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Mainstream, Vol XLVI No 31

Nervousness of the Government and Increasing Burden of Subsidies

Tuesday 22 July 2008, by Ruddar Datt


It is now really over a decade that a comprehensive paper on subsidies was presented by the National Institute of Public Finance and Policy (NIPFP) in 1997. The situation has changed drastically since then and there is a need to re-examine the issue. The main reasons are:

1. Implicit subsidies in various forms are growing both at the Central and State levels. Take, for instance, the large number of tax exemptions on Special Economic Zones (SEZs) granted by the government. They imply a big loss of tax revenues. Another instance is the role of the State governments in acquiring land for SEZs and passing on to industrial houses.

West Bengal, in its drive for industrialisation, agreed to the following subsidies on its Singur project to the Tatas. The land at Singur has been provided by the Government to the Tatas on a 90-year lease, with no downpayment. Secondly, for the first five years, Tatas will pay Rs 1 crore as rent and the yearly payment will increase by 25 per cent for each year interval of five years for the next 25 years. For the next 30 years, payment will increase by 33 per cent at a five-year interval and for the final 20 years, the rent would be Rs 20 crores per year. The West Bengal Government also agreed to provide a loan to the Tatas of Rs 200 crores at one per cent rate of interest while the VAT proceeds accruing from the sale of cars will be handed back to the Tatas against one per cent loan for the first 10-year period. But as against this, the total compensation to the farmers will be of the order of Rs 200 crores.

The question raised by the critics of the industrialisation paradigm of development is: are we following a policy of inclusive growth by taking away the livelihoods of farmers, sharecroppers and other associated persons dependent on land and on the other hand providing heavy subsidies of several kinds—land acquisition and development by the government on behalf of industry, subsidised power, generous tax holidays, financial support for purchase of equipment, sub-sidised credit and exemption of waiver from exports etc?

Similarly, the State governments have been providing free or highly subsidised electricity for agriculture which benefit mainly the rich farmers.

It has been estimated that various kinds of tax exemptions have resulted in revenue foregone to the tune of Rs 2,78,644 crores—a colossal sum indeed. The government has been praising the corporate sector for better tax compliance resulting in a sharp increase in corporation tax revenues, but facts, as they stand, reveal that although nationally, the corporation tax rate is 33 per cent, its effective rate is only 19 per cent. This sharp reduction in effective rate as against the prescribed rate of 33 per cent is the result of the plethora of exemptions granted to the corporate sector.

2. There is a need consider the legitimacy of other subsidies as well which fall in the category of non-merit subsidies.

3. In the case of petroleum subsidies, there is a tremendous change in the situation with respect to petroleum subsidy since the international price of crude petroleum has crossed $ 130 per barrel. If the government provides the subsidy fully to oil companies, then the subsidy amount is likely to reach 1.5 lakh crores this year. As a consequence, the fiscal deficit could be pushed up by an additional 3.2 per cent of the GDP. The government could partially salvage the situation by providing 50 per cent subsidy in the form of bonds and thus only the interest on bonds will be reflected in the Budget as a cost. But when the bonds mature at a future date, their redemption will exercise pressure on the fiscal deficit.

The situation in the case of the fertiliser subsidy is no better. The international price of fertilisers in four-to-five times the domestic price. The likely impact of the fertilisers subsidy is going to be of the order of Rs 80,000 crores as against the provision of Rs 31,000 crores in the 2008-09 Budget.

A similar situation prevails in the case of food subsidies. The international price of foodgrains has also risen sharply. On account of the shortage at home, India has decided to import one million tonne of foodgrains to subsidise it so that the weaker sections of society are provided foodgrains at subsidised rates. Thus, the foodgrains subsidy bill will be much higher than the provision in the 2008-09 Budget of the order of Rs 32,667 crores.

The Finance Minister made a provision of Rs 66,537 crores in the Budget for 2008-09—for food subsidy Rs 32,666 crores, for fertilisers Rs 30,986 crores and for petroleum for Rs 2885 crores. But both national and international factors are going to jeopardise these predictions. Even by issuing bonds to some public sector companies for petroleum subsidy, the country shall be only postponing a part of the burden for future years. Despite this, experts estimate that the total subsidy on food, fertilisers and petroleum products is likely to go up to four-to-five per cent of the GDP. The situation is, therefore, very grim.

But what are the policy options? Firstly, the government has no option but to accept the subsidy on petroleum imports. It can further increase the domestic price of petroleum products. Even if this is done, it will only reduce the burden of the government partially. The option of reducing petroleum imports is not available to the government in view of the expanding demand for petroleum due to the sharp increase in the growing demand and production for automobiles—motor cycles, three-wheelers and cars. Secondly, in case of food and fertilisers, the chances of charging the consumers more appear to be very bleak since the coalition government has to face the electorate in the general elections due in early 2009. Thirdly, the government has to take a decision about the large scale exemptions granted to industry so as to enhance its revenues. But in view of the commitment made on the SEZ projects, the government requires great amount of courage to slash down exemptions.

The only policy option available with the government is to present a comprehensive paper on all subsidies—at the Central as well as State levels, both implicit and explicit. It is quite possible that a national debate on the question of subsidies may result in throwing up a consensus on some short-term and some long-term options to reduce the mounting burden of subsidies. n

The author, a well known economist, is a Visiting Professor, Institute of Human Development, New Delhi.

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