A case for cash transfers in place of foodgrains

I suggest a way of doing it, at least partially, by converting the in-kind subsidy into cash transfers.

Let us first understand the point conceptually with a hypothetical example.

Consider two similar subsidy programs announced during a crisis and both having an outlay of, say, INR 100 initially. These programs are announced when the government’s tax revenue is, say, INR 1,000. Assume that the first one is given as a cash transfer and the second involves providing foodgrains worth INR 100 or 5Kgs worth INR 20 per kg.

Suppose both the programs continue unchanged for five years and the price of foodgrains has doubled to INR. 40. The government’s tax revenue also doubles with inflation to INR 2,000.

It is easy to see that the subsidy bill of the first program will remain unchanged, whereas the outlay required for the second one doubles to 200 (40* 5 Kg). More importantly, notice that the outlay on the cash transfer now accounts for only 5% of the tax revenue (5% of 2000). This is equivalent to cutting the subsidy by 50%.

However, the outlay on the in-kind transfer of food grains continues to be 10% of the tax revenue (10% of 2,000). In fact, if food inflation is higher than the rate of growth in taxes, the proportion of money allocated to subsidies may increase with time.

Suppose the price of foodgrains triples to INR 60 in the above case and tax collections only double to INR. 2000, the in-kind subsidy bill will
swell to INR 300, which is 15% of the tax revenue.

The fact that the PMGKAY is getting repeatedly extended suggests that it is politically hard to discontinue the program. Even the reduction in the quantity of food grains provided may not be feasible from a political point of view. In such a situation, if the government gives an option to the beneficiaries of the subsidy to receive an equivalent amount in cash instead of foodgrains, it is possible that a large section of the
non-distressed beneficiaries may opt for it as cash is far more fungible than foodgrains.

The cost such people pay is the potential loss in the purchasing power of the subsidy in the future due to inflation. As shown in the hypothetical example above, the government can gradually reduce its effective subsidy bill. Finally, because most people think in terms of
nominal value or the rupee value, the political economy costs will also be limited as the government need not reduce the rupee amount of benefit under the program to bring down its effective costs.

Readers may contend that the approach is morally wrong as it involves reducing the effective subsidy of the poor by exploiting their fixation on nominal values. While not completely disagreeing with the above criticism, I will still recommend the measure for the following four reasons.

First, the PMGKAY was announced during an extreme crisis, and the recent macro-economic numbers such as MNREGA participation, rural demand for various items, etc., suggest that the country is not in a situation where 800 million people have to be fed by the taxpayers.

Second, there is no escaping from the fact that an increase in food subsidy will come at the expense of some other, even more, important welfare expenditures. The program’s recent extension alone is likely to cost the exchequer a whopping additional INR. 44,000 crores- nearly three times the money spent on Aysuhman Bharat.

Third, an increase in taxes to fund this expenditure- the cleanest way to do so- is likely to hurt the investment climate. Burdening future
generations for providing free food to even non-distressed people is wrong both from an economic and a moral point of view.

Fourth, the recent UK experience suggests that markets can impose costs on politicians through higher interest rates and depreciation in the currency. Thus, even from a political economy point of view, it makes sense not to let the food subsidy bill go out of hand.

The purpose of this article is not to suggest that the government’s finances are already in bad shape. Thanks to the quick economic recovery and buoyancy in tax collections, the government is likely to meet its deficit targets this year. However, our experience with the policies followed in the aftermath of the global financial crisis should teach us that policies that work during the crisis can have negative effects when continued beyond the crisis. Therefore, it is essential that policymakers start thinking about withdrawing the food subsidy given to the non-distressed section of the population.

(The author teaches at the Indian School of Business (ISB))