On direct cash transfers & financial inclusion

Direct cash transfers, which were initiated by the previous UPA government and are being furthered by the current NDA government, are gaining increasing significance in the Indian economy today. In my opinion, this step is the cleanest way of providing any form of social welfare to the large part of the population which is heavily dependent on state subsidies. Of course, the precursor to this is for those poor beneficiaries to have a bank account to receive these cash subsidies, and to possess the know-how to operate those accounts. And towards this, the government’s financial inclusion program via the PM Jan Dhan Yojna is indeed taking some concrete steps.

To put things in perspective, the total subsidy bill of the Indian government as per reported 2013-14 figures amounts to about INR 260,000 crores, or approx 2.25% of the GDP. This might seem a small proportion of the overall government expenditure to start with, but is increasingly a matter of public debate, given the method of delivery of these subsidies. Unfortunately, a large portion of the subsidy, intended for welfare of the economically less-abled, does not reach the end user on account of a large and inefficient public distribution system. As per research conducted by the Department of Earth Sciences at Uppsala University in Sweden – “Pilferage and leakages at both central and local levels have been huge concerns in proper delivery of food grain. In 1999-2000, around 10 per cent of rice and almost 49 per cent of wheat allotted for the PDS have been diverted. Between 1999 and 2005, the leakages from the PDS at the all India level increased from 24 per cent to 54 per cent. In 2007-08, the overall diversion of the PDS grains was 44 per cent. States like Bihar and Punjab have witnessed abnormal leakage, i.e. more than 75 per cent, while states like Haryana, Pradesh and Uttar Pradesh have high leakage, i.e. between 50 to 75 per cent. Tamil Nadu, along with other states like Andhra Pradesh, Kerala, Tamil Nadu, Orissa and West Bengal, has less than 25 per cent leakage.”

Gist of the matter is – a public distribution system involving physical transfer of goods across locations, a large chain of middlemen, and lack of appropriate systems to monitor delivery will always remain an inefficient form of subsidy provision, and as is seen in India, will be characterised by massive corruption and leakages.

The government needs to take the following steps towards effectively implementing the dual objective of subsidy transfer to the targeted recipients and financial inclusion:
1)      Firstly, ensure the quantum of direct cash subsidies serves as a substitute, and not an addition to the already existing set of subsidies, which will then become a huge financial burden for the exchequer to bear. The driving motto behind DTC should be:
– Primarily, giving cash in the hands of individuals to make the choices/decisions best suited for themselves
– Secondly, a gradual reduction, spanning few years, in the subsidy bill towards strengthening the government’s financial position
– Plugging leaks in the public distribution system

2)      Initiate pilot projects, as a parallel implementation of the PM Jan Dhan Yojna, whereby cash is directly transferred to the bank accounts of the recipients of the subsidies. No doubt there have been such projects undertaken in the past (http://bit.ly/DTCPilots), and problems have been found in those. But the benefits and impact of these have neither been adequately studied, nor have steps been taken to correct problems where they were noted. Further, given DTC will completely revolutionise the subsidy transfer method, the government needs to step up communication and publicity on this matter, as well as consistently track and make improvements to these pilot projects.

3)      Educate the poor, constantly, about the benefits of these bank accounts, along with the large scale initiation of them via JDY. The subsidy recipients need to be educated on the incentives these create, and how direct cash transfer gives them the freedom to choose their bundle of goods, as per their individual needs. This will then truly qualify as financial inclusion. Towards this, we need increasing investment in human capital, by way of citizens serving as teachers and business correspondents at the respective locations. The government needs to create an incentive structure in order to attract private enterprise and high quality talent to serve as leaders for such projects.

