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Chapter 4 - Government Subsidies – Policy Perspectives
One of the most hotly debated topics in the contemporary world is about the
need and size of the subsidies offered by various Governments to their citizens.
It is pertinent to recall what President John F Kennedy, the youngest President
of the world’s most developed country US said in his inaugural address in 1961.
“To those peoples in the huts and villages across the globe struggling to break
the bonds of mass misery, we pledge our best efforts to help them help
themselves, for whatever period is required—not because the Communists may
be doing it, not because we seek their votes, but because it is right. If a free
society cannot help the many who are poor, it cannot save the few who are
rich.”161
The Oxford Dictionary162
defines subsidy as a sum of money granted from
public funds to help an industry or business to keep the price of a product or
service low or a sum of money granted to support an undertaking that is in the
public interest.
A subsidy, often viewed as the converse of the tax, is an instrument of fiscal
policy. Derived from the Latin word `subsidum’, a subsidy literally implies
coming to assistance from behind. The beneficial potential of a subsidy will be
161 See Speech at - http://www.bartleby.com/124/pres56.html 162 http://oxforddictionaries.com/definition/subsidy
120
at its best when it is transparent, well targeted, and suitably designed for
practical implementation.
According to the WTO’s Agreement on Subsidies and Countervailing
Measures163
(SCM Agreement) the definition of subsidy contains three basic
elements:
i) A financial contribution,
ii) By a government, (or) any public body within the territory of a
member country, and
iii) Which confers a benefit.
All three of these elements must be satisfied in order for a subsidy to exist.
The SCM Agreement contains a list of measures that represent a financial
contribution e.g., grants, loans, equity infusions, loan guarantees, fiscal
incentives, the provision of goods and services and the purchase of goods and
services.
In order for a financial contribution to be a subsidy, it must be made by or at the
direction of a government or any public body within the territory of a member
country. Thus, the SCM Agreement applies not only to measures of national
163 http://www.wto.org/english/tratop_e/scm_e/subs_e.htm
121
governments, but also to measures of sub-national governments and of such
public bodies as state owned companies.164
A financial contribution by a government is not a subsidy unless it confers a
“benefit”. In many cases as in the case of a cash grant, the existence of a
benefit and its valuation will be clear. In some cases, however, the issue of
benefit will be more complex. Although the SCM Agreement has provided
some guidelines to determine whether certain types of measures confer a
benefit, the issue of the meaning of “benefit” is not fully resolved.165
Subsidies, by means of creating a wedge between consumer prices and producer
costs, lead to changes in demand / supply decisions. Subsidies are often aimed
at166
:
i) inducing higher consumption / production;
ii) offsetting market imperfections
iii) achievement of social policy objectives including redistribution
of income, population control, etc.
164 Id 165 See generally Anne Van Aaken & Jürgen Kurtz, ‘The Global Financial Crisis And International Economic Law at http://www.cepr.org/meets/ltm/2407/AAKEN_KURTZ.pdf 166 http://en.wikipedia.org/wiki/Subsidies_in_India
122
4.1 Benefits of Subsidies
The Governments offer subsidies on education, health care, drinking water,
irrigation, electrical energy, petrol, diesel, kerosene, LPG, fertilizers, seed,
interest on bank loans, industrial incentives, food and nutrition. In addition,
there are a large number of hidden subsidies. Subsidies are justified on many
grounds, the chief among them being the sheer necessity of higher consumption
levels than what would be obtained on the basis of what a majority of the poor
can afford. Recently, when the global petroleum and fertilizer prices sky
rocketed disproportionate to the demand-supply gap, the Government of India
heavily subsidized these products, as passing the price increases to the people
was not possible because it would simply have been unaffordable for the
majority of people in the country.167
In addition, subsidies are sometimes justified for well-defined redistributive
objectives. Subsidies play a vital role in the economy of a country. A country
has various resources which are to be gainfully deployed for the benefit of the
population of the whole country. Subsidies are provided to ensure equitable
utilization of the resources for the people. Subsidy is money granted by a
Government to keep down the prices of commodities or services etc. As
subsidies may impact the prices of commodities they lead to changes in
demand/ supply decisions.
167 ‘Reports on selected themes in natural resources development in Africa: Renewable energy technologies (RETs) for poverty alleviation’ United Nations Economic And Social Council Document No: ECA/SDD/CSD.3/5, 29 August 2003
123
A cash transfer to the citizens is an easily understandable form of a subsidy.
However, it also has many invisible forms. Thus, it may be hidden in reduced
tax-liability, low interest government loans or government equity participation.
If the government procures goods, such as food grains, at higher than market
prices or if it sells at lower than market prices, these amount to subsidizing.
The developed, developing and underdeveloped countries have various items of
subsidies. Developing countries like India provide subsidies for their population
for improving standards of living; the underdeveloped countries provide
subsidies for meeting bare minimum needs of the vast majority of the
population. Subsidies represent a sizeable proportion of the Central and State
Governments’ non-plan revenue expenditure. For properly appreciating the role
and importance of subsidies, it is important to understand why India needs
subsidies or why it should not? 168
No doubt, a developing country like India needs subsidies due to various
reasons. Providing minimum consumption entitlement to the poor by
subsidizing the items consumed by them is extremely important for the welfare
of the country. Providing free education or free or subsidized health care,
housing, electricity, drinking water etc. for deprived sections of the society is
the most essential part of social justice is an overriding concern in all welfare
states.
168 http://theviewspaper.net/does-india-really-need-subsidies/
124
In the context of trade and business, subsidies have a tendency to hurt the
interests of other traders particularly in the area of international trade. The
tenets of free economy dictate fair play of forces of demand and supply.
However, countries at times resort to intervention measures to protect their
genuine economic interests. As long as such interventions are going to benefit
uniformly every enterprise or industry, they are welcome as they are useful and
necessary. Yet, they may be resisted by other affected parties particularly the
competing enterprises or industries of other countries giving rise to disputes.
