Freebies — What is it and what is it’s impact on the Indian Economy?
It was 2005 and I was writing my UPSC mains exams. My optional was Economics. I still remember reading that Indian economy was crippled with subsidies, interest payments and mismanagement of PSUs with crores of losses draining the exchequer !!!
We are in 2022 !!! and even after 17 yrs, the same problem continues today and the problem has become even more bigger !!!
Every one says that SriLankan Crisis will not repeat in India. But India is a conglomeration of many states and the fiscal risks matrix given by RBI in its recent publication clearly show that we have many states which are in the verge of attaining the same fate of Srilanka. Many states are already so crippled in debt and public sector losses that they are not even able to meet their committed expenditures likes salary payments and interest out go.
In Economics there is a concept of shut down point for a business. The point where you cant even recover your variable costs is the shut down point. If we see Indian states as a separate entity, many are actually at shut down point and draining the state exchequer with perpetual losses. Seeing India as a whole may be dangerous, since there are many pockets of mismanagement in various states which eventually would become a burden on the central finances.
At one end, many states have the problem of slowing down tax revenue, at the other end there is a high burden of committed expenditure like salaries, pensions, interest payments and never forget the subsidies given to DISCOMS of state electricity board.
In addition to these, there is a ever lasting love for farm loan waivers, new kinds of non merit goods to woo tax payer and increasing losses of many state PSUs.
At one end, we see some states like Rajasthan reverting back to old pension scheme and some states like Delhi providing free electricity, water and transport.
Freebies should not be misunderstood for public merit goods like Health and Education. Everybody is in agreement that Free Education and Health should be provided to masses especially the lower segments of the society.
When there is agreement on this, why are the governments not able to build good schools and hospitals or infuse more money into education and health sectors. The problem is that they are already in deep debt and an array of committed expenditures like interest payment, pension payments, salary payments and regular maintenance capex.
There is hardly any money left for additional capex investment in the state after taking care of ever increasing committed expenditures.
Freebies can distort the benefits for the future generations. For example, pension reforms were brought in 15 years back based on various IMF proposals to reduce the overall pension burden of the states. As life expectancy increases, pension burden is expected to rise and reverting back to old pension scheme would increase the tax burden for the Future generations. When there is a gap in financing, the first hit would be on the common man with increase in income tax and GST on various commodities.
Populistic measures like going back to old pension scheme may attract votes, but may hit the future generation with higher burden of taxes and states with higher debts.
Two states, Rajasthan and Chattisgarh, inspite of being in heavy debts and very little resources to rise its own tax revenue, have reverted back to old pension scheme.
Is there a rational for these?
In many states grinder, TV, Bicycles etc are given, but audits have discovered many ghost beneficiaries in delivery of such schemes. Many states like Tamil Nādu, Delhi argue that they are financially stable and there is nothing wrong in giving all these Freebies. This argument may not hold good in many Indian states including Tamil Nādu and Delhi since Debt burden of these states are massive. They can at least pay off the principals and reduce the interest payments for the future.
What is the gap in the state finances? Should we also look at subsidies and concessions provided by central government to make a point on how much the Indian tax payer is burdened? We will discuss all these issues with various data points collected from Economic Survey, RBI Bulletin and various other economic papers in the coming paragraphs.
Why this discussion is important for every taxpayer in the country?
Let us assume there is reduction of interest payments, pension payments, freebies !!!
In effect many states will have a revenue surplus.
In early years of this century more than 11 states had revenue surpluses. These revenue surpluses can in turn be transferred as tax cuts to honest taxpayers or variety of social sector expenditure.
Will not the taxpayers benefit and be happy. This is the entire crux of the debate….
Instead of all these wasteful expenditures which would not create any asset for the future generation, why dont we cut these expenditures and reduce taxes…
Place the income in the hands of the Honest Taxpayers and his disposable income would rise…and demand for various goods would rise in turn…ushering in economic growth in this country!!!
RBI Bulletin in its June 2022 published a detailed article on the state finances and raised an alarm that all is not well in many of our Indian states.
We already have few Srilanka’s in some our states. Without careful monitoring and professional management, these states can become a burden on the entire country. Remember ten States going down like Srilanka can result in a Financial Emergency for the entire country.
The above picture clearly shows that Gross Fiscal deficit of various states is breaching the 3% of GDP( Upper limit set by Finance Commission ) and does not appear good. Let us take the absolute amount
In absolute terms Rs 8.19 lakh crores is the gap in total expenditure which is almost 50% of the total tax collections of the central government for FY 2021–22. In FY 2020–21, this was even more higher at Rs 9.32 lakh crores. Compare this with FY 2019–20, which was at 5.25 lakh crores. An increase of 4.07 lakh crores in Gross fiscal deficit of all states. This is a serious gap and needs to be brought down systematically. Now there is a deficit even on revenue account and the revenue deficit is increasing drastically. It increased from Rs 1.21 lakh crores in FY 2019–20 to Rs 3.95 lakh crores in FY 2020–21. So it is clear that state governments are borrowing for day to day expenditure and this is worrisome.
