How the government will keep its entitlement commitments

You won’t like any of them

No one really knows how much the Food Security Bill (or Act, if it becomes law) will cost the exchequer. Given the way the legislation is framed, it is impossible to make an accurate assessment of its costs. That doesn’t mean we are short of proponents who argue that it should be (or, worse, normatively must be) affordable. We also have a few opponents who argue that it’s more expensive that what the proponents suggest. We’re talking about numbers whose order of magnitude is in the range of single-digit percentages of GDP.

The scheme is open-ended: there’s no expiry date, no sunset clause. It covers around two-thirds of the population—even those who are not really needy. This means that the outlays will have to increase as the population grows.

Obviously, finding the money to keep this scheme going year after year will be a big problem. There’s worse news though—this programme is over and above other open-ended spending commitments like the NREGA, fuel and fertiliser subsidies which are in the vicinity of 2%-3% of GDP. These are the explicit subsidies. We will not even attempt to calculate the implicit subsidies and opportunity costs in this post.

Many of these schemes work such that the subsidy load will increase when growth slows down. In other words, at such times, subsidies as a fraction of GDP will increase—tightening the government’s budget constraints and reducing its fiscal space.

The nature of these schemes is such that governments will be scared to cut them during times of distress, forget ending them altogether. So how will the Indian government finance the gargantuan entitlement economy and what might be the consequences?

First, through new and higher taxes. This has already happened. Didn’t you notice the ‘education cess’? Didn’t you notice the higher marginal taxes on high income earners? Expect more of the ‘Good Cause Cesses/Surcharges’, a fiscal sleight of hand to raise new taxes by citing a plausible good cause. (See this post on education cess for more). As the economic and fiscal situation gets worse, expect higher tax rates lower down the income pyramid. Corporate profits are also an easy target—so they too will be taxed in increasingly creative and extortionary ways.

The consequence of higher taxes are lower investments and higher tax evasion. Lower investment means lower growth. Higher taxes when you are already in a low growth phase is a recipe to stay in the low growth phase longer than otherwise.

The second way for the government to raise resources is through borrowing. It can borrow money abroad (and incur foreign debt) and borrow money from the domestic market. The former puts the Indian government at the mercy of its foreign lenders to the extent of its borrowings. If you do not recall the days of the 1960s-80s, when India was mired in foreign debt, ask someone who does.

The Indian government can borrow from Indian citizens and corporates through the bond market and other instruments (a new -Vikas Patra can be invented quite easily). While it transfers money into the government’s budget, it crowds out the private sector. Interest rates will rise because of the large government demand for funds, making it harder for entrepreneurs and businesses to raise funds to expand their economic activity. This too puts the brakes on economic growth. Higher interest rates during an economic slowdown will prolong it.

The third way for the government to raise resources is to get the Reserve Bank of India to print more money. This has the effect of increasing inflation and depreciating the value of the rupee vis-a-vis other currencies. Higher inflation makes people poorer. It makes poorer people even more poorer (because they do not own assets like real estate, shares or foreign exchange that can weather inflation). A drop in the value of the rupee will make it tougher to service foreign debt, both for the government and for private firms. If the rise in exports on the account of a cheaper currency does not outpace the higher cost of imports, the current account deficit will grow. It could even result in a balance of payments crisis, like the one seen in 1991.

The fourth way is what is termed an “austerity drive”—for the government to cut expenses. Because politics will not allow cutting back on salaries, pensions, subsidies and entitlements, the government will cut two things: office expenses and capital expenditure. So you’ll probably get to see ministers photographed coming to work on bicycles and civil servants working without air-conditioning. Other than schadenfreude, these measures achieve nothing substantial. Cutting down on capital expenditure—roads, power plants, defence equipment—does create fiscal space, but at the cost of future growth.

Where does this leave us? Well, at the edge of a vicious cycle of low growth, high inflation, low investment, higher unemployment, higher taxes, greater evasion and higher out-migration of talented individuals and firms. We’ve been there before. It’s unconscionable that we are being taken there again.

The only way to avoid this vicious cycle is to suspend entitlements and rekindle growth. It is unlikely that growth can be rekindled without sustained pro-growth measures: greater liberalisation, simpler taxation and coherent economic governance. The Delhi Straitjacket must be dismantled.

Related: INI9 Conversation with V Anantha Nageswaran on the falling Indian Rupee.

9 thoughts on “How the government will keep its entitlement commitments”

  1. FSB is disastrous- and this article hasn’t even talked about the various scams that will be in the making thanks to our leaky PDS (remember that PDS scam in UP?)- plus the fact that all these freebies would still not reach where they are needed the most- the most destitute, marginalized and poorly fed people, living in the most inaccessible, remote and underdeveloped areas.
    Further, I fail to comprehend that when the govt is already promising gauranteed employment to everyone in the country, what should the reason to top it all by FSB as well?

  2. It is clear that this govt does not expect to be reelected.What will be the choices before new incumbent,other than the ones discussed by you? Eg

    1.Downsize govt,sell off PSUs,Govt lands,Govt assets like centrally located jails,circuit houses,other govt offices…
    2.Downsize Governors’ & President’s offices and auction off Rajbhavans and Rashtrapati bhavan[yes] to highest bidders [ with no questions asked for source of income]
    3.Bring back black money stashed in foreign banks
    4.Catch HNIs among politicos and babus having assets above 100 crores.Reach out of court settlements with them @ 50 -50 or there about ask babus to quit w/o pensions etc

  3. Nitin,
    Can you please seek out an expert supporting the Food-Security-Bill(FSB)? Can you run a debate-series with the pro-FSB person in your blog? The reply-counter-reply should continue till you two end in fact-disagreement or philosophical-disagreement. In case one person can convince the other, that will be great (but not necessary) for the conclusion of the debate.