These disputes need to be resolved to ensure the free flow of transactions of
trade and commerce across the countries.
4.1.1. Rationale behind Subsidies
Subsidies are a kind of incentive which plays an important role in economic
development of developing countries. Subsidies bring out desired changes by
effecting optimal allocation of resources, stabilizing the price of essential goods
and services, redistributing income in favour of poor people thus achieving the
twin objective of growth and equity of nation.
The general rationale for providing subsidies is169
:
Correcting market failures
169 Meeta K Mehra, Mayank Sinha and Sohini Sahu, ‘Trade-Related Subsidies – Bridging the North-South Divide: An Indian Perspective’, 2004 International Institute for Sustainable Development
125
Protecting national production from competition
Reducing import dependence
Encouraging national employment
Ensuring balanced regional development
Enabling access to and affordability of basic services or goods by all
Stimulation of economic growth.
Subsidies are justified in the presence of positive externalities because in these
cases, consideration of social benefits would require higher level of
consumption than what would be obtained on the basis of private benefits only.
Subsidies as converse of an indirect tax constitute an important fiscal
instrument for modifying market determined outcomes. While taxes reduce
disposable income, subsidies inject money into circulation. Subsidies affect the
economy through the commodity market by lowering the relative price of the
subsidized commodity, thereby generating an increase in its demand.
With an indirect tax, the price of the taxed commodity increases, and the
quantity at which the market for that commodity is cleared, falls, other things
remaining the same. Taxes appear on the revenue side of government budgets,
and subsidies on the expenditure side.
126
India is perhaps the first country in the world which has taken upon itself the
responsibility for the economic and social welfare of the people by making it an
obligation under the Constitution of India. Chapter IV of the Constitution of
India170
dealing with the subject of Directive Principles of State Policy
mandates that:
Article 38 (1): The State shall strive to promote the welfare of the people by
securing and protecting as effectively as it may a social order in which justice,
social, economic and political, shall inform all the institutions of the national
life.
Article 38 (2): The State shall, in particular, strive to minimize 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.
Article 39: The State shall, in particular, direct its policy towards securing—
(a) that the citizens, men and women equally, have the right to an
adequate means of livelihood;
(b) that the ownership and control of the material resources of the
community are so distributed as best to sub serve the common good;
170 http://indiacode.nic.in/coiweb/coifiles/p04.htm
127
(c) that the operation of the economic system does not result in the
concentration of wealth and means of production to the common
detriment;
(d) that there is equal pay for equal work for both men and women.
State to secure a social order for the promotion of welfare of the people.
Article 41: The State shall, within the limits of its economic capacity and
development, make effective provision for securing the right to work, to
education and to public assistance in cases of unemployment, old age, sickness
and disablement, and in other cases of undeserved want.
Article 45: The State shall endeavour to provide early childhood care and
education for all children until they complete the age of six years.
Article 46: The State shall promote with special care the educational and
economic interests of the weaker sections of the people, and, in particular, of
the Scheduled Castes and the Scheduled Tribes, and shall protect them from
social injustice and all forms of exploitation.
Article 47: The State shall regard the raising of the level of nutrition and the
standard of living of its people and the improvement of public health as among
its primary duties and, in particular, the State shall endeavour to bring about
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prohibition of the consumption except for medicinal purposes of intoxicating
drinks and of drugs which are injurious to health.
4.1.2 Subsidies in the WTO Regime
The SCM Agreement of WTO classifies a subsidy as “specific” when it is
available only to an enterprise, industry, group of enterprises or group of
industries.171
Specific subsidies can be:
a) In the form of domestic support which need not be directly
related to exports, and
b) Subsidies that are tied to exports.
The SCM Agreement applies only to subsidies that are specifically provided to
an enterprise or industry or group of enterprises or industries and defines the
terms `subsidy’ and `specificity’.
SPECIFICITY
Assuming that a measure is a subsidy within the meaning of the WTO SCM
Agreement, nevertheless it is not subject to the SCM Agreement unless it has
been specifically provided to an enterprise or industry or group of these. The
basic principle is that a subsidy that distorts the allocation of resources within
171 See generally Santiago Ibáñez Marsilla, ‘Recent Stimulus Packages And WTO Law On Subsidies’, [2009] World Customs Journal Vol. 3(2).
129
an economy should be subject to discipline. Where a subsidy is widely
available within an economy, such a distortion in the allocation of resources is
presumed not to occur. Thus, only “specific” subsidies are subject to SCM
Agreement disciplines. There are four types of “specificity” within the
meaning of the SCM Agreement.
• Enterprise-Specificity: A government targets a particular
company or companies for subsidization.
• Industry-Specificity: A government targets a particular sector or
sectors for subsidization.
• Regional-Specificity: A government targets producers in
specified parts of its territory for subsidization.
• Prohibited Subsidies: A government targets export goods or
goods using domestic inputs for subsidization.
Categories of Subsidies:
The SCM Agreement creates two basic categories of subsidies172
:
i) those that are prohibited, and
ii) those that are actionable.
All specific subsidies fall into one of these categories.
172 Anwarul Hoda & Rajeev Ahuja, ‘Agreement On Subsidies And Countervailing Measures: Need For Clarification And Improvement’ Working Paper No. 101 (2003) at http://www.icrier.org/pdf/WP101.pdf
130
Prohibited Subsidies:
Two categories of subsidies are prohibited by the Article 3 of the SCM
Agreement. The first category consists of subsidies contingent on export
performance and are called “export subsidies”. The second category consists of
subsidies contingent upon the use of domestic over imported goods. These are
called as “local content subsidies”. These subsidies are prohibited because they
are designed to directly affect the trade and thus are most likely to have adverse
effects on the interests of other member countries.
These subsidies are given to recipients who meet certain export targets or use
domestic goods instead of imported goods. They are prohibited because they
distort international trade, and are, therefore, likely to hurt trade of other
member countries.
