Direct subsidy

DIRECT SUBSIDY

DefinitionO A benefit given by the government to

groups or individuals usually in the form of a cash payment or tax reduction.

O Subsidy is an assistance to a business or economic sector or producers

Subsidies…

O Subsidies inject money into circulation. O Subsidies affect the commodity market by

lowering the price of the subsidized commodity, thereby generating an increase in its demand.

O With an indirect tax, the price of the taxed commodity increases, and the quantity demanded for the product at the market for that commodity falls.

O Taxes appear on the revenue side of government budgets, whereas subsidies, on the expenditure side.

Subsidies are classified as

O Subsidies for public good-defense, Police & General administrationO E.g.parks, street-lighting.

O Subsidies for merit good- Protection against disease, environmental protection, educationO E.g. health services, education

Advantages and disadvantages

O AdvantagesO Reduces cost of productionO Help less privileged people to have access to

productionO Releases resources for other purposes O Increases the firms competitive edge in terms

of pricesO Enables greater social efficiency.

O Disadvantages O Is expensive and will require higher taxes.O Difficult to decide on who may receive a

subsidyO Giving subsidies to firms may encourage

inefficiencyO Increases dependence of firms and hence,

might not provide motivation necessary for increasing efficiency and supply.

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Direct Cash SubsidyO The government has started direct cash transfer of

subsidy to bank accounts of beneficiaries in 20 districts from January 1st 2013.

O The Direct Benefit Transfer system has been implemented in seven schemes such as scholarships and old age pensions from Jan 1. A total of 26 schemes will be covered under it.

O The scheme will be rolled out in 11 more districts on Feb 1 and 12 more districts will join on March 1st 2013.

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O There is no intention to transfer the subsidy on food, fertilizer, diesel and kerosene.

O In Kerala ,the system is active in Pathanamthitta & Wayanad districts.

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Direct Cash Subsidy, in the Indian Context


• Huge financial liability to the government.

India spends about Rs. 160,000 crore every year or roughly 2% of the country’s GDP on subsidies, all indirectly. And most of these subsidies do not reach the poor. In the Union Budget 2012-13, target is to keep 2012-13 subsidies under 2 percent of GDP and under 1.75 percent of GDP in the next 3 years.


• Financed through taxation.

Subsidies must be financed through taxation, the continual use of subsidies widens the government's budget deficit, and bigger budget deficits imply higher interest rates which dampen economic performance. On the other hand, India spends relatively little on education, health, or infrastructure.


• India to cut `unproductive` subsidy.

In India with the indirect system the benefits of subsidy are not received by those who need them. In the policy prescriptions by the World Bank to developing countries it prescribe that to enhance economic performance in the developing countries like India they should remove subsidies on agriculture, health, education, petroleum products, etc

Direct Cash Subsidy, in the Indian Context • Redirecting subsidies to those who need them

India should redirect subsidies to those who need them. We can not remove subsidy completely because• Subsidy encourages the production and consumption of goods

and services, • subsidy could be used to boost expenditure or aggregate

demand. • It might dampen economic activity. • Government uses the subsidy system for supply of fund to the

poor ones.• It can have adverse effects on the poor in these countries and

lead to political agitation

Direct Cash Subsidy, in the Indian Context • No reliable system to identify and target

the people in need of subsidy

So far there has been no reliable system in place to identify and target the people who are most in need of subsidy. But with systems like the Unique Identity Number in place, it might be possible to get the benefit directly to the deserving and leave out unintended beneficiaries.


Other shortcomings in the current system.

• Dual-pricing

• Unresponsiveness to customer needs

• Poor targeting of BPL population

• Diversion and leakages

• Distribution system

• Inefficient allocation of resources


Impact on government• The new system is expected to reduce this cost

and subsidy bill through better targeting.• In the Union Budget 2012-13, target is to keep

2012-13 subsidies under 2 percent of GDP and under 1.75 percent of GDP in the next 3 years.

• Could be a potential game changer for the UPA−II, in the next elections, which has been besieged by charges of corruption.

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International best practices

O Jamaica, Philippines, Turkey, Chile, Mexico, Indonesia, South Africa, Morocco and United States have adopted this system in the form of Conditional Cash Transfer (CCT) programs

O Direct cash is provided to the poor families on conditionO Investments in human capital

O Regular school attendance.O Attaining basic nutrition and health care.

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O The largest and the most successful conditional cash transfer program is the Bolsa Família Program (BFP) in Brazil.O Covered close to 100 % of Brazil's poor - 2007

O The government transfers cash straight to a family subject to conditions:O school attendance,O nutritional monitoring, O pre-natal and post-natal tests

O The entire system is managed through efficient targeting, disbursement and regular monitoring of the disbursed funds.

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The new subsidy system would be implemented in 2 phases

O Phase IO Direct transfer of subsidy through state governments/UT

AdministrationO States purchase commodity from manufacturers at market priceO Central government transfers the differential subsidy directly to the state

Governments/UTO Subsidy amount is proportional to commodity uplifted from the retail

points in a state/UTO States reform their distribution system based on the CSMS system

proposed by the Task Force.

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O Phase IIO Subsidy transfer to beneficiaries

OThe cash equivalent of subsidy is transferred directly to beneficiaries through their bank accounts by linking transactions to Aadhaar

OThe commodity purchase and then transfer of cash subsidy to their account will be based on successful authentication of the beneficiary through Aadhaar at the point of sale.

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Critical success factors

O The government’s efficiency in dealing with the fundamental issues like the basis of targeting, definition of poverty line & identification of intended beneficiaries

O Effectively subsidizing the poor for fertilizer or kerosene once the prices are market determined and are liable to fluctuate

O Devising a methodology to transfer the cash subsidy to the poor

O State Government’s endeavour in taking up fundamental reforms required in Public Distribution System (PDS)

Direct subsidy

Education

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