4)      Tie all of the above to the tax structure. Bringing every Indian citizen under the tax regime is obviously of primary importance to the government. This should include all these “new entrants” as well, for which the Finance Ministry and tax authorities need to work in conjunction with the PM JDY project leads. This could gradually also lead the way for the government to consider a regime of negative income tax, i.e. a system whereby the direct cash transfer subsidy effectively becomes a “tax payment” from the government to the citizen. Negative income tax (NIT) has been widely spoken about, and is an income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Thereby, people earning a certain income level would owe no taxes; those earning more than that would pay a proportion of their income above that level; and those below that level would receive a payment of a proportion of their shortfall, being the amount by which their income falls below the “desired” level – which is effectively the direct cash transfer subsidy. Implementing the NIT via the existing tax mechanism will also enable the government target the subsidies more effectively, i.e. provide them to only those citizens who are not economically as “well-off”, as well as track the effectiveness of this subsidy over time. Of course, the NIT still has the problem of creating perverse incentives, in that it would make the recipient constantly dependent on the cash flow – but again, the NIT seems like the “best bad way” of systematically delivering social welfare to a targeted population.

Government & freedom

Over the last many days, I have had various discussions with friends and colleagues over what really is the role of a government, what duties should it be entrusted with (it is after all a set of our paid & elected, albeit highly glorified, servants) and what constitutes a socialist vs capitalist state. I have been quite amazed at individuals’ impressions of capitalism (quickly & unfortunately mixing crony capitalism with rules-based capitalism), and equally amazed at their advocacy of freedom and socialism in the same breath.

Freedom in the true sense of the word can never be achieved without complete political, social and economic freedom. The three are obviously highly inter-related and inter-dependent, but if I attempt to define them separately in a very barebone fashion:

a) Political freedom – implies my right to vote and my right to choose the representatives in government

b) Social freedom – implies my right to freely express my views and gather in public places

c) Economic freedom – implies my right to use my money the way I want

Of course, these words are more profound in meaning, but stem from the above. In India, I may find some of (a) – although an FPTP electoral system destroys the purpose, some of (b) – although recent arrests on social media posts come dangerously close to trampling this, and very less of (c) – which primarily stems from a highly centralised government making life choices for a billion-plus population.

The Heritage Foundation gives a more all-encompassing definition of (c) – “Economic freedom is the fundamental right of every human to control his or her own labor and property. In an economically free society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both protected by the state and unconstrained by the state. In economically free societies, governments allow labor, capital and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to protect and maintain liberty itself.” Should come to us as no surprise that we find ourselves at the fag end of these country rankings in a measurement of the economic freedom index. And also of no surprise is the consequent fact that the topmost among these countries figure in some of the most developed economies of the world, and India is eternally classed as a “developing” nation.

I find it particularly surprising that the reduced, if not absent, third freedom is not as evident to every educated Indian citizen as it must be. Most obvious to me is our public distribution system based subsidy – wherein our government conveniently decides on the food-fuel-fertiliser economic basket for chunk of the population. This same government largely decides on who sets what price for which commodity, and stifles free-market competition. Pro-market and pro-freedom steps like FDI-in-retail and direct-cash-transfer are opposed tooth and nail. The government has developed a god-like, larger-than-life, rich-businessman status, and “hands out doles” in the form of subsidies to the poor. It truly sounds absurd!

Many of us seem to place very little reliance on the freedom of, and the intelligence and decision-making capability of each individual (for himself/herself) and seem to unfortunately think that this power should rest with the state. Advocates of such choices should soon realise that there is no limit to the power they are conferring, via such arguments, on the government.

Calls for a liberal political party to provide an electoral alternative have been voiced from many corners, but beat this – any new political party has to abide by the rules of the Indian Constitution, which our all-powerful government had conveniently got amended to include “socialism” as one of the guiding principles – sheer brilliance at trampling freedom, isn’t it? Today, 65+ years post independence from the British rule, we would be fools to think we are anywhere close to a free nation.

The problem of Education – part 2

Recently, I came across a news item describing the state of primary education in India. The article, apart from other things, provides some crucial statistics which demonstrate the abysmal quality of basic education in India and the country’s inability to improve the learning skills of our primary school children. Interestingly, equal blame is assigned to both the government-enacted Right To Education Act, as well as the inroads made by private players in the education sector. I would take a step back and assign almost the entire blame on the way the Indian government is thinking about the problem of education.

