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Posts tagged ‘Tax Revenue’

Funding the Republic

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The tricolour flutters happily at the Peer Makhdum Shah Dargah in Mahim, Maharashtra, hoisted by the peer’s devotees, as a symbol of the Indian Republic being alive and well. 

India is a Republic. But often it feels as though only the Union government must carry the can for doing unpleasant things – like levying tax on those who have the surplus income to add to the national kitty or getting heavy with tax evaders. Of course it is a juggalbandhi. The Union government invariably wants to grand-stand and hang on to financial muscle power so necessary to play “big brother”. State governments are only too keen to accept the federal goodies being thrown at them and thereby avoid the pain of efficiency enhancing structural reform in politics and in government. To be fair, the financial and political firepower of the Union government and individual states is asymmetric in favour of the former. This makes it difficult for a state to chart a lonely, unique, development path. The good news is we may be coming to the limits of this asymmetric sharing of development responsibilities.

The Union lacks funds for its core functions

Consider that rapid infrastructure development and public investment to strengthen competitive markets have become the stepchildren of the annual Union Budget process. This continues a trend, started by the previous government, of shoring up state government finances, at the risk of being stingy on spending in areas of its own core, constitutional mandate.

The Economic Survey 2017 notes that state fiscal deficits reduced sharply from 4.1 per cent to 2.4 per cent of the gross state domestic product (GSDP) over the last 10 years, since state governments adopted the Fiscal Responsibility Act. Enhanced Central transfers to states and reduced interest payments, courtesy debt restructuring, benefited states to the extent of 1.8 per cent of GSDP. To their credit, most states used the additional fiscal space to cover the revenue deficit and lower the fiscal deficit to below the target of three per cent of GSDP.

But how long can the Centre play the role of a responsible elder brother, darning his own clothes, whilst buying new ones for his younger siblings?

India’s poor infrastructure constrains growth. Low spending on infrastructure also limits job creation — something India needs. The Union government expenditure on infrastructure has increased from 0.6 per cent of GDP in 2015-16 to an estimated 0.9 per cent of GDP in 2017-18. But it remains inadequate. Adding the state government and corporate — public and private — expenditure on infrastructure totals less than three per cent of GDP in 2017-18 versus the five per cent of GDP we should be spending.

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Dodgy infrastructure: the bane of the Republic. photo credit: indiamike.com

Repairing the broken system for bank credit and private investment

Bank and corporate finances are the second black hole which the Centre’s Budget was unable to address. Banks have accumulated bad loans to the extent of `12 trillion, or 17 per cent of their assets. The Economic Survey 2017 exhaustively discusses the “twin balance sheet problem” — of banks that must write down at least one half of the bad loans and of large private companies that face bankruptcy, for failing to use the loans productively over the past eight years.

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The finance minister has been explicit that the government should not bail out the private companies who made bad decisions. This is well-intentioned but difficult to implement.

There are 13 public sector banks that account for 40 per cent of these bad loans. Merging them with efficient banks can mask the problem for some more time. But such mergers can spread rather than contain the contagion. Selling or closing a failed public bank or enterprise requires courage and conviction. Our inclination is to retain the “crown jewels” no matter how tarnished they get. Air India has got a capital infusion of Rs 1,800 crores in 2017-18 on top of the Rs 5,765 crores over the last two years.

Fifty private companies account for 71 per cent of the bad loans. The public mood is for the government to go for their jugular. This will make it politically difficult for the government to fund write-downs of debt. But vigilantism against corporates can rock the growth story, which we can ill afford.

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A fast track quasi-judicial process must distinguish between “wilful” and unintended default, caused by systemic shock. Different rehabilitation regimes should be determined for the two categories of defaulters. Wilful defaulters should be pilloried. The downside is that picking and choosing defaulters, itself can perpetuate what this government abhors — crony capitalism.The finance minister has allocated Rs 10,000 crores in 2017-18 for recapitalising banks. This is a placeholder. All eyes are trained on the additional resources unearthed by demonetisation. The RBI is yet to disclose the value of Rs 500 and Rs 1,000 notes which remain undeposited. This may be around Rs 1 trillion. Transferring the resultant excess sovereign assets, from the RBI to banks, can buy some breathing room.

