussion moderated by Prashanth Perumal J. Edited excerpts:
Where do we draw the line between welfare and freebies?
Reetika Khera: This is not an easy question to answer because it depends on your perspective and where you sit on the income distribution pyramid. Also, even if people are sitting at the top of the income distribution pyramid, you could still see something that the petitioner describes as a “freebie” as a welfare measure. There’s a reference in the petition to the Directive Principles. Directive Principles can certainly guide state policy. But it is not always possible to clearly say this is welfare, and this is a freebie. We can take the example of the Dravida Munnetra Kazhagam’s response to this petition where they refer to electricity, which is one of the things that the petitioner objects to as a freebie, as something that can provide clean fuel in the house, keep you warm, help a child study, etc. So, there are all kinds of ripple effects. Something at first glance may look like a freebie to someone who is privileged, but it may be something that enhances the future earnings of a poor person.
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N.R. Bhanumurthy: If we limit ourselves to the economic and public policy perspective, a freebie is any public policy intervention that will have a long-term impact on production as well as productivity. Any public policy intervention that doesn’t support medium-term to long-term production and productivity may be termed as a freebie. Many States and even the Central government follow some policies that don’t really support production and productivity. We need to have an institutional mechanism to control wasteful expenditure. We just talked about electricity. It is also important to understand and identify who can be the beneficiary of a particular public policy. You cannot have a blanket policy — for instance, say that you will give free electricity for all. So, there is a need to identify the policies that have a long-term impact. At the same time, there is a need to identify the beneficiary sets.
Is India spending too much on welfare or freebies? What do you think of comparisons with Sri Lanka?
N.R. Bhanumurthy: First, let’s first understand what’s happening to the fiscal situation of the States. Studies, especially by the Reserve Bank of India (Study on State Finances), have showed that from 2014 onwards, the social sector expenditure at the State level has been declining even after States were given more resources. We all know that health and education are important sectors to be funded by State governments.But we see that the allocation to those sectors by the States is actually declining. So, while one can argue that there is a need to spend more resources on welfare schemes, we also need to understand to what extent State governments can spend, and if there is a need for conditional grants. Second, a Reserve Bank of India report two months ago brought to light the fiscal situation of States. Going forward, at least five States are going to see fiscal pressure. Ultimately, I think we need to keep track of allocations to the social sector. At the same time, it is high time we started talking about public expenditure efficiency in this country.
It would be unfair to compare India with Sri Lanka. But clearly, there are some lessons to be learned, especially when we look at government liabilities. We always talk about fiscal deficit, revenue deficit, GDP growth, etc., but I think the most crucial variable in this whole debate is the public debt or outstanding liabilities. Fiscal crises happen not because of the fiscal deficit of any particular year, but due to the public debt stock that is accumulating over a period of time.
Reetika Khera: Welfare spending in India is woefully low. It is low in comparison to other developing countries – some years ago, public spending on health and education was 4.7% in India, compared to 7% in sub-Saharan Africa. And it is also declining in many States. Even at the Central level, welfare spending, at least in the sectors I track, has been declining. Beyond that, whenever we talk about welfare spending, we only focus on whether we are spending too little or too much. We never discuss whether we are raising enough revenues in the first place. Why is that question not asked in the Indian context when we know that we are not doing enough on the revenue front? For instance, the income tax base has been more or less stagnant in spite of the high economic growth we experienced until a few years ago. But there are also many tax instruments that we are not using at all in India. We don’t have a wealth tax, estate tax, inheritance tax, etc. Property taxes in India are very low compared to other countries. If we raised more revenues, we would have more to redistribute. The elite and the privileged don’t want to talk about these issues because they will end up paying these taxes. You referred to what happened in Sri Lanka. But I’m not really sure that the fiscal situation there was triggered by welfare spending alone There are many other things happening there which led to the crisis.
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Is there truth to the belief that States are more profligate in their spending than the Centre?