Similar to many such Acts passed by the Indian government, the RTE Act stems from the basic problem of ineffective implementation post formulation. As always, we have had a central authority lay down common rules and regulations for all our states and regions, without a sense for locality-specific and child-specific requirements. We have had a central authority specify the required number of teachers, the quality of school buildings and the kind of education to be imparted at each school in our country. We have had requirements laid down for the appointment of School Management Committees, but no checks in place to confirm they exist, even after 2 years of passing the RTE Act. To put this briefly, there is too much focus on the steps to be taken for ensuring quality education and too little (almost zero) focus on the outcomes.

Does a parent really care about the method by which the child learns to spell his/her name, or the way he/she learns to add/subtract numbers? Does a parent really care if the teacher did tell the child that 1+1=2? No. What matters to them is the result, the outcome. That after undergoing the whole process, the child understands the basic building blocks and is able to apply those principles in more complicated situations. That apart from knowing 1+1=2, the child is able to figure out by himself/herself what is 23 times 24, for example. And this very measurement of outcome from schools and corresponding incentivisation is what is completely missing from our education system.

Being a free-market proponent myself, the concluding statement in the original article caught my eye – “If markets are to run the country, why do we need governments?” And that brings us to the other ineffective solution we are running in India, by way of education subsidies. The recent study in Delhi confirms the general hypothesis, of preference for private schools over government schools. Currently, the government pays schools to educate the children, without putting in place a system for performance measurement of those schools, and without understanding the idiosyncratic needs of every child. A brilliant solution (in the form of education vouchers) would be rather placing that same subsidy money in the hands of the child (or his/her parents), and empowering them to be free to decide their own best-suited education choice (be it public schools or private schools). The child and his/her parents will be the best possible “performance management system” that we so fervently desire in our country. The concept of education vouchers, which is hand in glove with the negative income tax and the direct cash transfer systems, has been spoken about and applied effectively, worldwide. The Centre for Civil Society India has been experimenting this in India’s context with their school choice campaign – definitely a noble effort, and worth scaling up!

As I mentioned in my earlier post on this topic, equality of opportunity stems from education, and the above steps can form a very effective way in which a market and a government can co-exist in this sector.

The negative income tax – part 2

This is a continuation of my thoughts on this topic, part 1 being here. I have read some arguments against the benefits of the NIT system, which I lay down here, along with my thoughts against these arguments.

(1) The NIT system reduces incentives to work, since people are guaranteed a stream of income.

In my opinion, this is an argument for government subsidies in general, and not for the NIT system versus a traditional welfare benefits system. “Free benefits” (subsidies) of any form automatically create a disincentive to work and earn an income. A truly libertarian approach would oppose any form of paternalistic government involvement, but this problem of social welfare demands a solution in the form of some basic and minimal government intervention. And the best way to bring this into effect would be in the form of placing cash directly in the hands of the needy, enabling them make the decisions best suited for themselves. The NIT achieves exactly that. So, instead of the government telling me that I can spend a maximum of 50 on food, 30 on health & 20 on education, I would rather have the government (if social welfare is on its agenda) give me 100 and let me decide the split myself.

(2) Empirical evidence gathered from experiments conducted in the US during the 1960-70 period seemed to indicate that the group of people receiving direct cash benefits via the NIT system had “lesser incentives to try and get back to work” as compared to the group receiving welfare benefits via the “traditional system” (food stamps, child support, public housing, and so on).

I have my reservations on this criticism. Firstly, was the quantum of monetary benefits via the NIT as generous as that received under the “traditional system”, and if not, would this have skewed results in favour of the “traditional system”? Secondly, the timespan of this experiment. Over what period have these purported incentives been measured? Do we consider a period of few years sufficient for the benefits of a radical new system to accrue and overshadow the “more obvious” benefits of the established traditional system? Thirdly, does the part represent the whole? Can the result of an empirical test on a small population be extrapolated to the entire population? How can we be certain that this small population is representative of the entire set? How can we be certain that their personal choices will be the same as those made by the rest? Their values, family structure and choices which they deem are best for themselves – may not be applicable to or uniform across the entire population.