Prohibited subsidies can be challenged under the WTO Dispute Settlement
procedure where they are heard under an accelerated time table. If the dispute
settlement procedure confirms that the subsidy is prohibited, it must be
withdrawn immediately. Otherwise, the complaining member country can take
counter measures such as imposition of countervailing duty.
Actionable Subsidies:
Most subsidies, such as production subsidies, fall in the category of
“actionable” category. Actionable subsidies are not prohibited. However, they
131
are subject to challenge in the event that they cause adverse effects. There are
three types of adverse effects.
First, there is injury to a domestic industry due to subsidized imports in the
territory of the complaining member. This is the sole basis for resorting to
countervailing action.
Second, there is serious prejudice arising as a result of adverse effects (e.g.,
export displacement) in the market of the subsidizing member or in the third
country market. Thus, unlike injury, it can serve as the basis for a complaint
related to harm to a member’s export interest.
Finally, there is nullification or impairment of benefits accruing where the
improved market access presumed to flow from a tariff reduction is undercut by
subsidization.
Conversely, the complaining country has to show that the subsidy has an
adverse effect on its interests. Otherwise, the subsidy is permitted. The SCM
Agreement defines three types of damages that can be caused by actionable
subsidies.173
173 See generally J.H.H. Weiler & Sungjoon Cho ‘International and Regional Trade Law: The Law of the World Trade Organization’ at http://centers.law.nyu.edu/jeanmonnet/wto/units/documents/WTO_2006_UnitXII_DumpingandSubsidies_Revised.pdf
132
i) Products benefiting from subsidies in the exporting country
hurting domestic industry in the importing country;
ii) Subsidized products hurting rival exporters from another country
when the two countries compete in third markets; and
iii) Domestic subsidies hurting exporters of another country trying to
compete in the subsidizing country’s domestic market.
Transfers and Subsidies
Transfers which are straight income supplements needs to be distinguished
from subsidies. An unconditional transfer to an individual would augment his
income and would be distributed over the entire range of his expenditure.
A subsidy however refers to a specific good, the relative price of which has
been lowered because of the subsidy with a view to changing the consumption /
allocation decisions in favour of the subsidized goods. Even when subsidy is
hundred percent, i.e. the good is supplied free of cost, it should be distinguished
from an income-transfer (of an equivalent amount) which need not be spent
exclusively on the subsidized good.
Transfers may be preferred to subsidies on the ground that:
(i) any given expenditure of State funds will increase welfare more if it
is given as an income-transfer rather than via subsidizing the price
of some commodities, and
133
(ii) transfer payments can be better targeted at a specific income groups
as compared to free or subsidized goods.174
Exclusion errors and Inclusion errors:
Subsidies can be distributed among individuals according to a set of selected
criteria, e.g. 1) merit, 2) income-level, 3) social group, etc. Two types of errors
arise if proper targeting is not done, i.e. exclusion errors and inclusion errors.
In the former case, some of those who deserve to receive a subsidy are
excluded, and in the latter case, some of those who do not deserve to receive
subsidy get included in the subsidy programme.175
SUBSIDY BOXES (WTO terminology)176
In WTO terminology, subsidies in general are identified by boxes which are
given the colours of traffic lights; green (permitted); amber (slow down – i.e. to
be reduced) and red (forbidden).
In agriculture things are usually complicated. The Agriculture Agreement has
no “Red” box, although domestic support exceeding the reduction commitment
levels in the Amber box is prohibited. The Blue box stands for subsidies that
are tied to programmes that limit to production. There are also exemptions for
174 http://www.ndtvmi.com/b4/dopesheets/rahul.pdf 175 http://www.regulationbodyofknowledge.org/faq/socHigherIncomeCustomers/ 176 http://www.wto.org/english/tratop_e/agric_e/agboxes_e.htm
134
developing countries and subsidies to these countries sometimes called an S&D
box.
Amber Box
All domestic support measures considered to distort production and trade, with
some exceptions, fall into the amber box. These include measures to support
prices, or subsidies directly related to production quantities. The total value of
measures must be reduced.
These supports are subject to limits. Minimal supports are allowed at 5% of
agricultural production for developed countries, 10% for developing countries.
30 WTO members that had larger subsidies than the prescribed limits have
committed to reduce these measures (subsidies).
Blue Box
This is the “amber box with conditions” – conditions designed to reduce
distortion. Any support that would normally be in the amber box is placed in
the blue box if the subsidy also requires farmers to limit production by
imposing production quotas.
135
Green Box
All those subsidies (supports) that do not distort trade are placed in the green
box. Such subsidies have to be government-funded and must not involve price
support.
These categories of subsidies tend to be measures that are not targeted at
particular products and include direct income supports for farmers that are not
related to (decoupled from) current production levels or prices. They also
include environmental protection and regional development programmes.
Green box subsidies are, therefore, allowed without limits, provided they
comply with the WTO policy prescription.
4.1.3. Merits and Demerits of Subsidies
Like indirect taxes, they can alter relative prices and budget constraints and
thereby affect decisions concerning production, consumption and allocation of
resources. Subsidies in areas such as education, health and environment at
times merit justification on grounds that their benefits are spread well beyond
the immediate recipients, and are shared by the population at large, present and
future. For many other subsidies, however the case is not so clear-cut.177
177 http://wapedia.mobi/en/Subsidies_in_India
136
Arising due to extensive governmental participation in a variety of economic
activities, there are many subsidies that shelter inefficiencies or are of doubtful
distributional credentials. Subsidies that are ineffective or distortionary need to
be weaned out, for an undiscerning, uncontrolled and opaque growth of
subsidies can be deleterious for a country’s public finances.
In India, as also elsewhere, subsidies now account for a significant part of
government’s expenditures although, like that of an iceberg, only their tip may
be visible. These implicit subsidies not only cause a considerable draft on the
already strained fiscal resources, but may also fail on the anvil of equity and
efficiency as has already been pointed out above.