What do you do in your homes?
When your salary does not meet your expenditure. Firstly you will see whether you can cut down on unwanted expenditure. Secondly if you cant augment the revenue in short period, only option is to borrow from banks.
Now think of this situation that after one year, your expenditures has increased so much that you start borrowing to pay your monthly EMI’s.
This is what is happening with many of our state expenditures.
The states are not able to generate sufficient receipts for meeting their expenditures. So they have got into the habit of borrowing more and more from the markets.
Unlike individuals borrowing from the banks, governments borrowing can impact the overall interest rate in the financial systems. Remember when governments crowd out all the loans, there is hardly any loans left for the private sector and hence the cost of borrowing for the entire economy increases resulting in increase of costs etc.
As we go deeper, Andra Pradesh, Kerala, Punjab and Rajasthan have average GFD ( Gross Fiscal Deficit ) of above 3.5% of GSD. While Asssam, Gujarat, Maharashtra, Odisha and Delhi have ratios less than 2%.
In some states , Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andra Pradesh, Jharkhand, Madhya Pradesh, UP and Haryana ,the Debt -GSDP is almost 40 to 50%. Is not this staggering? Please see the table below published in RBI Bulletin, June 2022 paper.
Usually Interest Payments to Revenue receipts of 10% is usually acceptable. But look at some of these states which have much larger interest payments to revenue receipts percent.
AP ( 14.3%), Gujarat ( 14.2%), Jharkhand (20.9%), Karnataka ( 14.3%), Kerala ( 18.8%), Punjab ( 21.3%), Tamilnadu ( 21.0%), West Bengal (20.8%). So bulk of the state government revenues are being used to pay the interests. If these continues and goes unchecked, our future generations will pay taxes only for paying the interest payments of earlier loans taken by various state governments. Clearly there needs to be some accountability on taking loans.
You may be wondering what will happen to all the GST and Income Tax we pay. All these finally get distributed to central schemes and a bulk of 41% get shared with various states. The Receipt Budget 2022–23 gives the following shares and money that is devolved from the center
Notice that the top states like Karnataka, Maharashtra, Tamilnadu, Delhi and Gujarat which contribute substantially to the state exchequer receives very less from the centers.
Karnataka, Tamilnadu, Maharastra, Gujarat just receives 3.647%, 4.079%, 6.317% and 3.478% based on the Finance Commission Formula
Now larger states like Bihar, UP, West Bengal receives a sizable share. They neither contribute to the central tax collection, nor have their own resources to augment the tax and non tax revenues, but they get bulk of the share.
Think of this situation. When you have a big brother who works hard and gives you money. But you go and spend it on all parties and moj masti !!!
Finally what happens is that you are neither developing yourself, but also ruining your brother’s finances.
The same thing is happening here too, when you get a big junk of free aid from center without any actual work, there needs to be more monitoring by the big brother, the center, into the financial affairs of the states to ensure that finances are better managed.
But see what is happening now…
Big brother one day comes to know that you have overspent and instead of parties alone, you have ventured into gambling and other risky activity and borrowed huge sums to fund your thirst.
So what will finally happen, you are going to sink your big brother too…
The chart below shows the debt percentage of GSDP to Gross Fiscal deficit as percentage of GSDP.
Among the ten states, Andhra Pradesh, Bihar, Rajasthan and Punjab exceeded both debt and fiscal deficit targets for 2020–21 set by the 15th Finance Commission.
West Bengal, Kerala, Jharkhand exceeded their debt targets. So all is not that well with our state finances and some serious reforms are needed to avoid these states from entering a financial crisis
In a family, when you are in distress, you take loans. But you also clear off your loans in some time. When new income comes, you ensure that principals are paid off. The same thing could have been done in many of these states.
When there was a time when revenue receipts where increasing, debt should have been paid off. But today, the state governments are piling up loans after loans in the hope that the future generations will bear the interest burdens.
Now why is that the states are not self reliant and cant generate there own revenues. Let us look at the states tax in detail and we can see that the major source of revenue receipts is Central transfer ( devolution plus grants ), Own tax revenue , Own non tax revenue.
In tax revenue, the main sources are Stamp and Registration Fees, Sales Tax, State Excise, Taxes on Vehicles, Taxes and Duties on Electricity and SGST. From the table given below, most of the revenues come from SGST, Excise and property registration.
