Poverty & Inequality

NYAY e-Symposium: Not long-term solution to poverty but useful ‘first-aid’

  • Blog Post Date 02 May, 2019
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Maitreesh Ghatak

London School of Economics; IGC India

m.ghatak@lse.ac.uk

Maitreesh Ghatak (Professor of Economics, London School of Economics) contends that a cash transfer, as envisaged by NYAY, will provide some relief and a safety net to the poor living on the margins of subsistence. However, it is not clear how it will deal with the problem of targeting. Moreover, it is not a long-term solution to the problem of poverty, which requires investment in health, education, and skill formation, among other things. 

 

Can you explain why NYAY is necessary when we already have so many other poverty alleviation schemes? Why should we not just increase the budget for the existing schemes? 

There are hundreds of poverty alleviation programmes in India, from housing to food, from maternity benefits and child welfare to old-age support. Name a need, add a politician's name or a government title before it and the word yojana after, and you could very well be naming a real government scheme aimed at the poor. While their performances across the country vary, it is impossible to deny that these schemes are beset with problems that limit their effectiveness. To begin with, there is the problem of targeting, a problem that NYAY is also subject to as we discuss below. Often, those who should not be getting a benefit, get it (inclusion errors), while those who should be getting it, do not get it (exclusion errors). Moreover, for inclusion errors, the problem arises from the very nature of such targeted schemes – namely, there are systematic incentives to falsely claim eligibility. 

However, there are other problems that these schemes are subject to that, in principle, NYAY is not. First, there is the problem of leakage, wastage, and corruption in the delivery process. Second, even if the implementation process were faultless so that the first two problems were absent, administering these programmes uses up considerable manpower and resources and our State capacity is already overstretched. Third, some of these schemes involve subsidies that benefit the non-poor relatively more, since they consume more of the relevant good or service. For example, power subsidies favour those who have access to electricity and among them, those who consume more power. Fourth, there are sound economic reasons to believe that the use of subsidies or making some goods and services free leads to distortion of resource allocation, compared to cash transfers. No wonder then that policymakers and academics have been debating how to reform the existing policy architecture to enhance the effectiveness of resources devoted to poverty alleviation. Increasing budgets for existing schemes with no attention paid to effectiveness would be equivalent to pouring more and more water into a leaky bucket. 

Do you think that the money would be better utilised if instead it is used to improve the existing public education and health services? Or, have we simply given up on trying to make public education and health delivery functional? 

This is a false trade-off and those who oppose any scheme always invoke this ‘Trojan Horse’-type argument (except for schemes they favour) – this will crowd-out money from other schemes. If we literally took this argument to heart, no new scheme of any kind can ever be proposed. 

In my view, different policies are needed to address different problems. So yes, a cash transfer, as envisaged by NYAY, will provide some relief and a safety net to the poor living on the margins of subsistence but it will not provide a long-term solution to the problem of poverty. For that one needs investment in health, education, and skill formation to enable the poor to take advantage of growth opportunities, and in infrastructure and regulatory conditions to facilitate private investment for employment generation. To give an analogy, giving certain nutritional supplements may help a person who is ill to gain some strength, but it will not cure any disease, nor will it make the person an athlete. On the other hand, to those who say cash transfers are band-aids for the problem of poverty, my question is: don’t you need band-aids or first-aid boxes? Only when one says that we should replace the entire health budget by giving people band-aids then there is a problem. 

Would you prefer an alternate scheme that distributed the same amount of money through cash transfers over a larger number of households by reducing the amount to each recipient? If yes, why? 

Yes, I think the main problem with NYAY is that it is a targeted scheme and I have listed above some of the problems of such schemes. A more universal scheme such as Universal Basic Income (UBI) will solve the problem of targeting automatically but will be more expensive and so the amount of the transfer will have to be reduced for a given budget. This is the core trade-off between targeted and universal schemes and I have argued in a recent paper on UBI with François Maniquet: given the weaker State capacity as well as the problem of a lot of people living on the margins of subsistence, the case for UBI is stronger in developing than developed countries. The problems of targeted schemes that I mentioned above are very serious in my view and make me generally not sympathetic to them, unless the targeting criteria are somewhat objective like age (for example, pensions, child benefits), gender, or region. Also, the discretion and power it gives to our administrative system runs the risk of turning these into instruments of political patronage, which would tend to make them lose their legitimacy.

Also, there is another argument – signing up for this benefit would enable the government to expand its tax net – for example, by making it mandatory that if you receive this benefit then you have to file for income taxes. In fact, I would say that given that certain categories of income do not fall under the income-tax net either by design (for example, agricultural income) or due to imperfections in the tax administration system (for example, informal sector income), a UBI might create some political support behind a parallel reform in income taxes by making income taxes universal and, of course, progressive.  

Do you have any concerns about the fiscal burden of this extra expenditure? Do you think that the existing tax rates would have to be changed or the existing subsidies eliminated to accommodate NYAY? 

Yes, one of the most obvious concerns with the NYAY scheme is funding. The figure currently being discussed is Rs 3.5 trillion, which is obtained by multiplying Rs. 6,000 by the number of the poor constituting the poorest 20% of households, which, given India’s population and an average family size of five, turns out to be 250 million. As a fraction of GDP (gross domestic product), that is 2.14% while as a fraction of government revenue it is 16.7%. 

Only 5% of Indian adults file income taxes, and about 3% pay taxes, with the average amount of tax paid being around Rs. 60,000 per year. Only 5% of households earn Rs 50,000 a month or more, and so the prospect of raising more income taxes to fund NYAY is limited without a comprehensive reform of income taxes and making the net wider. 