(3) An arithmetic deficiency in the NIT system has been laid out by Henry Hazlitt. From my understanding of this, applying numbers from the above example, Hazlitt says that a person earning zero will have an initial NIT payment of 50, which will bring his total post-tax income to 50. However, that still being below the “poverty line” of 100, a further NIT payment of 25 (being 50% of the difference between 100 and 50) will be paid out, bringing his total income to 75. And this process will repeat via a geometric progression, until the point the person receives a payment of the entire 100. Further, every 1 unit of additional income he earns HIMSELF, bumps up his overall income by only 0.5 unit, which further introduces the disincentive we discussed earlier.

The first of these, I can easily see circumvented, by making NIT an annual one-time end of the year payment, with no further geometric knock-on effects. And part two of this argument, the disincentive, exists in any progressive tax regime, where those earning higher incomes are taxed at higher brackets. The NIT payment structure, while achieving the goal of providing some social insurance, also makes sure there’s a marginal overall income benefit for those earning more by themselves (clearly workable using basic mathematics).

All in all, any scientific system meant (with the intention of social insurance) to place cash directly in the hands of those who are deemed “needy” would be preferable, in comparison to a cumbersome public distribution system like the one we have in India which could be prone to leakages. An NIT system could work!

The negative income tax

The Government of India recently announced direct cash transfer schemes to deliver welfare benefits to millions of poor citizens. In my opinion, this is a wonderful step in the right direction towards providing any kind of social welfare, subject to clean and effective implementation. India’s public distribution system (PDS) for long has been a source of massive leakages, opacity and corruption, and providing cash directly in the hands of beneficiaries is a welcome step towards tackling many of these problems. Goes without saying, this will be deemed effective only if it REPLACES and doesn’t ADD to the existing set of subsidies being delivered, failure to meet which will add substantial additional burden to the exchequer. Clearly, this will not be a cakewalk and smooth implementation would require tackling many hurdles currently present.

This led me to read about the benefits of a cash-subsidy vis-à-vis an in-kind-subsidy, where I stumbled upon the theory of the Negative Income Tax (NIT). Simply put, a negative income tax (in effect, a cash subsidy) is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Thereby, people earning a certain income level would owe no taxes; those earning more than that would pay a proportion of their income above that level; and those below that level would receive a payment of a proportion of their shortfall, being the amount by which their income falls below the “desired” level.

For simplicity of calculations, assume that the minimum level of “desirable income” were set at 100 per “consumer unit”, and suppose that the NIT were a flat rate of 50% (the percentage that was originally proposed by Milton Friedman and later advocated by many economists). Then every consumer unit whose income fell below 100 would be paid a subsidy of 50% of the difference (= poverty line minus income). If its earned income were 50, for example, it would receive 25 (50% of 100 minus 50); if its earned income were 20 it would receive 40 (50% of 100 minus 20); if its earned income were zero it would receive 50 (50% of 100 minus zero).

There have been many proponents and opponents of the NIT theory, and tons of challenges (which I won’t call insurmountable) in its practical implementation. However, the multitude of benefits that I see from India’s perspective are:

(a) Giving power back to the people, in the form of cash: the current central government-run program of subsidies hands immense power to a few people at the top to decide on various lifestyle choices of the million beneficiaries of these programs. The key question that comes to my mind here is how can a few people decide, to so much level of intricate detail, the choices that are best suited for the entire population. If the government wants to play a part in the system of providing social insurance, might as well give cash to the beneficiaries, allowing them the freedom to use it the way they deem fit.

(b) Shutting down India’s inefficient benefits-in-kind public distribution system: I’ll be optimistic here and use the word “shutting down” instead of “minimising”, because the NIT applied in its purest sense will eliminate many middlemen, and put a stop to all possible leakages from the long PDS supply chain in India.

(c) Eliminating corruption and a large portion of India’s inefficient bureaucracy: this flows from the previous point. Corruption is plaguing our system, and the scams we read about, almost on a daily basis, run into lakhs of crores and so on. Again, the NIT applied in its purest sense, will help in cleaning up the system and introducing the much-needed transparency.

The 1.3 billion odd population in India always seems to be a big challenge to address, and a convenient political excuse for inertia in reforms. However, an NIT system like the above surely merits testing in the form of small pilot projects, likes of which were conducted in the United States in the 1960-70 period (results of which I will discuss later).