Second, the incremental tax collection from demonetised “black money” deposited in banks, can fund infrastructure development or recapitalise banks, as it dribbles in over the next two years. This windfall was to be distributed to the poor as cash support. But recapitalising publicly-owned banks, albeit with more vigorous oversight and more transparent and intrusive stress tests, has a higher priority. More credit for corporates translates into more investments, more jobs and higher economic growth. These are the fundamentals that must accompany fiscal stability.

More “give” rather than just “take”, needed from States

We are in the middle of an incipient financial emergency, which can be triggered by a shock. The RBI cautions against thinking that inflation has been tamed. Other than food and oil, where prices remain low, inflation hovers just below the red flag of five per cent. This limits the headroom available to overshoot the fiscal deficit red flag of three per cent of GDP.

The Centre needs considerable fiscal slack to fund infrastructure development and recapitalise the banks. State governments can help by enhancing their own tax resources. Imposing income tax on agricultural income and vigorously collecting property tax are low hanging fruit available to them. These measures can add around one per cent of GSDP to their resources. This will enable the Union government to scale back the long list of Central sector schemes for human development and social protection and use the funds instead for its core mandate — developing infrastructure, markets and a competitive private sector.

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The Goods and Services Tax Council meets: State’s follow the take rather than give strategy. 

States may well ask why they should bother, since they were never partners in the illicit gains from mega crony capitalism. But this would be short-sighted. Faltering economic growth adversely affects all boats. An increase of six per cent in economic growth boosts state government tax revenue by one percentage of GDSP with more jobs in tow. But above all, cooperative federalism must have some give — along with the take. This is the time for states to give to the Republic, as equal partners in national development.

Adapted from the author’s article in the Asian Age, February 14, 2017 http://www.asianage.com/opinion/oped/140217/to-raise-resources-give-and-take-needed.html

Red flags for FM Jaitley

Finance Minister Arun Jaitley

The embattled Finance Minister Arun Jaitley – clearly aware that the knives are out for him

 

Finance minister Arun Jaitley will be fighting from a tight corner on February 1, 2017, boxed in by low domestic demand and the approaching international headwinds of a protectionist United States.

Fighting on the backfoot is new to this government, which had it easy over the first two years. The windfall from falling oil and commodity prices created fiscal space over the last two years to check the right boxes on fiscal deficit and inflation. High interest rates kept the rupee strong. Deft footwork also boosted GDP numbers since 2014 to signal a new age of high economic performance.

Here are six red flags, which track if the finance minister’s courtroom fighting abilities are still intact as he presents Budget 2017-18.

red-flagDoes the growth estimate triangulate?

The estimate for growth during the current year 2016-17 and 2017-18 will show whether the government recognises that it has a problem. Assumptions of unrealistically high growth have a domino effect. They reduce the credibility of the tax revenue projections and the size of the fiscal deficit both of which track GDP growth. GDP growth estimates above 10 per cent in current prices (corresponding to six per cent in constant prices) or a number higher than Rs 149.5 trillion for 2016-17 and above 10.5 per cent in current prices (corresponding to 6.5 per cent constant prices), for 2017-18 is a red flag showing the government is burying its head in the sand.

red-flagDo the tax revenue estimates sound real?

An estimate for gross tax receipts, including the share of the states in Centrally-levied taxes, higher than the 10.8 per cent of GDP budgeted for in 2016-17 is unrealistic. Sticking to this level may be termed not aggressive enough in the context of the hyped-up expectations from the attack on black money. But note that this level was previously last achieved seven years ago, in 2007-08 before the financial crisis. Now, with fresh uncertainties in demand and corporate profitability, it remains an aggressive target. Anything higher is dodgy.

Any incentives for tax compliance?

red-flagAssuming higher average revenue from increased indirect tax rates, when the Goods and Services Tax rates have still to be negotiated with the states, give the wrong signals for growth, business and private consumption. On direct tax, some fiscal courage is required. Dilute the disincentive to evade tax, inherent in high tax rates — currently between 10 to 30 per cent — for middle-income earners up to an annual income of Rs 24 lakhs. It is reasonable to expect that better compliance will compensate for the hit taken on lower tax rates. Not doing so flags low confidence in the responsiveness of the tax machine to broaden the tax base. Challenging the machine to do better can work. Try it.

red-flagAre there band aids for the victims of demonitisation? 

Economic shocks affect the poor the most. Eighty per cent of the poor live in rural areas. The bottom 40 per cent of the population are either poor — a constantly changing group averaging around 22 per cent of the population — or are non-poor but vulnerable to fall into poverty due to personal or systemic shocks.

