governance, political economy, institutional development and economic regulation

Posts tagged ‘subsidies’

FM Jaitley’s conundrum: Fat wallet but empty pockets

Jaitley fat wallet

(photo credit: http://www.firstpost.com)

Imagine if FM Jaitley had admitted in his budget speech of February 28 that of the Rs 17.77 lakh crores (US$ 287 billion) of expenditure he was tabling in Parliament, less than one third was really available for innovating on the past trends and the bulk of the funds relate to liabilities already contracted before the year begins.

Given the lack of fiscal space for new commitments one would think then that the budget would be transparently split between contractual liabilities of past decisions, which are “sunk cost”- loosely defined and new budget allocations to make instant and easy sense to citizens. After all it is the “new” allocations that everyone looks forwards to, assuming that they could perturb the status quo and kick start growth.

But you will not find the budget classified thus, even though the eleven budget documents, excluding the Finance Bill, runs into 949 pages! Instead it is split between Plan and Non Plan expenses – a practice that should thankfully end now with the demise of the Planning Commission– or Revenue and Capital, another archaic distinction, which was traditionally used to track investment expenditure due to the traditional direct linkage between investment and growth. But increasingly, the right kind of revenue expenditure is also critical. Funded by the “revenue black box” are catalysts for efficiency and innovation led growth- skilled employees; functioning institutions and well maintained public assets.

The cost of feeding the public beast

How much needs to be spent just to keep government systems alive even if they do nothing of value for citizens? This is a close proxy for “current liabilities”.

First, civilian employee pay and allowances account for around 8% of total expenditure, not high at all by international standards where high, double digit proportions are the norm.

Second,  expenditure on pension of government employees accounts for 5% of total expenditure but growing rapidly as ex-babu couples age and live longer.

Third, the administrative cost (providing workplaces, consumables and equipment) of managing 3.6 million civilian government employees has to be paid for. Assuming administrative cost to be one third of pay and allowances it amounts to around 3% (0.33 of 8%) of total expenditure.

Fourth, annual interest on government debt accounts for 26% of total expenditure.

Fifth, is expense on maintaining physical assets- the Achilles heel of the government. Chronic under provisioning results in axle-breaking pot holes; overflowing public toilets; broken x-ray machines and no doors or windows in classrooms. Two decades ago the PPP model for providing public services seemed like the way to go but those hopes faded.

Guess what? Maintenance expense is not transparently available as a separate line item in the budget documents. This is not surprising since the government has, inexplicably, not adopted a more complete economic classification of budget items, endorsed by the IMF and followed internationally.

Today we will have to make do with assumptions- albeit conservative ones. A God send is that ever since the promulgation of the FRBM Act the government is obliged to share an asset register of civilian assets (which excludes cabinet secretariat-a code word for India’s spooks; defence; police; atomic energy and space which together account for approximately 46% of the annual CAPEX).

The register of physical assets (excluding land) for 2013-14 values civilian assets at a measly Rs 1.87 lakh crores (US$ 30 billion) for a Rs 141.09 lakh crore (US$ 2 Trillion) economy. It seems designed, like the asset declarations of politicians, to hide more than it reveals.

Assuming a thumb rule asset value 20 times the annual capital expenditure yields a “notional” but more realistic value for government assets (other than land) of Rs 48.76 lakh crores (US$ 786 billion). Annual maintenance at 2% of “notional” asset value requires an additional 5% of total expenditure.

Just these five “tied” revenue expenses, all of which account for 47% of the total expenditure, reduce the “free play” money with the FM to 53% of total expenditure.

The drag of politics

But it doesn’t end here. Central assistance for states is what gives leverage to the PM to negotiate with state governments. In the new “cooperative federalism” framework envisaged by the PM, after the niceties are done, bargaining power will depend on the fiscal muscle the union government can flex in inter-state negotiations. How else could the PM, for example, influence the governments of Haryana and Delhi or the governments of Tamil Nadu and Karnataka to share water with the minimum of bloodletting as the searing heat of May pushes up water consumption? The 2015-16 allocation accounts for just 1% but is highly politically sensitive to change.