The ten selected states in the above chart account for around half of the total revenue collected by all states and UTs. Some states are able to get a sizable portion of their revenue collected through their own tax revenue. However some states like Bihar and Jharkhand are still struggling with streamlining their own tax revenue sources. Tax administration needs to be more streamlined and made more tech friendly to make the collection go up in these states.
The more worrisome part is that some states like Madhya Pradesh, Punjab and Kerala have a declining trend of own tax revenue.
My father used to tell me a simple mantra.
If you raise a loan to build a house, its ok, but if you raise a loan to do a marriage function or clear off your outstanding loans, then you are in deep problem!!!
Let us look at the quality of expenditure
The share of revenue expenditure in total expenditure of these states varies in the range of 80–90 per cent. Some states like Rajasthan, West Bengal, Punjab and Kerala spend around 90 per cent in revenue accounts. So these states have very little money left for capital investment.
So most of the revenue expenditure is for meeting current years expenditure and not for any asset creation. Now let us analyze why this 80 to 90% revenue expenditure is needed and whether there is any chance of this coming down in the future?
Committed expenditure, which inter alia includes interest payments, pensions and administrative expenses, accounts for a significant portion (over 35 per cent) of the total revenue expenditure in states. As a result many of these states have lesser developmental expenditure
Let us look at the Pension Outgo !!!
Pension expenditure alone accounts for 12.4 per cent (average of 2017–18 to 2021–22) of total revenue expenditure of the 10 most indebted states. It is estimated that the pension outgo will continue to be in the range of 0.7–3.0 per cent of GSDP in the ten most indebted states until 2030–31
Pension is going to rise and rise and will not come down till 2030–31 !!!!
Now the next expenditure is State Subsidies and Freebies
As per the latest available data from the Comptroller and Auditor General of India (CAG), the state governments’ expenditure on subsidies has grown at 12.9 per cent and 11.2 per cent during 2020–21 and 2021–22.
The above chart clearly shows that many states have higher subsidies as part of the revenue expenditure. Tamil Nādu, Haryana, Madhya Pradesh, Maharashtra, Rajasthan, Chhattisgarh, Gujarat and Punjab all fall in these categories
In the recent period, state governments have started delivering a portion of their subsidies in the form of freebies. Freebies are different from public/merit goods such as the public distribution system, employment guarantee schemes, states’ support for education and health. On the other hand, provision of free electricity, free water, free public transportation, waiver of pending utility bills and farm loan waivers can be regarded as freebies. They erode incentives for private investment and disincentivize work force participation.
Some estimates of Freebies are given below. It is around 2.7% of GSDP in some states, which is very very high !!!
Freebies are a real problem. NABARD had done a Farm Loan Waiver research paper and found its strong correlation with elections. Let us look at the magnitude of the Farm Loan Waivers given by various political parties running into thousands of crores.
Notice that these Farm Loan waivers were provided just before the elections and most of the parties who announced Farm loan waivers won the elections with thumping majority.
So clearly these are election expenditures /bribes at the expense of taxpayers. What if this was transferred to tax payers as a reduction? This is the argument of the anti freebies economists.
These are just the tip of ice berg. There are hidden guarantees given for many projects especially in the power sectors. Nobody even talks about them. Let us look at the guarantees issued by state governments.
The guarantees given by state government on various loans as per above chart has reached almost 4.5% of GDP. While the power sector accounts for almost 40 per cent of these guarantees, other beneficiaries include sectors like irrigation, infrastructure development, food and water supply.
Contingent liabilities have surpassed 5 per cent of GSDP in states like Punjab, Rajasthan, Uttar Pradesh and Andhra Pradesh. Any default here can adversely affect state finances.
Power Sector companies audit indicated that they don't follow companies act, but most of their accounts are framed as per the earlier Electricity act. In case losses and provisions are made as per the latest Accounting Standards issued by ICAI, I’m very sure the losses of these companies would increase substantially. Most of these companies show their projects pending in capital work in progress without proper accounting for provision for impairment and write offs. There are many receivables which needs to be written off since they are pending from ages.
All DISCOMs are in perpetual losses. CAG report given below highlights some of the deficiencies in Tangedco of Tamilnadu State. As per this, in spite of UDAY scheme, Tangedco’s debts increased to Rs 1,23,895 crores at the end of 2019–20.
UDAY_Report_English_V.15.cdr (cag.gov.in)
However I would still stick to the estimates of losses provided by RBI which are given below.
One of the biggest failures is the power sector. The power sector accounts for much of the financial burden of the state governments in India. There are variety of ways and remember in the last 20 years there have been 3 bailouts where in states take over either the losses or the debt burden of the Discoms with substantial repercussions for state finances.