N.R. Bhanumurthy: When we talk about the fiscal situation of States, we need to keep in mind that before 2015-16, States used to spend more resources on capital expenditure largely following their Medium Term Fiscal Frameworks. But after that, as RBI studies pointed out, there is a deterioration in the quality of expenditures. It looks like State governments are taking the easy path, and that’s the reason we are debating freebies. It has led to a decline in tax resources as well. As you’re not spending on productive activities, it ends up driving down your tax revenues also. I think the problem seems to be on the revenue side as well as the expenditure side. Ultimately, we need to have a good tax framework, where you have much better resources for more social sector expenditure while also ensuring medium-term debt sustainability.
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Is there room, considering India is still a developing country, to raise taxes and engage in greater redistribution?
N.R. Bhanumurthy: We all know that less than 6% of the people pay income tax in this country. Many policy measures and institutions have been brought in to address the issue of widening the direct tax base. But in the case of indirect taxes I certainly feel that the Goods and Services Tax is going to be a game changer. I’ve seen that the government is also actually looking at how to remove multiple tax exemptions because of the perverse incentives. That is one thing. The second is when it comes to non-tax revenues, while we do see that there is a significant growth at the Central government level, there is a substantial decline at the State government level over a period of time. Although Finance Commissions keep providing incentives, I don’t see States actually taking advantage of that.
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Reetika Khera: There is an old paper by Thomas Piketty and his co-author that explores the reasons why India has not been able to expand its income tax base, like China or Brazil, which at that time (about 10-15 years ago) already had a tax base of around 8%. One is that the tax exemption limit in India keeps getting raised year after year. Now, there is clearly a compliance issue. Are we to believe that there are only 6% Indians who are above the threshold for the income tax? If it is true, this is a very serious situation. It tells you how dire the conditions are. And if more people are earning more than the income tax threshold, then basically we have a serious compliance issue. That is one very clear source of tax revenue. I’m not even asking for income tax rates to be raised, but rather, have better compliance. During COVID-19, one estimate suggested that the average net worth of the 953 richest Indians was more than 5,000 crore rupees. Their combined wealth is about one-quarter of India’s GDP. If you levy a one-time 4% wealth tax on them, you could get revenues worth 1% of GDP, which is not something to scoff at. Similarly, to put things in perspective, we are raising 0.2% of GDP through property tax, whereas the developing country average is 0.6% of GDP and in OECD countries it is 2% of GDP. So again, there is great scope to raise revenues. There has to be some redistribution – it is a core function of the government. The unfortunate thing is that a lot of people who are sitting at the top of the income distribution think of themselves as “middle class” and therefore grudge any taxes. I think they don’t realise that the tail [of the distribution] behind them is much longer. So, we need some perspective, and this discussion has to happen with data.
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What is your view on the Supreme Court’s suggestion to balance welfare spending and the loss that such spending may cause to the public exchequer?
Reetika Khera: The court has mentioned the need to balance welfare spending and our fiscal concerns. But I would also ask why the court isn’t saying that we have to balance the sops that are given to the privileged with our fiscal concerns. If there is no possibility of raising more revenues and you have a redistributive role to play, then clearly you should reduce the money that is flowing to the privileged. And it is flowing in many different ways. One is, of course, these big bad loan waivers, given to big corporations. There is also the reduction in corporate taxes. And there are things like the vanity projects that many governments have been spending on, whether it is these big statues, going into thousands of crores, bullet trains, etc. But also, on a more micro basis — for instance, for women in government service, there’s child care leave for up to two years. I understand and support even the expansion of maternity benefits. But what is this two years of paid leave for child care? Why should that not be questioned? The many sops that are flowing to the most privileged should be the first ones that should go if there is no possibility of raising revenues and expenditures have to be cut.
N.R. Bhanumurthy: Unfortunately, subsidy has become a bad word in this country. Although it’s certainly needed in some areas, it is very important for us to look also at implicit subsidies, which are mostly non-merit subsidies across sectors. And we have many studies, especially by Govinda Rao and Sudipto Mundle, which have showed that even today in India, we have more than 8% of GDP that actually gets spent on implicit subsidies. I think we need to really look at whether those implicit subsidies can be reduced so that you get more resources for the welfare or social sector expenditure.
Reetika Khera is Professor of Economics at the Indian Institute of Technology, Delhi; N.R. Bhanumurthy is Vice-Chancellor of Dr. B. R. Ambedkar School of Economics University