MINISTRY OF FINANCE

GOVERNMENT OF INDIA

Subsidies & Universal Basic Income

Module 7
Contemporary Themes in India’s
Economic Development and the Economic Survey

Arvind Subramanian
Chief Economic Adviser
Overview
• Measurement of the impact of subsidies- important concepts

• Subsidies to well-off: Examples

o Gold
o Aviation Turbine Fuel

• Desirable vs Actual Subsidization/taxation for some commodities

• Benefit going to the non-target group

Subsidy: Micro-perspective

• Subsidy benefits producers and consumers

• But fiscal cost exceeds benefits

• Hence, subsidy creates a deadweight efficiency loss

Subsidy: Macro-perspective. Benefit for some but also a cost
to others. No free lunch

• If fiscal deficit (FD) unchanged

• Other social welfare spending must be cut and/or
• taxes must be raised

• If FD increases and financed by printing money

• inflation will rise , disproportionately affecting the poor

• If FD increases and financed by government borrowing

• future generations must bear the burden
 Major Central Government Budgetary
Subsidies
Subsidy magnitudes

• In addition:
• Central government provides implicit subsidies: For example, by taxing at concessional rates (gold)
• Central government provides off-balance sheet subsidies: recapitalizing banks
• State governments provide subsidies: power
Sizeable Explicit Subsidy
Subsidies—Fertilizer As
Case Study
Why Fertilizer?
• Micro-intervention is a macro-economic fiscal issue

• Micro-distortions: black market and leakages; over-use and impact on soil

and health.

• Bewildering complexity offers rich lessons in economics

• Fertilizer subsidy is not capped unlike food, kerosene or LPG subsidies

Subsidized Urea leads to overuse, distortions in
nutrient balance, affecting soil quality

Ideal NPK Ratio -> 4:2:1

India Average (2013) -> 8.2:3.2:1
Punjab (2013)-> 61.7:19.2:1
Muktsar District, Punjab: 136.3 cancer cases per 1 lakh population
Three kinds of Subsidies
Subsidy Regime

Type Magnitude/(Rate in %) Regime

Nitrogen (N, Urea) Rs. 49,768 crores (~206) Elaborate but fixed price, variable subsidy rate
Subsidy related to quantity of nutrient (NBS);
Phosporus (P)
Rs. 20,232 crores (41 and variable prices, fixed subsidy rate
68, respectively) Subsidy related to quantity of nutrient (NBS);
Potassium (K)
variable prices

• Important to note that the policy is not on the nutrient (which is

under NBS) but the product.

• So Urea had fixed price and DAP has fixed subsidy.

Analytics
Urea: an increase in world price is borne by P, K: price rises but per-unit subsidy remains
government as higher subsidies to importers constant: farmer bears cost of higher world prices
D S S
D S S
D S S’
D S S’
   

    High prices
S borne by
2 farmer
  S   Fixed
1 per unit
subsidy
Prices/subsidies matter: Farmers
respond perceptibly
NBS
policy
institute
d
Urea Regime: Five Interventions
• Setting a controlled/administered price for urea, that is the price at which
urea must be sold to farmers. This price is currently set at Rs. 5,360 per
metric tonne compared to imported cost of about Rs. 16,500 per tonne,

• Providing a subsidy to 30 (soon 37) domestic producers that is firm-specific

on a cost-plus basis;

• Providing a subsidy to importers of urea that is also consignment-specific;

• Canalizing imports, that is, only three agencies are allowed to import urea;

• Directing movement of fertiliser, that is, instructing manufacturers and

importers how much and where to sell their urea;
Leakages: Not Going to Small Farmers
• Leakage 1: Across borders and industrial uses (now addressed through
neem coating)

• Leakage 2: Inefficient producers: Difference between import price and cost of

production

• “Leakage 3”: Large farmers

• About one-third of total subsidy reaches small farmers

Leakage: Percent of Farmers Saying they
Pay Above MRP

100% 100% 100% 100% 100%

67%
63% 62%

51%
48%
38%
32%
24%
20%
17%
15%
Perverse domestic subsidies in urea: Higher the
production cost, greater subsidy
Not an Employment-Intensive Industry
“Lost” Subsidies
Reform
• Eliminate just producer inefficiency

• Rationalize prices like in petroleum and diesel

• Direct Benefit Transfers

Bounties/Subsidies for the well-off
Measuring impact of Subsidies
Equity (Benefit)
• How important is that commodity for the “target group”, say bottom 30-40 per
cent.