Subsidies on items like food, fertilizer and petroleum and interest subsidy account for 14% of the total expenditure and also fall in this category. “We need to cut subsidy leakages not subsidies themselves” is what FM Jaitley remarked in his FY 16 Budget Speech on February 28, 2015.

The “Statement of Fiscal Responsibility” tabled under the requirements of the “Fiscal Responsibility and Budget Management  (FRBM) Act, 2003” unveils the FM’s hope that subsidies shall decline from 2% of GDP in 2014-15 to 1.6% of GDP in 2017-18. This could happen if annual GDP growth accelerates to the targeted 7.5% whilst the nominal amount of subsidy grows slower. But it sounds like an over optimistic assessment.

True, subsidies can be better targeted to eliminate waste and corruption. But there are also millions who are eligible for subsidy, but remain unable to access it today, because of complex administrative arrangements and poor documentation.  If the JAM (Jan Dhan, Aadhar, Mobiles) inclusion initiative succeeds it will likely swell the numbers accessing subsidy. Consequently, the jury is out on the net savings that better administration of subsidy can achieve.

Accounting for the amounts committed to assistance for states and subsidies, the “play” money available to the FM reduces from 53% to 38% of total expenditure.

Funding White Elephants

The remaining 38% or Rs 7.18 lakh crores (US$ 116 billion) sounds like a lot of money. But we still have not accounted for the FMs compulsion to fund the variable costs of programs managed by the mind boggling 72 (seventy two) departments of the union government-each a fiefdom in itself.

Not accounted either are allocations for ongoing projects which are unproductive “sunk cost” unless completed and operationalized. Budget 2015-16 proposes parceling out Rs 1.11 lakh crore (US$ 18 billion) of CAPEX  as grants to as many as 375 projects.

Oddly, the budget documents make no distinction between CAPEX allocations to ongoing projects and the CAPEX for new projects. Could this be because making such information public may reveal the absence of fiscal space for new projects or force government to abandon undeserving old projects?

Inefficient governments under-allocate to old projects thereby making space for announcing new ones. This makes sense politically, if sharing “pork” is the mantra of survival. But it happens at the expense of previous investment lying unutilized, worsening thereby the Incremental Capital Output Ratio- jargon for how much bang each buck buys and increases the interest burden every year as borrowed funds lie unproductively in incomplete projects.

To be sure none of this mess is of FM Jaitley’s making. But it is fair to expect him to clean it up since PM Modi’s is a government which works.

There are four initiatives the FM must launch to achieve this worthy objective.

First, he must walk the budget speech to aggressively resuscitate the PPP model and not solely because it pulls private capital into public projects. Partnering with the private sector forces the government to be efficient, effective and results oriented. Entering into explicit contracts with the private sector also makes information public, which can then be used to hold government accountable.

Second, the economic rationale behind civilian investment decisions must be made public. How are potential investments ranked? Hopefully, making the investment and economic analysis public knowledge can reduce the political noise and avoid wasteful decisions. We cannot just leave it to path breaking individual ministers like Suresh Prabhu to be punctiliously technocratic, as he was in the Railways Budget 2015-16. The weight of public opinion, via direct participation, must be institutionalized to assist the government in avoiding “bridges to nowhere”.

Third, at least ruling party MPs must commit time and effort to disseminate the logic of the budget to their constituents. It is for this purpose that Parliament takes a month’s recess during the Budget session- this year from March 24 to April 20. Have, at least, the BJP MPs fanned out to their constituencies to interact with citizens? Doing so would force MPs to understand the provisions better; come across as being well informed and initiate a more substantive dialogue at the local level. Delhi is a fish bowl in which MPs operate. Happenings here do not resonate with the rest of India automatically.

Finally, there is the appeal to save trees by reformatting the budget documents and making them shorter in length (500 pages for starters?) but more transparent in quality and to share both, the genuine constraints and the FM’s innovations to punch above his fiscal weight.

The budget of small things

jaitley 2015

(photo credit: dailymail.uk.co)

February is when the Indian Finance Minister (FM) gets flooded with unsolicited help from well-wishers on how to get his job done of presenting the Union government’s annual budget on the 28th.

This time, the flood is a Tsunami as a consequence of the Delhi state assembly electoral debacle for the BJP on the 10th February. Some fears are imagined. Others are real.