    I ask because there is no platform which is conducting a reasonable debate about the issue. Print media is not running anything on these lines. TV-media is incapable of any kind of prolonged reasonable debate.

    I am a layman who is more than curious about FSB. I see stalwarts/experts on both side of the bill. Hence a debate (ideally written debate) will be very helpful to me.

    I am currently anti-FSB. All the blogs I follow are anti-FSB too. Sometimes I get the uncomfortable feeling of being in an echo chamber. I cannot find a single reasonable and detailed pro-FSB article.

  4. “The Delhi Straitjacket must be dismantled” you conclude.

    Haven’t you got the spelling of “Sultanate” wrong?

  5. Now let me put this way through quote ” An idea that is put into action/use is more important than an idea that exists as an idea ” author unknown this for me is my training in very specialized subjects about cynics and non believers is in itself my specialized training experiences,and education what not you all name it so the end conclusion about specialized education and skills are nothing but like smart phone in the hands of a farmer he takes no time to operate and enjoy all apps to systems are like technology or an invention can be shared like smart phone keeping all troubles of seriousness of environment and our future food bill taken care through technology licensing to 197 countries for a price that ultimately give every advantage to have our agri produce more to have cold storage for the farmers as min sharad pawar said rs 44 th crores are lost every year not having storage spaces are added serious issues with taking all stake holders skilled and the unskilled never before they got job to play in the economy of India now have these untapped pool of huge population man power to increase food produce and the cost of year after year as many cynics worry through innovation are few points I spoken to few and talking here to get to those people let this or that work thanks

  6. knowledge of special idea is do an education and specialized education for all and every from the highr education institution and the universities as well iim’s and so on no education is worthy to part to our own indian students if future is changed from manufacturing to few having global business and the same destorying through insensitive greed I would say strongly they neither comply laws of the land nor any other dared to invent as environment and cost of food worry if any all questioning now have your home work on hand Now you if ask questions about India Wasting through food bill you are selfish no use for India If you think alternative keeping this food bill gets its success and wait for technology to help to compensate the cost of Rs 1.2 trillion only seen by all cynics the cost recovered rather than getting spoiled at every storage spaces not gone well among doubters then some price get recoered through subsidi then humanity side you all lost in this bill real issue through how worst cynics living in India Who question but never take responsiblities with govt and for poors but want DIL MANGE MORE GENERATION YOU PLEASE GIVE WAY FOR BETTER INDIA BETTER HEALTHY INDIAN INDIA TO EMERGE
    THANKS 3.54,SAT13

  7. If 70% in India are poor and the same 70% vote why wont the govt spend all our money trying to please that 70% to get elected? Pleasing the poor voter is going to be the norm in future, the economy be damned !
    In this same environment of a falling economy why are real estate prices relatively stable? Arent real estate prices a clear indication of the corruption in the economy?

    Here are reasons why India needs a Real Estate Exchange
    Corruption is one of the biggest problems India faces today. Fake projects, siphoning out of money meant for roads, hospitals, electricity, environment… the list goes on and on. Corruption takes money out of the mouths of the poorest of the poor. Only 7% of Indian students graduate high school !
    But where does this loot from corruption go? Into real estate, gold and into Swiss Banks.
    This is why the real estate market refuses to crash. The money from corruption fuels this market while the economy flounders.
    So India needs to digitize all land records and start a Real Estate Exchange. This will make sure all money entering the Real Estate market is accounted for. This will also help stop the rampant land grabbing and land encroachment done by politicians. Especially farmland.
    Much of Farmland is owned by politicians who show huge profits in farming to convert their ill gotten wealth into so called ‘white’ money. A tax on agricultural income is long overdue. This along with a pan card being required for all gold transactions would help clean up our ‘black’ economy.
    But a Real Estate Exchange will not only clean up our ‘dirty money’ economy.
    In cities such as Ahmedabad and Mumbai and many many other cities, minorities cannot get a house in many localities. In Ahmedabad, Gujarat, there are entire areas designated for ‘hindus only’ where not a single muslim lives. This creates fertile grounds for riots. Riot after riot has occurred due to this ‘ghettoization’ of India.
    A Real Estate Exchange, by ensuring anonymous transactions, will ensure the mixing of population without regard to religion or caste and could help prevent future riots.
    In the age of our rupee weakening to Rs 65 to a Dollar, a Real Estate Exchange would bring in dollars from all over the world into our very fast growing Real Estate sector. This would help enormously in strengthening the rupee and start a movement to providing homes for all.


  8. There is one method of raising revenue that I guarantee that I am going to like – legalise and tax marijuana, gambling and prostitution. Face it, this will bring a hell of a lot of stuff outside the underworld and out in the open.

    But I’m certain that this is not on the radar of anyone.

    On a slightly less libertarian note, increasing the tax rate on land above a certain value is something that can be done. The yield on high value labour (a.k.a. income) is taxed at 33% and the yield on high value land is taxed at nowhere near that range.

  9. Sir, the net increase in fiscal deficit and subsidy bill due to FSB may be tolerable. But, what i worry about is Labour mobility and productivity and incentive to work. FSB combined with existing MNREGA shall destroy work ethic, labour mobility. Inflation will increase due to less supply of labour in cities and towns. Mechanisation shall have to be resorted to. Labour from poor states of India like Bihar, UP, Orissa, West Bengal, Andhra Pradesh shall not only stop migrating to oher states but also go back to their home states as MNREGA & FSB shall ensure comfortable living without work.
    Even workers shall not be available for farming which shall reduced food grains production . India shall again become huge importer of food grains.
    I shall be happiest to be reasoned that I am wrong in fearing the above scenario.
    Thanks and Regards,

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