The allocation for rural poverty alleviation in 2016-17 is Rs 0.6 trillion across four schemes. The ongoing National Rural Employment Guarantee Act (NREGA) is a second best but a practical, quick-start option to scale up income transfer to the poor to insulate them for the twin economic shocks.

NREGA operates in all the 707 districts of India. This is politically sensible but wasteful. Out of the 29 states there are nine states in which the proportion of the poor exceeds the national average of 22 per cent. These “stressed states” should be specifically targeted. Separately, the government should target 40 per cent of the poorest districts, using the “poverty gap/person equivalent” metric to ensure that there is an incentive to first transfer income to the poorest of the poor. Anything less than an enhanced outlay of Rs 1 trillion for poverty alleviation red flags an irresponsible development strategy.

red-flagHas the fiscal deficit become an unreal holy grail?

Mr Jaitley has been steadfast in lowering the fiscal deficit from the level of 4.3 per cent in 2013-14 — the terminal year of the previous government. He courageously embraced the daunting target of 4.1 per cent, naughtily left for him to deal with by P. Chidambaram in the interim Budget for 2014-15.

He succeeded in meeting the target against all expectations. But he was subsequently, practical enough, to retain a target of 3.5 per cent of GDP for 2016-17 instead of the planned three per cent. Inflation is currently low, at well under five per cent per year — the target level determined in the monetary policy framework. The US generated economic shocks to world trade; to growth and to world demand will keep commodity prices low.

It is good to recollect that the fiscal deficit peaked at 6.5 per cent in 2009-10 soon after the financial crisis of 2008. We are yet again in a perfect storm of domestic and external shocks. The need of the hour is to be practical not foolhardy. If the finance minister chooses valour over vision and sticks to a fiscal deficit target of three per cent for 2017-18, the red flag of fiscal cowardice should go up. The brave accept challenges and fight them openly.

red-flagHas public investment been provided for?

Sluggish private investment requires that the slack be met by public investment. Banks are to be recapitalised, infrastructure developed and armaments upgraded. 2016-17 targeted 1.6 per cent of GDP for Central government investment expenditure. Budget allocations have always trailed actual investment expenditure so there is room for some bravado here. The investment red flag must be raised if targeted investment in 2017-18 is below two per cent of GDP.

To navigate the dragnet of stagnant tax income, lower growth and low demand, the finance minister must avoid raising any of the six red flags. To do so, he must systematically cut waste and pork to balance the Budget transparently.

green-flagPushing for doubling revenues from privatisation to a never-achieved estimate of Rs 1 trillion is one button he should press for increasing the fiscal leeway available to him. This will also signal that the reform process is alive and well. There is nothing like a resource constraint to separate the winners from the also ran.

Adapted from the author’s artcile in Asian Age, February 1, 2017 http://www.asianage.com/opinion/columnists/010217/red-flags-that-finance-minister-must-not-ignore.html

Fiscal courage needed on Feb 1, 2017

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In a welcome change of national focus, becoming rich is no longer enough unless the poor are taken along. Prime Minister Narendra Modi, who is very au fait with international headwinds, was prescient in his December 31 address. For the first time, it was not the youth, nor non-resident Indians, nor Hindus, that the PM was focusing on. His attention was primarily on the travails of the poor. He donned the mantle, first evoked by Prime Minister Indira Gandhi four and a half decades earlier in 1971, of a pro-poor proselytiser.

Recovering lost ground

Speaking in the shadow of the economic storm unleashed by the demonetisation of 86 per cent of the currency in November and December 2016, Mr Modi extolled the poor for their patience and resilience. They had shown, he said, “…even people trapped in poverty, are willing to… build a glorious India… through persistence, sweat and toil (they), have demonstrated to the world, an unparalleled example of citizen sacrifice.”

The finance minister would do well to gauge which way the wind is blowing when he rises to present the fiscal 2017-18 Budget on February 1. It is not as if the poor were ignored in the earlier three Budgets presented by him. But they only figured tangentially. Growth, macro-economic stability, infrastructure and jobs for the middle-class young, the usual Davos consensus, took pride of place.