Inspite of schemes like UDAY, the DISCOMs performance has remained weak, with their losses surpassing the Pre-UDAY level of 0.4% of GDP in 2018–19. Look at the yearly losses in absolute terms. In 2018–19, it was around Rs 80000 crores and in 2019–20, it was around Rs 75000 crores. If this is not mismanagement, then what else is mismanagement.
The combined losses of DISCOMS in the five most indebted states viz., Bihar, Kerala, Punjab, Rajasthan and West Bengal constituted 24.7% of the total DISCOMs losses in 2019–20 while their combined long term debt was 22.9% of the total DISCOM debt in 2019–20.
As per the charts above, Tamil Nādu leads the debt and losses followed by Rajasthan, Maharastra, Madhyapradesh and other states.
Also remember that overdues of DISCOMS to power generating companies (GENCOs) have increased substantially. DISCOMs overdues from Top 8 states has already crossed Rs 1,00,000 crores.
Now, Union Government and State Governments are stuck. If they dont rescue these companies, their would be a serious power crisis resulting in political repercussions. So the only way out is a bail out.
RBI has estimated the amount of bailout size that is required to make these DISCOMs work again.
A rescue package for bailing out these hailing DISCOMS will cost a bomb !!! almost 2.3% of the combined GSDP. India requires Rs 4,32,331 crore to bailout these DISCOMS.
Look at States like Tamilnadu which argue against Freebies. They require a staggering Rs 1,14,348 crores as a bailout package.
This is more than mismanagement and such a burden on the tax payers. Now let us reduce these burden from the taxpayers. That is cut tax collection by Rs 4,32,331/-
If you can just reduce these losses, taxpayers can get 10% tax cut easily and GST can be reduced in many areas.
The above analysis clearly shows that there is a real alarm bell regarding the state finances and it is high time we focus on managing the state finances in a better way.
Fiscal conditions among states in India are showing warning signs of stress.
The slow down in own tax revenue, a high share of committed expenditure and rising subsidy burden have stretched state government finances.
New sources of risks have emerged like relaunch of the old pension schemes, rising expenditure on non merit freebies, expanding contingent liabilities and the ballooning overdue of DISCOMs.
Its high time, state governments puts in a statutory mechanism to cut down the expenditure on non merit goods to stabilize the debt levels.
Many politicians are also talking about Corporate Freebies in the form of tax incentives and corporate loan waivers.
Tax Incentives are provided for corporates for setting up shops and create jobs in the country. The Receipts Budget provides the details of the entire tax incentives provided which are listed below.
This is a significant outgo with almost 1 lakh crore forgone every year. Similarly for non corporate taxpayers, there is around Rs 10000 crore forgone every year.
However the biggest incentives are provided to individual taxpayers
So almost Rs 1,70,583 lakh crores revenue is forgone because of various deductions and exemptions provided to the individual taxpayers.
Both the corporate and individual tax incentives are merit freebies and not non merit freebies. They promote various investments into sectors, encourage savings, drive investment and hence promote employment generation in the country and aid acceleration of GDP.
It is also clear from the above that the Individual tax payers get far more tax incentives than the corporates.
There needs to be some kind of optimization of Freebies on non merit goods and also clear monitoring of the delivery of the Freebies.
State Finances should be tracked and also tax incentives/deductions if found to be on merit goods should be encouraged only if the state finances are not burdened. Focus should also be on reducing state debts.
While tax incentives/deductions on non merit goods should not be encouraged.
The battle of Freebies is both a political and a economic one. There should be balance between the political ambition and also economic sustainability.
This is easier said than done !!!
It is not surprising that Public Interest Litigations are filed in Supreme court challenging the Freebies and requesting the court intervention into efficient utilization of public money.
In the initial hearing, Chief Justice of India Ramana, has made some thoughts on the case which would define the course of these entire debate
Firstly he stated that freebies should not be confused with genuine welfare schemes. He pointed to Article 38(2), which mandates the State ‘to strive to minimise the inequalities in income, and endeavour to eliminate inequalities in status, facilities and opportunities, not only amongst individuals but also amongst groups of people residing in different areas or engaged in different vocations’. Further, he stated that a political party or individual could not be prevented from making promises in furtherance of Article 38(2), if elected to power.
Secondly, he stated that what qualifies as a valid promise must be answered first. Would the promise to provide free and compulsory education be considered a freebie? Would subsidies on electricity, seeds, and fertilisers that are designed to facilitate earning for small farmers, be considered as a freebie? Would the promise of healthcare, drinking water, or minimum units of electricity fall under the ‘freebie’ category? In contrast, how would the distribution of ornaments, television sets and consumer electronics free of cost to voters be justified as welfare measures?
Thirdly, he mentioned that there is a real concern about efficient utilization of public money but also raised a question whether the courts can intervene in such matters or is it the role of the parliament alone?
This are interesting questions that would decide the course of the Freebies battle in the coming days.