On the face of it, therefore, there is absolutely nothing wrong in giving
subsidies on various items for various sections of population that are socially
and economically deprived. Indeed, as is made out in the Directive Principles of
State Policy of the Constitution of India, it is the bounden duty of the State to
provide free education, health care and food and nutrition to the people at
affordable cost. So, the social and economic compulsions determine the nature,
size and extent of subsidies.
The ideal situation is when the Government is able to provide everything free of
cost to its citizens. But it is not possible due to paucity of resources – both
financial and physical. The economic activity has to go on according to
universally accepted principles.
137
Economic effects of Subsidies:
Economic effects of subsidies can be broadly grouped into
i) Allocative effects: these relate to the sectoral allocation of
resources. Subsidies help draw more resources towards the
subsidized sector.
ii) Redistributive effects: these generally depend upon the
elasticities of demands of the relevant groups for the subsidized
good as well as the elasticity of supply of the same good and the
mode of administering the subsidy.
iii) Fiscal effects: subsidies have obvious fiscal effects since a large
part of subsidies emanate from the budget. They directly
increase fiscal deficits. Subsidies may also indirectly affect the
budget adversely by drawing resources away from tax-yielding
sectors towards sectors that may have a low tax-revenue
potential.
iv) Trade effects: a regulated price, which is substantially lower
than the market clearing price, may reduce domestic supply and
lead to an increase in imports. On the other hand, subsidies to
domestic producers may enable them to offer internationally
competitive prices, reducing imports or raising exports.
138
Ultimately, the primary sources of revenues to the Governments are taxes and
fees. There is a limit beyond which these cannot be resorted to. Similarly, there
is a limit beyond which the revenue deficit and the fiscal deficit of a
Government cannot go. One of the major allegations against the subsidy
system all over the world is that it is more a product of political compulsions
and opportunism rather than the economic and social compulsions.
Because of the increase in the political competition, each political party has
been trying to entice the people with many unfortunate types of bait. Some of
the political parties have even offered free colour TVs, free rice, free electricity,
free houses etc.
With every election, the list has been increasing and along with it the revenue
deficits and the fiscal deficits. The adverse impact of the fiscal deficits results in
the expansion of money supply leading to inflation.
There are consumptive subsidies and productive subsidies. As long as subsidies
have the positive effect of creating extra wealth and employment, they are
considered to be good. Offering subsidies for personal consumption on a long
term may not be very desirable.
The benefits can however be maximized only when the subsidies are
transparent, well targeted, and are so designed as to be effective in terms of
139
implementation without any leakages. It is often complained that the
Government is granting subsidies which do not reach their target groups and on
the other hand are manipulated by the rich. The whole issue of granting
subsidies or not has given rise to many questions which need to be answered by
the Government, economists and politicians as well. The subsidies in effect are
inverse of taxes.
Just as taxes increase the prices of the products taxed, subsidies reduce the price
of the product subsidized. And just as taxes increase a Government’s income,
subsidies reduce it. Hence, subsidies are sometimes called negative taxation.
There is a broad consensus that subsidies are not bad as long as they reach the
targeted groups and for a specific purpose and time. No Government can afford
to make its citizens dependent on it for each and every thing eternally. All these
subsidies have to be for a specific time intended to accomplish a particular
target. Otherwise, it will become untenable, as it is happening in India
presently.
In recognition of the growing concern over the increasing proportion of
subsidies both in absolute terms and as proportion to the gross domestic product
of the country, the Government of India had brought out a discussion paper in
the year 1997 on the subject of subsidies. The paper was widely discussed and
debated. The National Institute of Public Finance and Policy published a book
140
on “Budgetary Subsidies in India” in March 2003, the executive summary of
which is extracted below:
Government subsidies, which often remain hidden in the budgetary magnitudes,
were discussed at length in a Discussion Paper which the Government of India
brought out in May 1997 (DP 1997). This paper had considered the subsidy
regime in India as unduly large, non-transparent, largely input-based, poorly
targeted, generally regressive and inducing waste and misallocation of
resources. The present study revisits the issue of budgetary subsidies in India,
provides an estimate of the implicit budgetary subsidies for 1998-99, examines
recent trends, and discusses critical policy issues in the context of subsidies.
Meaning and Rationale
Goods and services provided by budgetary resources may be classified as
public and private goods. But there are many congestible goods in the
intermediate space. In a budgetary context, subsidies are taken as unrecovered
costs of public provision of goods that are not classified as public goods. These
are private goods or congestible goods where user charges can be levied either
according to individual consumers or according to groups of consumers. In
particular, the present study (as in DP 1997), focuses on governmental
provision of social and economic services.
Subsidies are justified in the presence of positive externalities because in these
cases social benefits require higher consumption levels than what would be
141
obtained on the basis of private benefits only. In addition, subsidies are
sometimes justified for well-defined redistributive objectives.
However, the financing of subsidies induces its own costs whether these are
financed through additional taxation or borrowing. The welfare gains of
subsidies should be matched against the costs of financing subsidies. Over-
subsidization could adversely affect allocation of resources and environment.
Subsidies in this study, as in the comparable previous studies including DP
1997, are measured as the excess of costs over receipts on relevant budgetary
heads in social and economic services. The costs are calculated as the sum of
current costs and annualized capital costs. The receipts comprise interest
receipts, dividends and other revenue receipts from user charges.