A sombre 2017 ahead

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We face a sombre fiscal year ahead. The International Monetary Fund’s economic outlook — a source the finance minister has used previously to highlight India’s outlier growth performance since 2014 — has projected a growth of only 6.6 per cent in 2016 — one percentage point less than the 7.6 per cent estimated pre-demonetisation. Worse, even growth in 2017 at 7.2 per cent will suffer. Even this is dependent on the shock being temporary. The subtext is that if the ongoing jihad against corruption is extended indefinitely and indiscriminately, business sentiment will collapse. Corruption is a curse. But it must be tackled surgically by an army of savvy saints, who are hard to find.

Lower growth in 2017 would reduce tax revenues. Hopefully this can be compensated by taxing some of the Rs 4 trillion, suspected to be dodgy money, deposited in banks during demonetisation.

Sops only for revenue and economic return multipliers

This stash should also encourage the finance minister to take the risk of slashing income-tax rates to boost revenue through better tax compliance and boost demand. The maximum tax rate for an annual income between Rs 25 to Rs 50 lakhs should be 15 per cent (current rate 30 per cent), with suitably lower rates for lower income slabs. The tax on income between Rs 2.5 to Rs 10 lakhs should be broad-banded at five per cent (current rate 10 to 30 per cent). Tax studies show that the revenue dividend is more pronounced by reducing tax in the lower income slabs. This is probably because the proportionate cost of evasion reduces at higher income levels so it is tough to beat. High income wallahs tax arbitrage internationally via corporate earnings. So, they declare domestically only enough to justify their easily verifiable lifestyle and assets.

Lower growth also red flags the fiscal deficit as a percentage of GDP, which acts as a cap on public borrowing to spend. High fiscal deficits can lead to inflation and public indebtedness. But courtesy demonetisation money is cheap. Banks deposits have swelled by Rs 6 trillion since October 28, 2016. This is low-interest money waiting to be used by the government and its assorted entities. Inflation is well below the target five per cent. This presents the option for temporarily breaching the fiscal deficit target of three per cent for 2017-18 to infuse income into the poorest households.

Rich farmers, poor workers

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Sops for agriculture are falsely conflated with poverty-reduction objectives. Admittedly, investing in agricultural growth is an efficient strategy for reducing poverty. Eighty per cent of the poor live in rural areas. But this is too blunt an approach.

Fifty-four out of 180 million rural households (30 per cent) own no land and survive on manual labour. Benefits from agricultural growth are indirect for the poor. Scheduled Castes, Tribes and Muslims are overrepresented in this group. They need instant relief. Consumption loans of Rs 20,000 for each household, deposited into bank accounts, repayable by labour in village improvement schemes, can combine the advantages of a direct benefits strategy, coupled with the self-selecting benefits of the National Rural Employment Guarantee Act programme. This requires an allocation of Rs 1 trillion — three times the NREGA allocation. This would be a fit use for the demonetisation windfall.

Neo-middle class vulnerable to sliding back into poverty

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But income support is a short-term mechanism to reduce poverty. The World Bank assesses that the Indian growth strategy, whilst effective in pulling people out of poverty, is less effective in keeping them out of poverty. By 2012 poverty levels were down to 22 per cent, from 45 per cent in 1994. But an astonishingly high 41 per cent in the neo-middle class were vulnerable to sliding back into poverty. Even in the go-go years (2005 to 2012) around seven per cent of the neo-middle class slid back into poverty. Sudden economic stress, like the loss of jobs, can significantly increase this proportion.

Reduce multidimensional poverty through better services 

Vulnerability to sliding back into poverty can be fixed if the poor get steady jobs, which are more likely if they are educated. Shocks to household budgets can be mitigated by access to healthcare. Nutrition can be improved through clean water supply and sanitation. Lower tax on low-income earners reduces the effective cost of labour versus capital, making labour competitive in the formal sector. Public services, which reduce the multidimensional index of poverty, can be ramped up by the private sector, if the government provides viability gap funding.

Junk low economic return schemes & protect the poor from shocks

India can be on track, to meet the interim sustainable development goal of reducing the level of extreme poverty to nine per cent by 2020, if we safeguard growth and cocoon the poor from shocks by providing access to better public services. The finance minister must identify the allocations specifically for the core objectives and discard the chaff generated by the testosterone of high growth.

Adapted from the authors article in Asian Age January 20, 2015 http://www.asianage.com/opinion/columnists/200117/safeguard-poor-bring-india-back-on-track.html

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The budget of small things

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(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.

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