Let us pause to think about ‘freebies’ versus incentives

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Context: Sri Lanka government cut taxes across the board and provided several free goods and services, as a result of which the economy collapsed and the heavily-indebted country has had no choice but to default on its commitments.

As a corollary, the issue of freebies given out by Indian states has come under the lens here.

How various states in India indulge in giving freebies and are they justified?

States like Tamil Nadu and Bihar are known for giving women sewing machines, saris and cycles, but they buy these from budget revenues, contributing to the sales of these industries.

  • It can be considered a boost for the supplier industry and not a wasteful expenditure, given the corresponding production.

Punjab has been criticized for giving free water and power that helps rich farmers. The contention is that only the rich have access to pump sets that are run free of cost to extract water.

  • Here also, it can be argued that wheat and rice prices would have been higher if those costs were borne. Therefore, this is an incentive to produce at a low cost. It is analogous to support-price driven procurement by the Centre, which is also aimed at farm income support.

A similar thing is being done for the industry under Production-Linked Incentive (PLI) scheme, which promise businesses around 5% of their turnover for meeting investment and sale. The difference is, therefore, in terminology. A ‘subsidy’ is looked down upon, while an ‘incentive’ is considered progressive.

NPAs and Farm loan waivers: When industry defaults and a non-performing asset (NPA) is created, the payout indirectly comes from bank funds, which includes deposits. With no NPAs, depositors could get better returns and borrowers could be charged lower rates, as NPA provisions and write-offs raise the cost of intermediation.

– Farm loan waivers involve payments made to lenders from state budgets.

Here too, one cannot accept one and reject the other, as both sectors work under risk and uncertainty.

Fertilizer subsidies also ensure that food prices are kept under some control.

Can states exceed their deficit limits arbitrarily?

It is said that states are habituated to giving freebies, be it in the form of loan waivers or free electricity, cycles, laptops, TV sets and so on.

But, as the Fiscal Responsibility and Budget Management (FRBM) rules are more binding on states, so they can’t borrow beyond their limits and any deviation has to be approved by the Centre and central bank.

Therefore, while states have flexibility on how they choose to spend their money, they cannot in ordinary conditions exceed their deficit ceilings.

Centre’s role in giving freebies

Most so-called freebies are given by the Centre rather than the states.

– For example, the PM Kisan scheme assures cash transfers to farmers and costs the exchequer about 65,000 crore. Can we really object to such outlays, given that Indian inequality remains so stark and has not been addressed by the much talked-about ‘trickle-down theory’ of growth?

Way forward

The classic principle of the greatest benefit to the most disadvantaged needs to be invoked for government expenditure.

It is true that states will have to handle their finances better and a line needs to be drawn on hand-outs. Ideally, a proportion of state expenditure should be earmarked for so-called freebies. This would ensure better overall utilization of resources.

But the term ‘freebies’ should also be defined better so as to distinguish cash transfers from ‘free gifts’, as the latter can act as a direct boost to supplier industries.

A fair assessment of these would serve India well.

Source: This post is based on the article “Let us pause to think about ‘freebies’ versus incentives” published in Livemint on 27th Apr 22.

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