4.2. Subsidies in India
The reforms programme initiated by the Government of India in 1991 aimed at,
among other things, reducing fiscal imbalances and improving allocative
efficiency by minimizing the distortions in relative prices arising from
budgetary and fiscal imprudence. Containing and targeting subsidies constituted
an important element of reforms. Subsidies are the converse of indirect taxes
and are specific to goods and services. Subsidies are different from transfer
payments, which are straight income supplements to individuals, who are
142
normally the poor and the vulnerable. Providing minimum consumption
entitlement to the poor by subsidizing the items consumed by them is an
extremely important welfare dimension of fiscal policy. Subsidies can correct
for the under-consumption of goods with positive externalities. With the social
benefits of a particular service or commodity exceeding the aggregate of private
benefits to individual consumers, market solutions result in under-consumption
and subsidies can make the necessary correction. However, the benefits can be
maximised only when the subsidies are transparent, well targeted, and suitably
designed for effective implementation without any leakages.178
The size, incidence, allocation distortions, and recent upsurge in some subsidies
are the key issues in the context of budgetary subsidies in India. The main
issues pertaining to subsidies in India may be listed as179
:
(i) are budgetary subsidies provided for the right reasons;
(ii) are many wrong goods/services being subsidised;
(iii) does over-subsidisation lead to harmful effects;
(iv) are subsidies too large relative to resources;
(v) what are the implications of cross-subsidies and off-budget
subsidies;
(vi) has there been an upsurge in some subsidies in recent years;
(vii) what are the implications of subsidising inputs;
178 Department of Economic Affairs, Ministry of Finance, ‘Central Government Subsidies In India - A Report, (Prepared with the assistance of the National Institute of Public Finance & Policy) December, 2004 at http://finmin.nic.in/reports/cgsi-2004.pdf 179 See generally Parthapratim Pal, ‘Current WTO Negotiations On Domestic Subsidies In Agriculture: Implications For India’ at http://www.icrier.org/pdf/WP%20177.pdf
143
(viii) is the subsidy regime in India regressive;
(ix) what is the interface of subsidies with inefficiencies;
(x) is there a case for increasing subsidies in some sectors; and
(xi) is there a need for distinguishing long-term subsidies from those that
should have a limited life?
Central Budgetary Estimates: Magnitudes and Trends
Aggregate central budgetary subsidies in 1998-99 were estimated to be Rs.
79828 crore, amounting to 4.59 percent of GDP at current market prices, and
constituting 53.40 percent of the net revenue receipts of the centre, which, as an
item, is the highest draft on revenue receipts as compared to estimates for
earlier years.
The central subsidies decreased from 4.25 percent of the GDP in 1994-95 to
3.49 percent of the GDP in 1996-97. Reversing the trend of a decline since
1994-95, they increased to 4.59 percent of GDP in 1998-99. Four reasons
account for the inordinate increase in the central budgetary subsidies in 1998-
99180
:
(i) the impact of salary revisions in the wake of the recommendations
of the Fifth Central Pay Commission;
(ii) the deterioration of position of railways from a surplus sector into a
subsidy sector;
(iii) large increase in explicit subsidies of the centre; and
180 Id
144
(iv) increase in other input costs unaccompanied by any improvement in
recovery rates. The explicit subsidies, especially in food have risen
sharply since 1996-97. Explicit subsidies on interest, though modest
in absolute terms at around Rs. 207 crore in 2003-04, have been
quite large at over Rs. 1,000 crore in 1996-97, 1998-99 and 1999-00.
In recent years, petroleum subsidies have been an important item. In
2002-03, when petroleum subsidies were shown explicitly in the
Budget for the first time, they were as much as Rs. 5,225 crore.181
In the case of central subsidies, economic sector subsidies are nearly five and
half times as large as those for the social sector. Economic sectors arranged in
diminishing order of size of subsidies are: agriculture and allied services,
industry and minerals, energy, general economic services, and transport.
In the context of central subsidies, current costs dominate total costs in both
social and economic services, and more so in social services. The energy sector
is a notable exception where the capital costs have a much larger share.
Governments are prone to give subsidies for variety of activities, both for
boosting economic activity and for political compulsions. It is very often
noticed that ineligible people / groups get onto the bandwagon and eligible and
genuine ones are left out. Since they are not always linked to economic, social
and other platonic objectives, they tend to breed corruption, inefficiency and
181 Id
145
wastages in their implementation. Moreover, there would be tremendous
financial strain on the State exchequers. Therefore, there is need to have a
relook into subsidy issues in India.
In a study182
on the kerosene subsidy in India it was found that a major reform
and overhaul of the system of the subsidy was the need of the hour. The subsidy
was established during World War II and although it started as a distribution
scheme to consider shortages at that time it became a subsidy soon after and has
remained ever since. Although numerous attempts have been made for the
subsidy reform none have been implemented as yet. The study found that
subsidies become permanent if not efficiently implemented and also give rise to
corruption if not monitored well.
State Subsidies: Broad Trends
Budgetary subsidies of the state governments amounted to 8.96 per cent of the
GDP and about 90 percent of their revenue receipts. After adjustment for salary
arrears paid in 1998-99, the state budgetary subsidies are estimated at 8.47
percent of the GDP.
Relative to the GDP, aggregate budgetary subsidies of the state governments
have fallen in 1998-99 as compared to the earlier available estimates for 1994-
95. The recovery rate has also fallen. This can only be explained by a fall in
182 Dr. Bhamy V. Shenoy, ‘Lessons Learned from Attempts to Reform India’s Kerosene Subsidy’ March 2010, available at http://www.iisd.org/pdf/2010/lessons_india_kerosene_subsidy.pdf
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expenditure (relative to GDP), revenue and capital, allocated to social and
economic services in the State budgets.
Agriculture and irrigation sectors account for the largest share in the state
subsidies, followed by elementary education, energy, secondary education and
medical and public health.
For the special category states, subsidies relative to their GSDPs are extremely
high amounting to 22 percent for the larger special category states, and about 34
percent of their GSDPs for the smaller special category states.
Per capita state subsidies generally show a regressive pattern: the higher the per
capita income of a state, the higher are the per capita subsidies. Per capita
subsidies in the special category states are noticeably higher than those in the
general states.
The state public sector has drawn an implicit subsidy amounting to Rs. 9561
crore. The overall recovery rate in the state level public sector for the budget is
dismally low at 1.64 percent of the costs.183
183 See Prof. Suneel Gupta, ‘Subsidies in India’ at www.slideshare.net/avnishbajpai/subsidies-in-india
147
Per capita subsidies in education and health showed a regressive pattern where,
in comparative terms, low subsidies are available to residents of low income
states and vice-versa.