BJP only for the rich?

The BJP has traditionally been a party which works well with the private sector. If viewed through a “zero-sum” filter, this strategy could be perceived as working against the immediate interests of the poor. The classic example is whether electricity supply should be subsidized and if so to what extent and in what manner and whether the private sector’s bottom line concern for profitability can be consistent with an electricity subsidy for customers?

The “Davos mafia”- banks, big business and “growth” fundamentalists are keeping a hawks eye on everything the FM now says to detect signs of his wavering from the hard path of economic reforms announced by him last year. Their expectation is that he will resort to “populism” to placate the poor, with an eye on the nearing state elections in Bihar.

Will Bihar drive the budget?

The BJP cannot afford to lose Bihar. Doing so will surely crack the political invincibility of PM Modi. Some believe it is already dented by an ill-advised, last minute tactic in Delhi of pitting the PM versus Kejriwal, even though it was known as early as January 15th when the elections were announced, that the BJP was unlikely to win.  None of this environment is of the FMs making. But it hampers him greatly in being bold, outspoken and visionary on economic reforms- as he has shown an inclination to be.

Statistical flights of fantasy

It does not help that the Indian Statistics establishment has further queered the pitch by an ill-timed release of a new formula for calculating GDP which shows that the UPA government was doing fairly well on growth (6.9%) even in its last year (2013-14) accompanied by reduction in the trend rate of inflation (consumer price index) to 9.5% from 10.2% the previous year.

This raises the bar for the FM in FY 2015-16 to unrealistic levels in growth (>8.5 %?) and possibly also inflation expectations (<5% ?).

The dilemma of the FM is that if he follows a tough approach to economic efficiency he gets branded as heartless and gutless if he doesn’t.

Privatization can soften the subsidy cuts

Privatization of our clunky 277 publicly owned industrial companies; poorly governed 7 public insurance companies and 27 banks is a no-brainer to calm both the heart and the gut of the FM.

The share of publicly owned companies in the Indian stock market capitalization is 48%. If more of them were publicly listed this proportion would increase further.

The capital gains from privatizing- selling at least a 50% plus 1 share in publicly held equity to private investors is sufficient to meet the existing annual aggregate subsidy outlay of around Rs 4 lakh crores (USD 66 billion) for the next five years till 2020 with linked fiscal benefits from tax revenue on higher growth and profitability of these entities. Associated economic benefits like more jobs and employment would be additional.

The FM has the choice of either being fiscally profligate or remaining cautiously courageous whilst perturbing the entrenched interests which feed-off the public sector; a small proportion of unfit employees who would lose their secure jobs; petty contractors who have developed a nexus with public sector contracting authorities and Trade Union leaders. None of these are part of the 300 million poor people of India. Nor are they part of 90% of the workforce, which operates in the unorganized sector as contract labour.

The FM would be well advised to err firmly on the side of “financeable equity”. This objective points him to generate additional revenues to finance selected tax breaks and subsidies.

Here are three suggestions that could set the tone of the FY 2015-16 budget.

Metric of administrative efficiency

First, the FM should announce that this government intends to demonstrate its credentials of being an efficient administration by collecting more revenues from the existing taxes despite offering selective tax relief. This fits well with the already publicized drive against “black money” and the return of undeclared foreign assets of Indian national, residents.  This also reassures tax payers that the government intends to retain stability and predictability in the tax regime.

There is nothing like burning ones bridges to bring out the best in oneself. The FM did this last year by taking up the challenge of meeting a 4.1% Fiscal Deficit target for this year and 3.6% of GDP for the next. He should carry through this resolve now without opting for the “lazy” alternative of using the new, inflated GDP data to project a rosy revenue estimate.

Surplus income with small tax payers boosts demand

Second, the FM should demonstrate the government stated preference for “small government”; private finance lead investment and the market.

One equitable way of doing this is to leave more income in the hands of the small tax payer by increasing the income tax-free level from Rs 2 Lakhs per year (USD 3300) to Rs 5 Lakhs (USD 8200). This simple measure takes 90% of the existing assesses (around 29 million in numbers) out of the tax net but impacts only 10% of the revenue.

