Subsidy burden of states

Context: Comptroller and Auditor General urged states to make a proper accounting of subsidies, remove revenue deficits, reduce fiscal deficits and keep outstanding debt at an acceptable level. In this context, let us discuss the problems with the subsidy regime.

Subsidies & freebies

As per CAG, the state government’s expenditure on subsidies has grown at 12.9 per cent and 11.2 per cent during 2020-21 and 2021-22. 

 In the recent period, state governments have started delivering a portion of their subsidies in the form of freebies.  Though there is no precise definition of freebies, they are different from subsidies provided by the government on public/merit goods, such as the public distribution system, employment guarantee schemes, states’ support for education and health, and expenditure which brings economic benefits.

On the other hand, freebies like the provision of free electricity, free water, free public transportation, waiver of pending utility bills and farm loan waivers often undermine credit culture, and disincentivise work at the current wage rate leading to a drop in labour force participation.

Issues with Subsidies & freebies

  • Regressive: Some of the subsidies such as Electricity, Fertilisers, MSP etc. are universal in nature and are given to all households irrespective of their socio-economic status. Being universal in nature, such subsidies benefit the richer households more than the poor households and hence are considered to be regressive in nature.
  • Leakages & Corruption: Inclusion and Exclusion errors; Duplicate and Ghost Beneficiaries; Presence of Middlemen, Poor administrative efficiency etc. E.g., 46% leakage in PDS.
  • Subsidies create distortions and ultimately affect poor people: Farm subsidies like MSP encouraged the production of water-intensive crops like rice & wheat and prevented crop diversification. This ultimately resulted in the low-income growth of the farmers. 
  • Cross-subsidization: Subsidies/Freebies like low/free passenger fares or free electricity for the public result in cross-subsidization through commercial usage. This increases the cost of doing business and hence hinders the growth of a private investment.
  • Distorts credit culture: Freebies like Agricultural loan waivers hampers the credit culture among the public and may result in the accumulation of bad assets in the banking sector. 
  • Revenue deficit: Increasing investments on subsidies & freebies increase the Revenue expenditure and hence the Revenue deficit. This leaves little headroom for the governments to invest in capital expenditure. 

Hence, rationalising subsidies is important for state governments to reduce their debt burden in the long term. 

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