Targetting Subsidies

That subsidies suffer from a major targetting problem is widely acknowledged. The former Prime Minister of India, the late Mr Rajiv Gandhi famously said that only 15 paise of the rupee spend as subsidies actually reaches the intended beneficiary. A Planning Commission report bemoans that only Rs of the Rs 3.65 spent on food subsidy actually reaches the beneficiaries. It is also well acknowledged that a significant proportion of any subsidy is either skimmed away by those who are not eligible for the assistance or lost through rent seeking activities or frittered away in the bureaucratic maze.

A subsidy is intended to either boost consumption or to boost production, ie it should facilitate either an upward shift in the demand curve or a downward shift in the supply curve. It is introduced by the Government to take care of market failures. Classical economic theory teaches us that any subsidy should, to the extent possible, be directly delivered to the end user. Therefore for a service subsidised by way of lower prices, it is most efficient if the government directly pays the subsidy differential to the beneficiary, instead of artificially keeping the prices low.

These direct payments to the beneficiaries would reduce the massive market distortions that creep in by way of lower prices. These lower prices distort the market in more ways than one. It causes skewed consumption patterns (power, diesel, fertilizers), adulteration and fraudulent practices (kerosene), pilferage (PDS), unaccounted for consumption (water supply), and ineligible beneficiaries (housing). By transferring the subsidy directly as cash payments to the beneficiaries, wherever and to the extent possible, we are eliminating market distortion problems and reducing the problem to one of identification of the subsidy beneficiaries.

What are the major subsidies of the State and the Central Governments? The Public Distribution System, Welfare Pensions, input subsidies to farmers, procurement subsidies for agriculture commodities by way of Minimum Support Prices, subsidised rural and urban housing, subsidised urban civic services, public transport, self employment, kerosene and petroleum products.

Agriculture input subsidies and the Minimum Support Price on procurement are classic examples of wrongly directed subsidies, which not only suffers from huge leakages but distorts the market for agricultural commodities. It causes overuse of certain categories of fertilizers and under use of certain others, and similarly skewed production patterns among agricultural commodities. Instead if these price support and other subsidies can be delivered directly to the beneficiaries by way of direct payments, we can susbtantially reduce its ill-effects. In fact these direct payments in turn can be delivered to the farmer by bundling it with some other public service accessed by the farmer (by way of reduced cost on that public service). With the extensive use of kisan credit cards, we can even think of transferring payments directly to the farmers, as is done in the US.

What are the urban civic services, which can be better targetted by direct subsidy payments to the beneficiaries? Public taps are located in certain poor locations on the pretext that those people cannot afford the connection charges and the monthly tariffs. But these taps suffer from the problem associated with any common resource - overuse. A more economically efficient way of delivering this subsidy would be to identify the three or four houses in the locality requiring such support and providing them individual household connections. The connection charges can be lowered (there is more economic logic in even giving them connection without connection charges!) and the monthly tariffs can be subsidised and this subsidy amount can be delivered back to them through lower bi-annual property tax assessment. This will eliminate the problem of overuse and capture by ineligible beneficiaries. The same logic can be extended to other utility serices like electricity, sewerage etc.

As a corollary, we can collect different user charges through established revenue streams like Property Tax. Electricity charges are another well established revenue stream, which can be utilised for bundling other revenue streams. Though there is a provision of collecting user charges from bulk garbage producers like hotels, hospitals, vegetable shops, auditoriums, schools and colleges etc, it has proved very difficult to collect the same. Instead, the average user charges, quantified for different categories of generators, can be factored into the Property Tax of these bulk garbage generators. For those very big generators, who are smaller in number, we can continue to collect user charges based on the quantity.

Lower prices for diesel and kerosene distorts the market in more ways than one. Kerosene subsidy can be delivered directly to the consumer, by say again, lower property tax on the house or some other means. Diesel subsidy can be directly delivered to the vehicle owner by lower Motor Vehicle Tax or susbidising his vehicle loan repayments. The subsidy on public transport tickets can be delivered directly to say children, through say, lower school fees.

This arrangement of direct payments requires extensive monitoring mechanisms and database management. At a time when e-Governance infrastructure is developing rapidly, we ought to be initiating these interventions in such important process areas. This is not to claim we can do this everywhere. But wherever we can, we ought to be delivering subsidies through direct payments than by tinkering with the price mechanism. Indeed the first option for us to deliver subsidised services should be through direct payments. It will go a long way in eliminating, market distortion, pilferage and wastage, and free-riding on public resources.