All India Subsidies184
In 1998-99, aggregate budgetary subsidies of the central and state governments
are estimated to be 13.54 percent of GDP at market prices, and 85.8 percent of
the combined revenue receipts of the centre and states. After adjustment done
for salary arrears paid in 1998-99, the aggregate all India subsidies are
estimated to be about 13 percent of GDP.
As compared to 1994-95, subsidies as percentage of GDP have virtually
remained unchanged. Although central subsidies have increased as percentage
of GDP, the state subsidies show a small fall. The relative share of the centre is
about one-third of the total subsidies, and that of the states, about two-thirds.
Agriculture, irrigation, energy, and industry and minerals have the highest
shares in that order, followed by elementary education.
Together, the public sector covering both central and state level public
enterprises, obtains a subsidy from the budget of an estimated amount of Rs.
20,540 crore which is a little more than one percent of GDP.
184 See generally Rishi Muni Dwivedi, ‘Subsidies in India,’ 2006, New Century Publications, pp. 430 pages
148
Policy Issues
Cross-subsidies arise in the context of regulated price structures which
distinguish between prices according to use/products for the same group of
goods/services. Considerable cross-subsidies exist, for example, in the power
and, until recently, in the petroleum sectors.
There are many off-budget subsidies in the system. An important off-budget
subsidy in the petroleum sector has recently been brought on the budget.
Subsidies that arise due to guarantees extended by governments for loans taken
by the public enterprises are also off-budget subsidies. These have the potential
of becoming budgetary liabilities if there are defaults in loans guaranteed by the
government or if deficits and surpluses do not balance out as in the case of the
Oil Pool Account.
Subsidies often promote inefficiencies. For example, fertiliser subsidies
promote inefficiencies, and are ill-targeted. In general, administering subsidies
through inputs should be discouraged. In the case of fertiliser, presently the old
RPS system is being given up. After an adjustment period of five years,
fertiliser’s subsidies should be given up in their present form. At best, there
may be a case of subsidising small and marginal farmers to a limited extent.185
185 Vijay Paul Sharma & Hrima Thaker, ‘Fertilizer Subsidy in India: Who are the Beneficiaries? W.P. No. 2009-07-01 at http://www.iimahd.ernet.in/publications/data/2009-07-01Sharma.pdf
149
In the case of food subsidies greater decentralisation can lead to efficiencies in
carrying and transportation costs, and delivery and targeting mechanism. A
well-designed two tier intervention can increase efficiencies and reduce
subsidies to the public distribution system, while providing for the food needs
of the BPL population better. Subsidisation of food, targeted towards the BPL
population, as a policy objective should be delinked from that of support
provided to agriculture. These objectives should be addressed through separate
policy instruments.186
Improving the quality of publicly provided services is crucial to persuading
users to pay higher charges. At the same time unit costs need to be reduced to
ensure full cost recovery, wherever desirable, and viable. Surplus employment
and other operational inefficiencies must be reduced.
Subsidy reforms must focus on selected sectors in the first instance which
would yield maximum results. In particular, attention can be focused on food
and fertiliser subsidies at the central level, and agriculture, irrigation, power,
industries, and transport sectors at the state level.
Increase in input costs depends significantly on market conditions and is almost
continuous. Increase in user charges should be synchronized with this in terms
of automatic periodic revisions. Autonomous bodies that can look after the
186 See P. S. George, ‘Costs and Benefits of Food Subsidies in India’ at http://www.ifpri.org/sites/default/files/pubs/pubs/books/ppa88/ppa88ch16.pdf
150
interests of the users as well as service providers are needed to constantly
monitor the link between cost escalation and user charges.
The most alarming aspect of the surging subsidies is not the size, but the
manner and purpose of spending on them. Subsidies provided in India187
suffer
from both inclusion error (wrong kind of people benefiting) and exclusion error
(deserving people left out of subsidies). Efficient subsidies must be transparent,
targeted and-in any case should be for a limited period.
It is clear from this document that the issue is not about removing subsidies but
about how to make them effective so that they reach the target consumers and
people are benefited from it. The policy- makers should try out new-
mechanisms to reach the target consumers more effectively.
The Government has to work on arriving at a political and national consensus
on the subsidy issue. It is important that we restructure subsidies so that only
the really needy and the poor benefit from them and all leakages are plugged.
All subsidies should be targeted sharply at the poor and the truly needy like
small and marginal farmers, farm labour and urban poor.
187 D. K. Srivastava, C. Bhujanga Rao, Pinaki Chakraborty & T. S. Rangamannar, ‘Budgetary Subsidies in India: Subsidising Social and Economic Services’ National Institute of Public Finance and Policy, March 2003 at http://planningcommission.nic.in/reports/sereport/ser/stdy_bgdsubs.pdf
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Reforms can only be made in the subsidy system when the policy- makers,
politicians and economists will understand that the question is not whether to
subsidise or not, but who to subsidize and how.
It may be important to look at the following measures for effective utilization of
subsidies:
1. The focus should be on physical achievements and not on
financial disbursements.
2. The effects of subsidies should be monitorable and measurable in
terms of quality or quantity.
3. Subsidies should be given as a one-time help or for a short
period. Subsidies on continuing basis should be avoided.
4. The parameters fixed on subsidy should be transparent.
5. Subsidies should be cost- effective. Most of the assistance should
reach the intended beneficiary and very small amount should be
spent on administrative arrangements.
6. Subsidies should be properly targeted, i.e. benefit should go to
the really deserving.
7. Timing of subsidies should be made proper. For example, free
seed distribution should be just before sowing.