• Measured as expenditure on that commodity as a share of total expenditure for

the target households.

Leakage (Cost)
• What fraction of the subsidy goes to the “non-target” group.

• Measured as consumption of that particular commodity by the non-target group

(Rich/Well-off) in the total consumption.
Benefit-Cost ratio for selected commodities

.25
Electricity

.2 .15
Benefit
.1

LPG

Petrol
.05

Kerosene
Gold

Railways
Diesel Air fare
0

.6 .7 .8 .9 1
Cost

Note: The target group here is assumed as population in bottom 6 deciles (bottom 60 per cent of the population) and
non-target is the top 40 per cent population as per the NSS Consumer expenditure Survey 2011-12.
Implicit subsidies
• The subsidy is not always explicit, it can be implicit effective
subsidy which is the difference between the price that the non-
target group pays and what it should have paid (may be due to
lower tax rates on a commodity).

• Higher the Benefit-Cost ratio, higher is the case for

subsidization of the commodity.
Gold: Benefit goes only to the well-off
• Taxed at about 1-1.6 per cent (States and Centre
combined)
• Compare with effective indirect tax today of about 26 per
cent for normal goods.
  % share in gold Cumulative
Decile
consumption share
Top 1 63.4 63.4
  2 16.4 79.7
3 6.9 86.6
 
4 4.5 91.1
 
5 3.4 94.5
 
6 2.6 97.1
  7 1.3 98.4
   8 0.9 99.4
  9 0.4 99.8
Bottom 10 0.2 100.0
 Implicit subsidy on Aviation Turbine Fuel: Subsidizing those who travel by air

• The real consumers of ATF are those who travel by air, who
essentially are the well-off.

• There is ZERO expenditure on airfare from the bottom 30 per cent

of the population.

• However, the tax on petrol/diesel is much higher than the ATF,

which less affluent sections also consume somewhat. (32% excise
on petrol and diesel vs 14% on ATF)
Implicit subsidies in the form of foregone income tax: “Small” Savings

• Income tax exemptions are implicit subsidies

• By definition, these benefit the very very rich. Why?

• Economic Survey estimates that even the lowest slab of income tax-
payers fall in the top 5 percent of the income distribution

• In the case of small savings, the effective return to savers because

of tax exemptions substantial
 Desirable vs Actual Taxation or Subsidization

61
55

20

1.6

-10

-22
-38
-36

Note: Middle-class or non-target group for this exercise is defined as top 40% of the population and the target/poor group is the
bottom 60% of the population.
The subsidy on electricity is for rich.
The normative tax rates for normal commodities is assumed as 19% and petroleum products as 50% and for gold as 6%
 Benefits going to the non-target group
Category Implicit subsidy to “non-target” group
(in Rs crore)

LPG 28,219

Railways-1 (only A/C) 1,115

Aviation turbine fuel 762

Gold 10,800

Personal Income Tax Exemption 59928

5435
Fertilizer subsidy to large farmers

Total 106259
Source: Economic Survey 2016-17
• Non-target group is defined as top 40 per cent of population for LPG, ATF, Gold .
• Everyone getting exemption in case of Personal Income Tax Exemptions in 2015-16.
• Service Tax of 14% assumed as normative tax for railways. (Calculation based on 2014-15 tax rates)
• Large farmers are with a land size holding >=5 ha.
• The normative tax rates for normal commodities is assumed as 19% and petroleum products as 50% and for gold as 6%
Universal Basic Income
Overview
• What is UBI?

