The real cost of freebies

The actual cost of such expenditure can be gauged from the state of India's infrastructure, government-run schools and hospitals

It is likely that the ongoing “freebies” debate will not yield anything substantial in the near term, but the wider discussion on how the government spends offers hope for the future. Usually, the interest in such subjects remains limited to pages like these. This column, for instance, had raised the issue of subsidies in January in the context of promises being made by political parties before the last round of Assembly elections. The matter got more attention in recent weeks after Prime Minister Narendra Modi talked about it, and the Supreme Court decided to hear a petition in this regard filed by a Bharatiya Janata Party leader. Although the court has expressed concern, it remains to be seen what it can do since this is essentially a legislative matter. Some other political parties have also decided to intervene in the matter, which has helped broaden the debate further.

While it’s always important how efficiently the government spends in a country like India, the issue has become more relevant because of the pandemic’s impact on government finances. Budget deficits at both the central and state level increased significantly, while the general government debt expanded to about 90 per cent of gross domestic product (GDP).  The government thus not only has to support the economy but also repair its own balance sheet. How government finances are managed over the next few years would significantly influence India’s post-pandemic economic trajectory. For instance, the fiscal deficit at the Union level expanded to 9.2 per cent of GDP in the pandemic year and the government is targeting to bring it down to 6.4 per cent of GDP in the current year. In the current year, the government is expected to use about half of its tax revenue for interest payments. If the debt stock remains elevated, the higher interest payments will limit the government’s ability to spend on growth-enhancing asset creation and welfare programmes.

The state government finances face similar issues. In fact, the quality of spending is more important at the state level because collectively they spend far more than the Union government. But the fiscal condition in some of the states is worrying. A recent study by economists at the Reserve Bank of India (RBI) showed that the 10 most fiscally vulnerable states account for around half of the total expenditure by all state governments. Increasing budget constraints in these states would affect overall spending. The study further showed that debt stock in five out of 10 vulnerable states is no longer sustainable — debt has been growing at a faster pace than the gross state domestic product (GSDP) for the last five years.

It is thus necessary that governments at both levels aim to rationalise and prioritise spending to increase potential growth. Since governments cannot touch some of the committed expenditure heads, such as interest payments, they would need to rationalise subsidies. As the RBI study highlighted, the share of subsidies in total revenue expenditure for states increased from 7.8 per cent in 2019-20 to 8.2 per cent in 2021-22.  Subsidies account for more than 10 per cent of revenue expenditure in some states. Estimates suggest expenditure on freebies accounts for 0.1 to 2.7 per cent of GSDP in different states.

To be fair, there is no clear definition of freebies and is often clubbed with essential welfare spending, which distorts the discussion. So, to take this debate forward in a meaningful way, it is essential to segregate budget subsidies and the level of expenditure incurred. In this regard, a 2019 paper by Sudipto Mundle and Satadru Sikdar could be useful. The paper showed that the level of subsidy provided by the central and state governments declined from 12.9 per cent of GDP in 1987-88 to 10.3 per cent in 2015-16. More importantly, the paper clearly differentiated between merit and non-merit subsidies. It limited merit subsidies to food, primary and secondary education, health, water supply and sanitation. All other subsidies were considered non-merit or unwarranted. As the paper noted, the share of merit subsidies increased from around 36 per cent in 1987-88 to over 44 per cent in 2015-16. But this meant that over 50 per cent still went to non-merit subsidies. The study did not include expenditure under the  Mahatma Gandhi National Rural Employment Guarantee Act and the PM-Kisan Samman Nidhi. Most non-merit subsidies, accounting for over 4 per cent of GDP, were provided by the state governments.

Thus, what needs to be done is to first ascertain how much is being spent on merit and non-merit subsidies by the Centre and the states put together. This can be done by an independent group of experts. Since the quality of expenditure needs constant monitoring, the idea of an independent fiscal council needs to be revisited. The council could provide an independent assessment of the state of the economy, resource mobilisation, quality of expenditure for both levels of government, and longer-run projections.

Since the allocation of resources can only be decided by the legislature, the council’s assessment and recommendations would not be binding. However, its analysis and reports would allow for a more informed debate. It would be clearer, for instance, to the voter that if a government is finding it difficult to service debt, it is in no position to provide free power to all households. Fiscally stressed governments would cut welfare and capital spending, which will hurt citizens at the bottom of the income pyramid the most. So, there are no freebies. The actual cost of such expenditure can be gauged from the state of physical infrastructure, government-run schools and hospitals in most parts of the country.