Another method of funding this scheme would be to have an additional social welfare tax that is levied on capital gains (at present these taxes are 10-15% only), wealth, or some forms of consumer expenditure. Given that estimates suggest that the black economy is around two-thirds to three-quarters of the country’s official GDP, the argument for taxing luxury expenditure items is particularly compelling. 

What would you say to people who are worried that an infusion of cash would increase demand but not the supply and cause a price rise? 

This is a concern for any large-scale cash transfer programme and is a valid concern for the standard reasons of short-run price elasticity for goods that the poor are more likely to consume (such as food and fuel) being low. And inflation is a serious economic concern, one that should not be taken lightly. However, right now we have recession-like conditions prevailing in the economy with real wage rate growth rates in agriculture being negative and farm prices facing a squeeze and so the threat of inflation is less of a concern. 

Which of the existing subsidies from the central government are dispensable and substantial enough to be considered for elimination? 

If we look only at the fertiliser and petroleum subsidies, which are considered neither efficient nor equitable, at 0.56% of GDP or 4.42% of central government expenditure, that is approximately one-fourth of the promised sum under NYAY. Unlike food, there is little rationale for these subsidies, whether in terms of equity or efficiency. If we look at all subsidies other than food (including, for example, various kinds of interest subsidies) then that constitutes 35% of the proposed sum. 

Also, the central government offers a number of tax concessions or incentives on income tax to corporates, individuals, and associates of individuals, apart from exemptions on customs and excise duties. These are commonly referred to as ‘revenue forgone’, and available estimates by Jayaraj and Subramanian (2016) suggest that this constitutes 6.5% of GDP. 

Estimates by Mundle and Sikdar suggest that if we look at both central and state government subsidies together, using data from 2015-16, these amounted to 12.12% of GDP and leaving aside the income supplements, and subsidies on merit goods and services like food, basic education, health, water supply and sanitation, almost half of it are non-merit subsidies. If we look at bad debt written off in 2017-18 as a percentage of GDP, that is 0.76% – this too is a form of a subsidy that benefits the rich. So, yes, there is scope for funding NYAY but like all expenditure cuts, it is not going to be politically easy to pull off. 

Targeting the bottom 20% seems to be a herculean task.  Which data can the governments use to identify the bottom 20%? What sort of targeting mechanism would you suggest? 

I have heard some arguments that are similar to proxy-means tests (PMT). These are used to estimate the income or consumption when precise measurements are not available or difficult to obtain. This typically involves collecting information on assets owned by the household (such as, type of house, ownership of livestock, and various durable consumer goods) as proxies for income or consumption. I am generally not enthusiastic about going down this route, short of a full-scale rehaul of formalising our payroll and income-tax institutions so that everyone has to report all income. However, one solution I have recently proposed is to integrate the NYAY scheme with MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act). NYAY is a cash transfer scheme targeted at the poor, which is unconditional, that is, to receive it, they do not have to do anything. Under MNREGA, you get paid only if you work. As a result, it is self-targeting — only those who really need the money would be willing to do extra work to earn it. On the other hand, it is not ideal for the poor who are unable to work, for example, children, the elderly, the disabled. One can think of a transfer policy that combines the two in the following way. We can have a flat base amount (for example, the Rs. 6,000 per month figure that the NYAY scheme is referring to) that is given to all and then we can allow individuals to claim more if they work under MNREGA. Those with no income (including none earned via MNREGA) will receive just the base amount. Others will have more, in proportion to the labour they supply. This would also give a mechanism to implement the NYAY scheme by making it costly for people to receive additional income beyond the base amount and solve the income-verification problem that is inherent in the NYAY scheme. 

The proposed scheme is bound to generate perverse incentives for a significant part of the population. They would try to show that they are a lot poorer than they are or even to lower their incomes in order to qualify. How would you construct the scheme to minimise the damage from this obvious problem? 

I have pointed out in a number of pieces right after NYAY was announced (see here and here) given that targeting the poor is a big problem for any means-tested scheme, based on the descriptions of the scheme that are available, it seems people would have every incentive to underreport income. It is a serious problem and all that I have heard so far signal good intent but no concrete steps. Incidentally, I am not persuaded by the adverse work incentives argument that some people make. Let us take the sum of Rs. 6,000 per month per family that NYAY promises. The average family size in India is about five. That means, it is Rs. 1,200 per person per month. What is the poverty line in India? It is Rs. 32 per person per day in rural areas and Rs. 47 per person per day in urban areas. In per month terms, these figures are: Rs. 960 and Rs. 1,410 per person, respectively. If we adjust these figures (which are from the Rangarajan report and uses 2011-12 prices) for inflation, these numbers would be Rs. 42 and Rs. 62 per person per day respectively for rural and urban areas, implying a monthly sum of around Rs. 1,200 and Rs. 1,800. I do not think its plausible to think that these sums are enough for a person to lose incentives to earn further income - if we multiplied this sum by five then I can begin to see a plausible argument emerging. 

How would you ensure that this scheme does not turn out to be a Trojan horse to weaken or destroy the existing schemes like NFSA and MNREGA? 

The problem here is that of commitment. If like inflation or budget-deficit targets we could ring-fence certain percentages of the budget for certain schemes that would partly address the problem. Short of this, continuous vigilance and electoral accountability are the only mechanisms we have at hand. 

The deficiencies in the existing poverty alleviation schemes stems from weak State capacity. Will NYAY also not be hampered by the same? 

Yes, that is true though, it is a cash transfer scheme and so, in principle, somewhat less subject to these problems. However, the problem of the targeting part of it is as daunting as in any other means-tested scheme. 

This post is part of I4I’s e-symposium on NYAY: https://www.ideasforindia.in/topics/poverty-inequality/decoding-congress-nyay.html  

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