Pancaked, indirect taxes on consumption (customs/excise; sales tax; municipal taxes) drain 50% of the disposable income of such tax payers in any case, so there is an equity view point also along with the argument for the greater efficiency of a more focused and selective tax effort.

Increase tax revenue equitably and efficiently

India’s tax revenues need to be increased by at least 1% point of GDP but not by continually “milking” the narrow tax base available historically. This approach is neither efficient nor does it build political credibility amongst the tax victims –the salaried middle class. Imposing a new, low tax with a huge tax base as on stock or commodity market transactions and siphoning off a part of the windfall due to the crash in oil prices could be two such option.

Extending income tax to the creamy layer with huge agricultural assets on a presumptive basis is a must. Tax free agricultural income is the easiest refuge for rebranding “black money” as “white”. This loop hole needs to be stamped out.

Agricultural income tax is a tax resource reserved for the State governments. But the Union Government could incentivize States by offering a higher share of GST to states willing to introduce agricultural income tax. This would be in the spirit of efficient, equitable, cooperative federalism.

Third, the Jan Dhan Yojna for financial inclusion has opened 125 million new bank accounts during the last few months. The bulk of these accounts remain dormant. But despite such caveats, this is a good scheme. Recent work, including by Thomas Piketty illustrates that personal wealth is the biggest asset in incremental wealth creation. Why not extend then, albeit in a small measure, the key to wealth creation to the poor also?

Endow the poor for wealth creation

Dhan” (wealth) is an asset-something you own. It is a pre-condition for wealth creation. Why not open bank or Post Office accounts for the poor also? Of course the poor have no surplus to put into a bank. But the government can fill this gap by depositing Rs 10,000 (USD 164) into each of the bank accounts of all “poor” account holders as a 10 year fixed deposit from which only the interest income would be available to the account holder till maturity. To narrow the ambit and the financial implication of the scheme initially, only poor women and poor senior citizens (the most marginalized of the poor) could be eligible.

Fiscal fundamentalists will deride this measure as irresponsible in an environment when subsidies have to be contained, if not reduced. There are two reasons why their apprehensions are unfounded.

First, the small value of the deposit and its unavailability for withdrawal for 15 long years reduces the attractiveness of the scheme for would be scammers. The annual interest earned of Rs 800 (@8%) per account is not enough to attract fraud but sufficient to keep a genuinely poor person interested in the account as a source of additional income. For the Bank this provides a pool of valuable long term resources for their Treasury operations.

Second, the fiscal outlay, whilst significant, is not unmanageable. The likely pool of “poor” women and senior citizens would be around 200 million. If full coverage is targeted over a three year period, an annual budgetary allocation of around Rs 70,000 crores (only 18% of the existing aggregate allocation for subsidies) would be required. The spread effect, both political and economic, is hugely significant.

In comparison, the Union government alone spends an estimated Rs 4 lakh crores (USD 66 billion or 4 % of GDP) on subsidies. Much of this outlay is either lost in transit to the beneficiary (as in food subsidy- refer to Ashok Gulati, India’s brilliant agricultural economist) or the targeting of the subsidy is so vague (fertilizer and energy subsidies) as to benefit the poor only marginally. A “wealth and income transfer” scheme aided by the Unique Identification mechanism, where available, is likely to be more efficient and effective.

The recent developments in Southern Europe and now in Delhi should convince Mr. Jaitley that “demonstrated equity and inclusion” as a “brand” is in. Citizens do appreciate a tough “reforms” stance. But it must be balanced by effective instruments for income transfers to the poorest of the poor.

Why spend more on babus? 7th Pay Commission

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Babus are looking forward to another bonanza, courtesy the 7th Pay Commission, which the previous government constituted just before demitting office. The armed forces, always better organized, are first off-the-mark with an earmarked Pay Cell already created, headed by a two star General, to lobby for better terms and conditions. Other Unions and Associations will also gather themselves together, once PM Modi signals the go-ahead.

Here are five reasons why he should not do so.

