Poll freebies may be good politics but it is bad economics

The reckless freebie culture has a direct impact on common tax payers.

(Sanghnomics is a weekly column that tracks down and demystifies the economic world view of Rashtriya Swayamsevak Sangh (RSS) and organisations inspired by its ideology.)

As the elections for state assemblies of Haryana and Jammu and Kashmir get underway, the manifestoes of various political parties are full of promises of freebies. These promises, being made for short-term political gains, will have long-term impact.

Subsidies vs Freebies

It is important to understand that there is nothing wrong in providing subsidies on certain goods and services to make them affordable for all. But the line between the freebies and subsidies is getting blurred due to reckless competition amongst political parties to woo voters at any cost.

A research paper on the risk analysis of state finances published by the Reserve Bank of India (RBI) has dealt with this issue prudently.  It said, “In the recent period, state governments have started delivering a portion of their subsidies in the form of freebies. While there is no precise definition of freebies, it is necessary to distinguish them from public/merit goods, expenditure on which brings economic benefits, such as the public distribution system, employment guarantee schemes, states’ support for education and health. On the other hand, provision of free electricity, free water, free public transportation, waiver of pending utility bills and farm loan waivers are often regarded as freebies, which potentially undermine credit culture, distort prices through cross-subsidisation eroding incentives for private investment, and disincentivise work at the current wage rate leading to a drop in labour force participation.”

The paper points out that some freebies may benefit the poor if properly targeted with minimal leakages, but their advantages must be evaluated against the large fiscal costs and inefficiencies they cause by distorting prices and misallocating resources. Additionally, the provisions of free electricity and water are known to accelerate environmental degradation and depletion of water tables.

OPS: Good politics, bad economics

The main opposition party Congress has been promising a return to the old pension scheme in all the election manifestos. It has made a similar promise even in the ongoing assembly polls. The credit for a Congress victory in the last assembly polls in Himachal Pradesh also goes to the party's promise of returning to the OPS. But the additional burden that OPS and other freebies have put on Himachal Pradesh’s fiscal health is visible. The state is struggling to pay salaries and carry out development work due to resource constraints as a major chunk of its resources have to be diverted to fulfill offers of freebies. Punjab and Karnataka are also facing similar challenges as unreasonable promises have been made by the opposition in their desperate bid to oust the Bharatiya Janata Party governments.

The RBI clearly warns in its report titled ‘State Finances: A study of budgets of 2023-24’  that  the return to the Old Pension Scheme (OPS) by a few States and reports of some other States moving in the same direction would exert a huge burden on State finances and restrict their capacity to undertake growth enhancing capital expenditures. Internal estimates suggest that if all the State governments revert to OPS from the National Pension System (NPS), the cumulative fiscal burden could be as high as 4.5 times that of NPS, with the additional burden reaching 0.9 per cent of GDP annually by 2060. This will add to the pension burden of older OPS retirees whose last batch is expected to retire by early 2040s and, therefore, draw pension under the OPS till the 2060s. Thus, any reversion to OPS by the States will be a major step backwards, undermining the benefits of past reforms and compromising the interest of future generations, says the RBI report.

Free Electricity: A blow to state finances

Providing free electricity up to certain units to all consumers has become a major poll plank for Congress, Aam Aadmi Party and several other opposition parties.

A significant share of state subsidies is getting spent on the electricity sector. According to a PRS Legislative Research report titled ‘State of State Finances 2023-24’, over the last several years, states have spent around 8 to 9 per cent of their revenue receipts on providing subsidies. A significant portion of such subsidies are spent to provide free or subsidised electricity. “Concerns have been raised over rising subsidies for non-merit goods in several states.  Providing such non-merit subsidies may constrain the fiscal space available for capital expenditure,” says this report.

Another report by Pahle India Foundation titled ‘The Impact of Power Subsidies on State Finances’, clearly says that the power subsidy regime in its current design places an unsustainable burden on state finances. It recommends that power subsidies should be either reduced significantly or completely eliminated in highly fiscally stressed states like Punjab.

The reckless freebie culture has a direct impact on common tax payers. The governments will have to raise taxes to generate additional revenue to finance the freebies. Also, a major chunk of the resources goes in financing these freebies leaving too little for the developmental works which need high capital expenditure. The common characteristic of all the states promoting freebies culture is that they have all walked into a debt trap.

But political parties continue to offer freebies and those who are voting for them because of freebies aren’t realising that we are compromising our future by indulging in such unsustainable practices.

Earlier Sanghnomics columns can be read here.