Budget Ruminations: How To Disburse Subsidies

Recently, Prime Minister Modi made a telling point: taxpayers, he said, resent their hard income paid as tax being wasted on freebies, but are ready to pay even more tax,  if revenues are genuinely used for uplifting the poor.  Implicit in this statement are three important thoughts for fiscal reform for consideration of the finance minister in the run-up to the forthcoming Budget. 

The first of these takes me back to the freezing January morning of 1992, when Alan Lewis,  our professor at Bath university and an international authority on fiscal psychology, invited our attention to one of his studies.  Taxpayers the world over, he pointed out, demand all kinds of freebies from their governments- better hospitals, schools, unemployment allowances, old age pensions, etc. Their enthusiasm wanes considerably when they have to pay higher taxes to obtain these benefits. 

PM Modi appears to have emphasised this very point: Taxpayers who wrote to him were able to make the required fiscal connection between public revenues and public spending. They supported public spending only when it resulted in genuine welfare measures but did want politicians and bureaucrats to squander the state’s resources frivolously, especially on freebies designed to win brownie points with vote banks. 

But there lies the rub.  Although the statistics of the Income-tax department in our country show that the number of taxpayers on its rolls has now increased to more than 84 million, only 1.13 per cent of our population (about 15 million) actually pays tax. The rest get away by claiming deductions which reduce their incomes below the exemption limit. So one major challenge for the present government is to find ways to make more people make the fiscal connection between taxes and public spending. This is possible only if more people from the middle class begin to pay taxes.  A strong, well-informed public opinion emanating from such people may well restrain political parties in power from announcing vote-catching but unsustainable subsidies. 

Better quality public spending may also result if both Central and state governments were compelled to transparently transfer all benefits ( rather than just a few) to the bank accounts of the targeted beneficiaries. This is the second reform implicit in the P.M. statement. Direct transfer to bank accounts of the targeted beneficiaries is a far more efficient way of disbursal than income tax reliefs or grants that go to reduce the cost of consumption or production of goods.    This way government, taxpayers and society at large can know how much subsidy is being given to whom, for what purpose and at what cost. Government can also immediately know whether it can afford the subsidy or not.

The librarian of our university explained this reform to me. “We can if we like,” he said, “provide you free photocopying facilities, instead of charging ten pence per copy.  This price however helps us to cover our costs for providing you with this facility. When you pay a price you will make copies only of articles you really need. This prevents overuse of the machine; also, the service pays for itself. 

“When we want to help poor students, it is much better both for us as well as them to give them a monthly stipend. This way we don’t distort the price of any good or service, and they also learn to live within a budget.”

Following this one fundamental principle could have prevented many distortions in our economy. Farmers in Punjab and Haryana, for example, would not have been seen fighting for more remunerative minimum support prices. Nor would they grow paddy in unsuitable climatic conditions of Punjab and Haryana.

Finally, the PM also implied that nothing in life is free.  As significant as the direct cost of a benefit is its opportunity cost: the benefit lost when the same resources cannot be put to an alternative use. Subsidies, therefore, should never be based on populist considerations but on well-considered social cost-benefit analyses. 

( The writer was Chief Commissioner of Income-tax and is the author of the Moral Compass- Finding Balance and Purpose in an Imperfect World, Harper Collins India, 2022 )