The first corrective steps were taken by the 12th Finance Commission headed
by Dr. C. Rangarajan. This Commission made a large number of
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recommendations for keeping the revenue and the fiscal deficits both of Central
and State Governments under control. They recommended a legislative frame
work for the fiscal responsibility. They fixed certain targets for reducing the
revenue and the fiscal deficits in a phased manner. This has indeed contributed
in a large way during the last five years, during which period, most of the States
have been able to abide by the targets set in the Fiscal Responsibility and
Budget Management (FRBM) Act, 2003.188
It may be seen from the RBI’s State Finances report for the year 2008-09 that
the gross fiscal deficit of all the States together which was 4.2%, 4.6%, 4.2%,
4.1%, 4.4% respectively for the years 1999-2000, 2000-01, 2001-02, 2002-03
and 2003-04 has come down to 3.4% for 2004-05 and to 2.5% for 2005-06,
1.9% for 2006-07 and 2.1% for 2008-09. Similarly the revenue deficit which
was as high as 2.8% for the year 1999-2000 has come down to (-)0.5% , which
in fact means a revenue surplus. This is a phenomenal success. As a result,
various State Governments have been able to step up the much desired Plan and
Capital Expenditure giving momentum to virtuous cycle of economic growth.
Still the main issues, viz., transparency and proper targeting of beneficiaries
continue to dominate the debate.
It is not as if the problem of subsidies exists in only poor and developing
countries. It is much more in developed countries like the US and European
Union.
188 For the text of the legislation see http://www.finmin.nic.in/law/frbmAct2003.pdf
153
With the emergence of World Trade Organization removing the trade barriers
between countries, the subject of subsidies – both internal and external – has
once again become contentious between the developing and developed
countries particularly in regard to the agricultural subsidies.
The sector-wise subsidies given in the State of Andhra Pradesh are given in the
statement at Table-1 (Annexure-A).
The statement clearly indicates that during the last 5 years, commencing from
2006-2007, the component of subsidies vis-à-vis budget allocations vary from
25.46% in 2006-2007 to 38.40% in 2010-2011. The maximum subsidy, in
terms of amount, relates to the following sectors during 2010-2011.
i) Power ..Rs.4,500 crore
ii) Rice & Essential commodities ..Rs.3,000 crore
iii) Agricultural input & related activities ..Rs. 447 crore
iv) Imputed subsidies to DCU Departments ..Rs.8,149 crore
Departmental Commercial Undertakings
The Departmental Commercial Undertakings (DCUs) are incorporated
enterprises owned, controlled and run directly by the public authorities. These
undertakings normally do not hold or manage financial assets and liabilities
apart from their working balances and business accounts payables and
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receivables. These undertakings charge for the goods and services they provide
on commercial basis.
Imputed Subsidies
Operating losses of Departmental Enterprises in electricity, manufacturing,
transport, etc. with the exception of irrigation, were treated as negative
operating surplus. The Departmental Enterprises incur losses as a result of
government policies on pricing of the final products. Such losses due to
charging non-market prices for the products have been treated as imputed
subsidies.
4.3 Andhra Pradesh Government Subsidies
Till the 1980s, both the Central and State Governments have managed their
finances well within their means. There was hardly any revenue deficit as
percentage of the GDP / GSDP. Consequently, even the fiscal deficits were well
within the accepted limits. The menace of increasing revenue deficits
particularly as a result of ever growing subsidies as part of non-plan
expenditure has been seen particularly post 1990s.
For instance, in case of Andhra Pradesh, the State had a cumulative revenue
surplus of Rs.128 crores for a period of 38 years ending on 31-03-1994. As a
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result, the State invested the borrowings together with its revenue surplus in the
long term assets that have the potential for generating revenues and
employment leading to an asset liability ratio of 101:100 as on 31-03-1994.
This was a healthy position by any reckoning.
As against that, for the 10 years period 1994-2004, the State suffered a huge
revenue deficit of Rs.22,000 crores which necessitated diverting the borrowings
meant for creation of long term assets for meeting the revenue expenditure; so
much so that, the asset liability ratio as on 31-03-2004 fell precariously to
63:100. The Government had to enact Fiscal Responsibility and Budget
Management (FRBM) Act, 2003 by imposing upon itself the responsibility of
bringing down the share of revenue deficit to GSDP to 3% by the year 2008-09.
If subsidies which are in the revenue nature go on increasing both in absolute
terms and as percentage of the revenues and GDP, the country has to postpone
important expenditure on creation of infrastructure and assets that have the
potential for creation of employment and revenues. The country will inevitably
get into a vicious cycle of economic activity and not the much needed virtuous
cycle of economic growth. And this is the surest way of keeping any country
for ever poor and underdeveloped. We therefore, have to make a balance
between welfare and development.
We take the case of AP Government which had to address these issues on a
priority basis, given the negative asset / liability ratio. The main priority was to
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reduce the revenue deficit and if possible eliminate the same completely even
before the due date mandated in the FRBM Act. This naturally means an
increase in the Plan expenditure and an increase in the Capital expenditure.
Following are the excerpts from the Budget speech of the Hon’ble Finance
Minister of Andhra Pradesh delivered in 2009 to the State Legislature189
:
‘One of the greatest achievements of our Government is to restore the fiscal
health of the State, which was in a very poor state in the year 2004. The State
had a cumulative revenue surplus of Rs.128 crore for the 38 years period
ending on 31-3-1994. As against that, most unfortunately, the State ended up
with a cumulative revenue deficit of over Rs.22, 000 crore in the 10 years
period of 1994-2004. Most of the moneys borrowed went towards meeting the
revenue deficits and not for capital asset creation during that decade. Members
will be happy to note that the State has met the targets set in the AP FRBM Act
2005 in respect of Fiscal Deficit and Revenue Surplus well in advance.
The State earned revenue surplus for the year 2006-07 and 2007-08, while
suffering only a marginal revenue deficit of Rs.64.11 crore for the year 2005-
06. With the result, the capital expenditure as percentage of fiscal deficit for the
period 2004-08 increased to 150% as against 45% during the period 1994-
2004. Members will be happy to note that the State Government could carry on
its fiscal management without having to resort to ways and means advances or
189 http://budget.ap.gov.in/
157
the overdraft facility even once during the last five years which was a matter of
routine during the previous regime.