• Arguments in favour and against

• Why UBI in India?

• Fiscal Cost and Budget Space

Conversation With and Within The Mahatma
• “I will give you a talisman. Whenever you are in doubt, or when the self becomes too much with you,
apply the following test. Recall the face of the poorest and the weakest man [woman] whom you may
have seen, and ask yourself, if the step you contemplate is going to be of any use to him [her]. Will he
[she] gain anything by it? Will it restore him [her] to a control over his [her] own life and destiny? In
other words, will it lead to swaraj [freedom] for the hungry and spiritually starving millions? Then you will
find your doubts and your self melt away.” – Mahatma Gandhi

• “My ahimsa would not tolerate the idea of giving a free meal to a healthy person who has not worked
for it in some honest way, and if I had the power I would stop every Sadavarta where free meals are
given. It has degraded the nation and it has encouraged laziness, idleness, hypocrisy and even crime.
Such misplaced charity adds nothing to the wealth of the country, whether material or spiritual, and
gives a false sense of meritoriousness to the donor. How nice and wise it would be if the donor were to
open institutions where they would give meals under healthy, clean surroundings to men and women
who would work for them…only the rule should be: no labour, no meal.” – Mahatma Gandhi
What is UBI?
• Social security in which all citizens/residents receive unconditional sum of money

• A radical and compelling paradigm shift in thinking about social justice

• Key Ideas: Universality, Unconditional, and Agency

• A just society needs to guarantee each individual minimum income – Universality
• Should not be related to actions or behavior– Unconditionality
• Poor are treated as agents rather than subjects, therefore cash not kind – Agency
 International Experiment I [Oil Economies]

• Originally proposed for Nigeria and Iraq to address natural

resource curse

• Iran recently replaced oil subsidies with a direct cash transfer

International Experiment II [Advanced Economies]
On Going Pilot

• Motivation: Automation, Robotics

• Coverage: Universal (irrespective of wealth, income, employment

status)

• Beneficiaries: Adult Pension

Source: Futurism
International Experiment III [Low Income Countries]

Give Directly: Largest Basic Income experiment in Sub-Saharan

Africa

• Motivation: Poverty alleviation

• Coverage: Universal

• Target Group/ Beneficiaries : $30 million grant for 10-15 years

Arguments in favour and against
Favor Against
Poverty and vulnerability reduction Conspicuous spending

Poor treated as agents not subjects Moral hazard (reduction in labour supply)

Better targeting of poor Gender disparity induced by cash

Insurance against shocks Implementation Issues

Improvement in financial inclusion Fiscal cost given political economy of exit

Psychological benefits Political economy of universality – ideas

for self-exclusion
Administrative efficiency Exposure to market risks (cash vs. food)
 Problems with existing schemes I: Multiple Schemes

• Government runs hundreds of social welfare

Other Sub-schemes
schemes (940 Central Sector and Centrally
Sponsored Schemes as per Budget 2016-17) Mid-day Meal
Swachh Bharat
Abhiyan

• Top 11 welfare schemes alone account for more ICDS

than 50% of the total spending on CSS. Pradhan Mantri Gram
Sadak Yojana
National Health
Mission
• Most of the schemes are small in terms of
Pradhan Mantri Awas
allocation and are existing for decades. Yojana
LPG Subsidy
SSA
• Each scheme laden with huge ADMINISTRATIVE
COST and burden of running hundreds of welfare MGNREGA
schemes Urea Subsidy
Food Subsidy
 Problems with Existing Schemes II: Misallocation and Leakages

District wise share of overall poor Share of allocation

Leakages

Source: Well Done Abba; Youtube, Big

 How much will UBI cost ?
●
A quasi-universal UBI of RS. 650 per person per month (70% of the
population receiving the benefits), will cost 4-5 % of GDP

Poverty Rate (2011-12) (LHS)