First, the history of Pay Commissions (the first was in 1946 with the rest following almost every ten years) validates that they achieve very little beyond finding the lowest commonly agreeable formula, for farming out pay increases to babus and the armed forces.   Never has the pay increase been linked to higher productivity or even to aggregate measures of productivity, like economic growth. Growth, admittedly an overly-broad measure, is now on the downslide and expected to remain that way for at-least another two years. Aam admis find it difficult to swallow, that babus should get paid more, whilst they themselves are struggling to make ends meet.

Second, babus have been getting 100% inflation neutralization twice a year, since 1996. The dreaded inflation (often itself the outcome of loose fiscal control and inefficient expenditure policies) consequently, flows-off babu backs, like water-off a duck, but swooshes down onto aam admis and makes their life miserable. The biggest sufferers are the 700 million poor.

The urgency for another increase in the “real” pay of babus is difficult to justify, in a strained fiscal environment, where subsidies have to be gradually moderated and administered prices of petroleum products, electricity, fertilizers increased-all of which stoke inflation.

Government also has to increase the tax-GDP ratio in 2014-15 to provide the funds needed for stepping up long forgotten defence equipment; higher outlays for education, health, sanitation, water and infrastructure; all this within a fiscal envelope which does not further aggravate inflation. Increasing existing babu compensation, in real terms, will only stoke the flames of inflation.

Third, if the government feels that the existing pay structure does not promote efficient functioning, it has only to look at the reports of the past two commissions. Both Commissions recommended excellent measures for linking pay enhancement to productivity, which remain unimplemented. The Administrative Reforms Commission did similar stellar work in 2008. Throwing more money at the problem of inefficiency is a highly ineffective way of trying to deal with it, which is bound to fail. Better to brush the dust of previous research and get down to implementation.

Fourth, less than 4% of India’s working age population of 500 million (ILO) is employed by government. The total formal sector employment (including in government) is less than 10%. Unlike government, in the rest of this “labour aristocracy” there is no assured inflation indexing and individuals have to justify every year, why employers should even neutralize inflation let alone give them an additional increase in “real” pay.

The residual 90% of other workers live in a jungle, where they survive by their wits, with no help from law or regulation. The Minimum Wage Act is a non-functional piece of legislative gloss, which is regularly contravened in the unorganized sector. None of us, including babus and politicians, who employ household help or buy products made in the informal sector, where “sweat labour” is the norm, walk-the-talk, by being willing to pay the prescribed minimum wage rates.  Even the lowest level of compensation in government is way above the minimum wages.

Fifth, the process of babu pay determination has acquired a routine automaticity, which needs to be disrupted. Opponents of abandoning the business-as-usual stance, argue that the outcome of stagnating babu pay in real terms will be higher levels of corruption. This is difficult to buy. Despite the consistent increase in babu pay since 1952, corruption has also grown not decreased. Babus, even at the leadership level, including the previous PM, “passively accepted” corruption, even if they have not actively associated themselves with the loot. They have not endeared themselves to aam admis by such behavior.

PM Modi has already started the process of interacting directly with babu-level chains of command and demanding from them, measurable, targeted performance, aligned with the government’s priorities. Pay rewards should follow only in 2018 (one year prior to elections in 2019) if performance improves.

Between now and then, the government should start publishing Annual Service Delivery Report Cards for every urban ward and every rural village, listing the manner in services have improved. Pay rewards beyond 100% inflation indexing (which already exists) should come only if the citizen reports show improvements from 2015 to 2017.

Let’s apply the same “value for money” standards to public finance, which resonate so well with our personal lives, vividly captured in the “kitna daite hai” (how many miles does it go in a liter of fuel?) metric, popularized by MARUTI.      

Myopic Urbanization

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Divisive economics is worse than divisive politics. Proponents of Urbanization are the loudest proponents of economic divisiveness. The vision they subscribe to is of shinning cities connected by corridors of gold, glittering like diamonds in a waste land of the rest of Bharat. Their justification is that the rest of the World has adopted this approach. But India constitutes 17% of the World’s population and around 33% of the World’s poor people. It is for us to define “good practice” in development, not to blindly follow international examples, which do not relate to the context of India.