As per the latest report of RBI on State finances for the year 2008-09, AP stood
first in the country in respect of its allocation on plan expenditure, development
expenditure, social sector expenditure and capital expenditure. As per that
report, AP’s social sector allocation is Rs.38,544 crore for the year 2008-09, as
against the actual expenditure of Rs.13,267 crore for the year 2003-04. Even
for the year 2007-08, AP stood first in respect of per capita expenditure on all
the above sectors as against States with more than three crore of population.
Members will be happy to note that for the third consecutive year, AP’s Plan
Expenditure has been highest for any State in the country in absolute terms. The
total Plan Expenditure in the State has gone up from Rs.10,759 crores in 2003-
04 to Rs.36,184 crores in 2008-09 and the budget for the next fiscal is
Rs.38,477 crores. Similarly, the capital expenditure has gone up from Rs.3,804
crores in 2003-04 to Rs.17,359 crores in 2008-09 and the budget for the next
fiscal is Rs.18,236 crores.”
Andhra Pradesh could provide subsidies without increasing the tax rates or
power tariff for any class of consumers for a full period of five years. This
could happen because the revenues grew at much higher pace than the national
level for the five years period 2004-09 because of increased economic
buoyancy.
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It is interesting to note that the Government of AP has implemented many
welfare programmes in an unprecedented manner during the five years period
2004-09. 190
Some of the important schemes are – (i) an additional 55 lakh pensions were
sanctioned to the old-aged, destitute, physically challenged etc., (ii) two rupees
a kg rice scheme has been extended to cover about 80% of the State’s
population, (iii) for the first time, in any State in the country, Rajiv Arogyasri
scheme has been implemented, meeting hospitalization expenditure upto rupees
two lakhs per family per annum covering about 80% of the State’s population,
(iv) about 40 lakh weaker section houses were constructed during 2004-09, (v)
free education at all levels for the children of parents whose annual income is
below Rs.1 lakh per annum, (vi) the Government has been providing free power
to farmers – 1600 crore units of power per annum, in addition to subsidizing
interest on crop loans and (vii) loans to women SHGs so as to enable the
beneficiaries to pay only 3% interest per annum.191
The Government could do this and still earn revenue surplus. The US-based
CATO Institute in association with Indicus Analytics and the Friedrich
Naumann Foundation recently published the rankings in terms of Economic
Freedom Index of Indian States. Mr. Swaminathan Ankilesaria Iyer, a
renowned economist and a former World Bank advisor, summarizing the
190 See generally http://www.aponline.gov.in/apportal/HomePageLinks/schemes.htm 191 http://siadipp.nic.in/state/ind_policy_ap.htm
159
Report, in his article entitled ‘Exemplary Andhra’ published in Financial
Express dated 19th March, 2011 wrote192
:
“Between 2005 and 2009, Andhra Pradesh and Gujarat were the two
states that registered the biggest improvements in economic freedom,
with their overall scores going up by 0.11 points each. Andhra
Pradesh’s score went up from 0.40 to 0.51, which is proportionately
faster than Gujarat’s move from 0.46 to 0.57. In overall state rankings,
Andhra Pradesh moved up from 7th position in 2005 to 3rd position in
2009.”
This improvement in economic freedom and business climate has helped almost
double the state’s growth rate. In the Ninth Five Year Plan period (1997-98 to
2001-02) the state had an average annual Gross State Domestic product (GSDP)
growth of 5.59%. But in the last five years for which data is available (2004-05
to 2008-09), GSDP growth accelerated to an average of 9.07% per year. The
state was an outperformer, consistently growing faster than India as a whole,
save in the drought of 2008-09.
The indicators relating to the size of the state show encouraging progress. The
ratio of GSDP to the revenue expenditure of the government (excluding capital
spending) shot up from 3.4 in 2005 to 7.93 in 2009. In other words, GSDP rose
more than twice as fast as government spending on administrative matters,
including subsidies and employment schemes. But this did not mean at all that
192 http://www.financialexpress.com/news/exemplary-andhra/764484/
160
government spending was muted. On the contrary, there was a veritable
spending boom.
This spending boom focused on irrigation and infrastructure, aiming to improve
conditions for farmers and businessmen. In this, the approach succeeded rather
well. Agricultural growth averaged 6.82% per year in 2004-09, more than
double the all-India average of 3.26%. And industrial growth in the state
averaged 10.75%, against the national average of 8.70%. While the government
grew bigger, the state economy grew still bigger, so the relative size of
government declined.”
This clearly establishes the fact that the State did not resort to increasing taxes.
So, as long as the Governments are able to manage the fiscal position according
to the accepted norms and within their means, there is nothing wrong in
implementing a plethora of welfare measures. It is however very important to
note that in no case Governments can afford to make their citizens depend on
them for bare necessities in a long run.
After all, good governance should lead to helping citizens help themselves for
as long a period as it is required. Needless to say, the Government has to create
opportunities and remove inequalities so that people can find gainful
employment to support themselves.
161
The analysis of AP Governments economic policies shows that the government
has supported development in the form of subsidies and welfare programs. The
role of Intellectual Property for sustainable economic development has been
well documented in addition to increasing importance of IP in global trade. GIs
being an important Intellectual Property tool and a collective private right
however has not seen rapid protection since the ownership lies with a group of
people rather than being individually vested upon. Therefore GIs makes an apt
case for support from the Government in order that it gains prominence and
provides for sustainable economic development.
However any subsidies which might be given to GIs should be well designed,
transparent and focused. Enough consideration should be given to the type of
subsidies considering the nature and scope of GI. The type of subsidy should
also be based on the consumption or protection pattern of the concerned GI.
The benefits of permanent subsidies which are usually not in the interest of the
state vis-à-vis short term and medium subsidies with a provision for review of
the effectiveness of the subsidy should be evaluated before implementation.