Fiscal Cost (De Facto targeting, 2016-17)(RHS)

How much will UBI cost ?
●
Alternative Scenarios
●
(De jure universality, de facto quasi targeting)
●UBI for Women: half the cost

●Urban: one third the cost

●Vulnerable groups (widows, pregnant mothers, the old

and the infirm): less than 1% of GDP
Do we have Fiscal Space for UBI ? [Centre]
Implicit Middle Class “Subsidies” (percent of GDP) Total
LPG 0.21
Railways-1 (only A/C) 0.01
Railways-2 (Sleeper Class) 0.07
Aviation turbine fuel 0.01
Fertilizer (Urea) 0.04
Personal Income-tax Exemptions 0.44
Interest Subvention Scheme for farmers 0.1
Mudra (Interest Subsidy) 0.11
●
Current subsidies to Gold
SUB-TOTAL
0.08
1.05
middle class and Existing Social Sector Programmes/ Schemes (2014-15, percent of
GDP)
fertilizer etc. cost Total Subsidy
-Fertilizer
2.07
0.57
about 2-3 per cent of -Petroleum
-Food
0.48
0.94
GDP Schemes (Central Sector and Centrally Sponsored) 3.7
-Top ten Schemes 1.38
Education 0.49
Medical, Public Health, Sanitation 0.1
Family Welfare 0.13
Grants to State and UTs 0.62
Pensions 0.75
Police 0.38
Defence 1.1
Interest Payments 3.22
Resource Misallocation Across Districts
Do we have Fiscal Space for UBI ? [States]
The Funding

The Promise: 1 lakh per family per household

18%
Beneficiary Individuals 20 lakhs Center
UBI Amount (per individual per year) Rs.20,000 State

UBI Amount (per family per year) Rs.1,00,000

82%
Total Cost (per year) Rs.4,000 crore
Cost as % of SGDP (2016-17) 3.0%

(Rs. crore) Center State

Welfare Schemes 884 1116

Subsidy 3908
Nutrition
Spending 272 210

Other Schemes 203

UBI Anxieties
• India slowly building a safety net in the form of PDS, MNREGS
etc. UBI might undermine it

• UBI will expose the poor to market risks associated with food,
kerosene etc.

• UBI might reduce pressures on state to provide essential

services such as health and education
Prerequisites: Jan Dhan and Aadhar Penetration
Success of UBI is crucially dependent on a well-functioning JAM (Jan Dhan, Aadhar and
Mobile) system as it ensures that the cash transfer goes directly into the account of a beneficiary

Current Status of Jan-Dhan penetration in India

Ripe to Implement ?
• Supported by both ends of ideological spectrum

• Should not be an add-on to the existing government programs

• Universality but political expediency and fiscal constraints might

require de jure universality to yield to de facto quasi-universality

• Powerful idea: time even if not ripe for implementation is ripe for
serious discussion
Releasing Cognitive Burden
• Impact of Give Directly experiment in Kenya (Household Response to
Income Changes: Haushofer, Shapiro)
• Beneficiary households reported a 0.2 standard deviation (sd) increase on
psychological well-being*
• 0.16 sd higher for female recipients

• “…one senses a reluctance of poor people to commit themselves

psychologically to a project of making more money” – Economic Lives
of the poor, Abhijit Banerjee and Esther Duflo
Releasing Cognitive Burden

“We try so many things but

the world does not move in
our favour”

An Annawadi girl, ‘Behind the Beautiful Forevers’

Katherine Boo
Recommended Readings & Sources
• Chapter 9, Economic Survey, 2016-17
• Futurism UBI Blog
• Chapter 6, Economic Survey, 2015-16
• Economic Lives of Poor: Abhijit Banerjee and Esther Duflo
• The Impact of Unconditional Cash Transfers in Kenya: Jeremy Shapiro,
Johannes Haushofer
• Behind the Beautiful Forevers : Katherine Boo:
• Chapter 9, Economic Survey, 2015-16