From UPSC perspective, the following things are important :
Prelims level : Positive externalities
Mains level : Paper 3- What commodities should be distributed for free or subsidised level
The newly elected Punjab government’s announcement of providing up to 300 units of free power to every household has raised questions: What constitutes “freebies”?
Two categories for providing support
- In India government provides two types of support.
- 1] support to low-income households for augmenting their consumption of selected goods and services.
- 2] Government also provides incentives to support selected categories of investors and producers.
- Different objectives: The economic objectives in these two categories are quite different.
- The first category would include the free or subsidised provision of foodgrains and services such as health and education.
- Examples of the second group include the central government’s recent initiative for production-linked incentives to various sectors and tax concessions.
- In the past, incentives in the form of reduction of corporate taxes have been offered to promote investment in general, or in certain regions such as backward areas.
What commodities should be distributed free?
- The key question is to decide what commodities should be distributed free or at a subsidised level and what the level of subsidy should be.
- Essential goods: The provision of foodgrains at a heavily subsidised price to target groups has found general acceptance, particularly among political parties, even though there are some critics of the measure.
- The distribution of commodities which are considered “essential”, primarily foodgrains, faces no criticism.
- Merit goods: There is also a category of goods which are called “merit” goods where significant positive externalities are associated with their consumption — for instance, health and education-related provisions, including mid-day meals and breakfast.
- In such cases, subsidisation is justified: If only market prices prevail, the community will consume less than what is socially desirable.
What should be the suitable mode of providing support?
- The question of a suitable model for providing budgetary support arises in the context of both consumption and production-supporting initiatives.
- 1] In the first case, budgetary support to a targeted segment of the population for augmenting their consumption of essential items may be provided either through direct income support or by a free or highly subsidised provision.
- Procurement set up and distribution system: When the provision of subsidised goods is involved, there may, in general, be a requirement of a procurement set-up and a public distribution system.
- Managing procurement and distribution by government agencies involves additional costs which tend to be higher than the corresponding supply through the market because of leakages and avoidable administrative costs.
- 2] Production-related incentives: In the case of production-related incentives, alternative methods include direct budgetary support and indirect support through tax concessions.
- Both have a differential impact.
- These schemes also require to be carefully designed to avoid their misuse and minimise their costs. The provision of free power to farmers was often misused.
- In the case of tax concessions, there have not been any convincing studies as to whether the stated initial objectives were achieved in line with the large budgetary costs.
- The magnitudes involved amounted to 1.9 per cent and 2.5 per cent of the GDP in 2018-19 and 2019-20 respectively.
What should be a prudent fiscal limit for funding such programmes?
- Let us consider the case of distribution of commodities that are meant to support consumption.
- Limited budgetary resources: This question should be considered in light of our limited budgetary resources.
- Stagnating revenue to GDP ratio: In India, the revenue to GDP ratio has been stagnating over a long period of time.
- During 2010-11 to 2019-20, combined revenue receipts of central and state governments, relative to GDP, have languished in the narrow range of 18.4 per cent to 20.3 per cent.
- In contrast, in many developed and emerging market economies, this ratio tends to be much higher.
- In 2019, these ratios were 36 per cent and 30.1 per cent for the UK and USA.
- It is advisable to limit the distribution of commodities and services at highly subsidised levels to essential and merit goods.
- Infrastructure expansion: Production may be incentivised more effectively by other methods such as infrastructure expansion.
- Determining the total quantum of support: In respect of production-related incentives also, greater care is required for determining the total quantum of support as well as the specific forms of such support.
- Limit of 10 %: It would be prudent to limit overall fiscal support for the distribution of commodities to less than 10 per cent of the total expenditure of the central government and state governments until their revenue GDP or GSDP ratios are successfully increased in a sustained way.
Governments that do not pay adequate attention to the strength of their fisc eventually become exposed to the cost of the choices that they make.
Back2Basics: Merit goods
- Merit goods are the goods that are provided generally by the government to certain sections of the society.
- Unlike in the case of pure public goods, the merit goods are not provided to the entire society; rather they are given to certain targeted people.
- The government here believe that the deserving people may under-consume such goods and hence provides these to them at low cost or no cost.
- A positive externality exists if the production and consumption of a good or service benefits a third party not directly involved in the market transaction.
- For example, education directly benefits the individual and also provides benefits to society as a whole through the provision of more informed and productive citizens.