Where have all the subsidies gone?

If one has a good idea of where we went wrong in the last five years, one can begin to project the future and what the finance minister might or might not be able to do on February 28. No matter what the source, the discussion and complaint has centred on the fiscal deficit. And the fiscal situation is dire an increase of nearly 2 percentage points in the consolidated fiscal deficit in the last five years.

But the fiscal deficit is the net difference between revenues and expenditures. So, theoretically, the fiscal deficit can expand because of a shortage of revenues or an excess of expenditures or both. Consequently, depending on one's ideological preference, the emphasis is either on raising taxes or on cutting expenditure. And given a country like India, whose politicians and many of the glintelectuals (glitterati intellectuals) do not believe in any evidence based policy, the concentration is on raising taxes. The last two months have been dominated by discussions of how to raise tax revenue and, of course, "motherhood" dictates that one cannot go wrong by suggesting that the rich should pay more. If it is pointed out that the top 10 per cent of earners in the country pay for almost all of corporate and individual tax revenue, the refrain of the glintelectuals is: why can't they pay more?

Back-of-the-envelope calculations for the Indian economy are now made easier with several important numbers approaching 100 or multiples of 100 levels. Nominal GDP in 2012-13 is estimated to have been Rs 94.6 lakh crore (lc); for 2013-14, with 12 per cent growth, nominal GDP is estimated at Rs 106 lc. For the same year, poverty is forecast to be 220 million or 18 per cent of the population. This based on a Tendulkar poverty line equal to Rs 1,000 per capita per month (pcpm) and the average consumption level of the poor equal to Rs 834 (Rs 12,000 and Rs 10,000 on an annual basis).

These simple calculations, assuming conservative historical trends, imply that the government needs to annually spend, in 2013-14, Rs 0.44 lc(obtained as the multiple of 220 million poor with an average poverty deficit of Rs 2000 per person per year). This fraction is 0.40 per cent of the GDP and what is needed to be spent on the poor in order to claim that "India is a land with NO poverty according to the official poverty line". This claim assumes perfect targeting. Further, the amount needed to eliminate poverty declines with economic growth. In 1983, the perfect targeting outlay was equal to 7.8 per cent of the GDP and in 2004-05, 1.6 per cent of the GDP.

Assume, for a moment, that the government was actually desirous of doubling the real incomes of every poor person in India. This will mean an outgo of nearly Rs 2,20,000 crore each year and will push every poor person in India to a consumption level above the poverty line. The table documents the actual expenditure on various inventive poverty reduction schemes that Indian politicians have offered and spent grandiosely on.

The trend in the averages is striking. Under Atal Bihari Vajpayee's tenure, when incomes were low, the government spent close to 1.6 per cent of the GDP on poverty reduction programmes. India was a lot poorer 10 years ago and could not afford the average perfect targeting requirement of 2.2 per cent of GDP. During UPA 1, this deficit turned into a surplus (India became less poor) but the populist government spent twice the amount "needed" to remove poverty. The situation has worsened considerably in UPA 2, and in 2012-13, the government is spending more than six times than what is "needed".

The criminally sad nature of our populist policies is brought out by the following calculations. We spend Rs 1,00,000 crore on diesel subsidies. I don't know about you, but I know precious few, indeed none and none by a few miles, poor people who consume diesel. If the diesel subsidy were to be eliminated and the money given to the poor, their consumption would increase by 50 per cent! If the food subsidy were to be eliminated (and only 23 per cent of the poor's food was accessed from PDS shops in 2009-10), the incomes of the poor would increase by 50 per cent. If all subsidies were to be eliminated and the money given to the poor, their incomes would be two and a half times their present income.

Of course, perfect targeting is not possible, and all the money saved from elimination of subsidies should not go to the poor. Indeed, it should not go to anybody, but should go to help make India look more like a modern economy than a poor cousin of Hugo Chavez's Venezuela. And Venezuela has oil

to squander.

This simple analysis has several implications for Indian policymaking and the budget. For starters, all this talk about raising tax rates, imposing commodity taxes, increasing dividend taxes, etc, is shown plainly to be what it is utter and glib nonsense. The gains to be made for the Indian economy are by drastically reducing "in the name of the poor (INP)" expenditures. The talk should not be in terms of motherhood reductions of the fiscal deficit, but reductions in the even more politically correct motherhood expenditures on the poor.

The big story, the big debacle, the big policy mistake, is the irresponsible increase in the combined (state and Centre) fiscal deficits of about 2 to 4 percentage points of GDP. This had averaged 6.3 per cent of the GDP in the "good" years, 2003-04 to 2007-08. For the last five years, the fiscal deficit has averaged 8 per cent, or 1.7 percentage points higher than the 2003-04 to 2007-08 average. Is it just a coincidence that this increase is almost identical to the increase in populist subsidies alone 1.6 percentage points between NDA-Vajpayee and UPA 2?

It is time we recognised the debate on INP policies. Several people will lose if a re-orientation is made. Many of these people are politicians, many more are in major political parties and I would conjecture that a large amount of the leakage ends up in the coffers of political parties as election financing. These men and women are powerful and stand a lot to lose if money meant for the poor reaches the poor. How much is this leakage or "corruption"? Rajiv Gandhi had conjectured (Congress party leaders please note) way back in 1985 that 85 per cent of the money meant for the poor was lost in transition. And Rajiv Gandhi was a raging optimist. Fifteen per cent of Rs 3,01,000 crore is Rs 45,000 crore, and even if this fraction of money did actually reach the poor, poverty in India today would be less than 5 per cent, if not zero! In other words, money for the poor leaks away indeed, floods away.

The choice for India, and P. Chidambaram, is crystal clear. We need to abandon the reckless adventurism of UPA 2 (and parts of UPA 1). Budget 2013-14 should be about subsidy control, and about considerably improved targeting. Technology in the form of Aadhaar is now available; cash transfers are an important component of anti-poverty policy in most countries. The budget should remember the insight of Rajiv Gandhi, and it should concentrate on the relationship between outlays and outcomes.

The writer is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Blufin, a leading financial information company

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