A second “best” defense of “urbanization wallahs” is that it is “inevitable” so best to plan for it. The “inevitability” is related, yet again, to the manner in which growth has happened in the past and not to the specific prospects for India in the future. The fact that even by 2039 only 50% of the population is expected to be in “urban areas” is glossed over, whilst making the inevitability argument. In any case we must not succumb, further than we already have, to the “everything is written” syndrome. It is for Indians to write their own destiny.

Here are three reasons why a divisive focus on urbanization is retrogressive.

First, people tend to fall into the category the State creates for them. Caste, gender, religion are traditional fault lines created by “Authority” such as it was defined since ancient times. None of these provide any progressive social value today. The modern World identity of Urban versus Rural is as corrosive.

The needs of a shopkeeper in a village or a city are much the same; a serviceable road linked to the habitations of their bulk suppliers and customers; electricity for extended business hours, storage of perishable goods and medicines; security of life and property; a collection service to collect the trash generated by customers and sanitation facilities; customers with money in their pockets and a bank in which to safely put her money and access credit; telecommunication links to remain in contact with current events and clean water. Why would we want to discriminate in the standards of supply of these public goods between urban and rural areas? By creating “urban” and “rural” labels we are perversely creating a modern fault lines around which antagonistic interest groups start to coalesce. Please stop this. We have enough fault lines as it is. It doesn’t help when power elites benefit from the touting of urbanization.

Second, sustainable development is indivisible. You cannot steal from the future to make the present pleasant. You cannot fatten the urbanite at the expense of the rural poor. In our democratic society, you cannot cordon-off urban development from rural prosperity as China can and does. Urban centric development is self-corroding due to unlimited in-migration from rural areas in much the same way as international immigrants storm the national borders of developed countries, spawning land and migration mafias and vote banks. Cities and rural areas are organically linked as a sugar factory is linked to the cane fields; a steel factory to the iron ore mines and an electric power generating station to the coal mines, the water or solar, wind or marine energy harvesting area.

 Area based “indivisible” development optimizing on the comparative advantage of each development area has been a standard development tool. Why have we abandoned it? Let us instead abandon the decrepit slogans of the past and opt for integrated development which maximizes value generation using resources which are available locally whilst benefiting from India’s vast, common, domestic market and the liberalization of international trade. Innovation in India need not be limited to cities it has to be a fundamental credo of growth.

Third, the literature tells us cities benefit from the economics of agglomeration. That is why incomes are higher in cities and businesses happy to locate there. Population density is higher so it is cheaper to provide public services. Product markets are larger so scale economies kick in for suppliers and effective competition can pass on the benefits to consumers. Finally, the human element; traditional identities (religion, caste and gender) are replaced by modern identities in the anonymity of cities; professional human networks leverage human capacity and aspirations change. In a recent survey, two thirds of Lady Shri Ram College alumni (admittedly an elite Delhi college for women pulling in the best) viewed their professional identity as the primary one, even over gender.

All these are indeed the virtues of cities, but should they also not make the cities self-financed? Do they justify the subsidies provided by the State to keep cities alive and humming at quality-of-life standards far above rural areas? Collection of user charges even in metros is rarely more than 40% of the cost of providing services. Revenue collected by cities from their own sources (by taxing residents and from their real estate and other assets) only meets slightly more than 50% of their expenditure. The rest is grants from the Government of the related State or the Government of India. Development schemes which are off-budget for Cities but are directly funded by the Central Government, like the Jawaharlal Nehru Urban Renewal Mission further add to their kitty of goodies. A full accounting of the actual distribution of the government’s resources between urban and rural areas, including expenditure on education, health, science and technology, industry would further skew the allocation in favour of cities, where the elite reside. This resource allocation bias for cities is indefensible.

Relying on urbanization for economic growth is an end-of-the-pipe option, like a housewife resorting to RO filtration to drink clean water as against the State cleaning the rivers and other ground water sources. It is expensive and exclusionary.

Ignoring the human cost of migration from the villages to cities, in search for work, including the life cycle social costs of predominantly male migration, in large numbers, is scary.

Lastly, in the context of the recent democratic trend of targeted social disruption as an instrument of political power, cities are powder kegs waiting to be blown up. A “soft” State, like India, cannot cope with the unleashing of such violent and disruptive, social pressures.   

 

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