Redistribution Economics | It will be tough to boost welfare spending without compromising on fiscal targets

Inequality and growth have been rather touchy topics lately. Empirical work in this area posits that greater equality can help sustain growth. This, in turn, is based on a loose consensus that inequality can undermine progress and reduce the pace and durability of growth. To be sure, there is also an opposite take. In his book Equality & Efficiency: The big Tradeoff  Arthur Okun focussed on the negative effect of redistributive policies and highlighted the trade-offs between efficiency and equity, and on  efficiency “leaks.”

In the case of India, the notion of a trade-off between redistribution and growth seems deeply embedded in policymakers’ consciousness and public discourse. Ever since Dr Arvind Subramanian proposed Universal Basic Income as a ‘’radical new vision’’ in the 2016-17 Economic Survey, there has been a rather dramatic shift not only in discourse but also in terms of acceptance from the political economy.

Both the ruling party and the opposition have proposed redistribution schemes to benefit sections of the poorest families. That is not all.  At least 8 states have now rolled out a quasi-UBI kind of income transfer schemes on the lines of the PM-KISAN scheme with Telangana being the first off the blocks with its Rythu Bandhu Scheme.

Note that these schemes are late entrants. India was one of the first countries to make an elaborate effort at redistribution. The central government alone runs about 950 central sector and centrally sponsored sub-schemes which cost about 5 percent of GDP. However, the most common and biggest gripe has been that it often leaves out the really deserving and needy.

Thus, the 2016-17 Economic Survey advocated that ‘’serious consideration be given to the new idea of a universal basic income as a more effective way of achieving Mahatma Gandhi’s objectives of ‘wiping every tear from every eye’.” It also averred that UBI is less likely to be prone to exclusion errors;  by directly transferring money to bank accounts, and circumventing multiple layers of bureaucracy, the scope for out-of-system leakages will be low.

The intent and policy drift are crystal-clear now. The key question then is how can India make room for large entitlement-based transfers? Will it mean a compromise on fiscal targets?

If the government sticks to fiscal targets, then there are only two options: Raise the tax-to GDP ratio or rejig expenditure. Party manifestoes offer little clarity on implementation. Some have even promised to lower tax rates while doing so!

A look at global experience shows that typically welfare expenditure is enhanced when the tax- to-GDP ratio is at least 20 percent.. However, India has embarked on such expenditure at much lower levels of tax revenue (approximately 17 percent of GDP if one combines centre and state revenues).

India’s ‘’core’’ tax revenues (i.e. excluding non-debt capital receipts such as divestments) have largely remained stagnant in single digits over the last couple of decades, witnessing an uptick only lately. Yes, the successful implementation of GST should boost the tax-to-GDP ratio over time. However, there is a dire need for direct tax reform to enhance the tax effort. Rising welfare expenditure cannot go hand in hand with a stagnating tax-to-GDP ratio.

Another way, of course, is expanding the pie or nominal GDP itself. The size of population makes it clear that India should depend on growth rather than just redistribution. But political parties as well as people, like in other places including some of the developed world, seem to be giving up on the ability of economic growth to lift living standards.

The second option, rejigging expenditure, is also a tough policy act which may not be politically palatable. The central government spends almost  three-quarters of its total expenditure on non-discretionary (interest payments, salary & wages and employee pensions) and semi-discretionary items (such as subsidies, MGNREGA and grants to states/UTs).

It is very tough politically to withdraw or take away subsidies or grants once given. Remember that binding entitlement-based transfers can balloon over time and the net present value of such promises should be taken into account. Recurring expansionary safety nets, espoused by leading parties at the Centre and states, would only constrain fiscal flexibility further and could lead to a deterioration in the quality of spending.

In the end analysis, if income transfers are used alongside continuing subsidies and rising procurement prices etc, it will cause a fiscal hiccup. There are no easy answers if the next government wants to prop up welfare spending without compromising the fiscal deficit.