Why subsidies need to be curtailed and targetted – a guest post

The increases in railway passenger fares and freight charges have come at an inopportune time. Though necessary to improve the precarious financial condition of Indian Railways, the raising of charges a few days before the Railway budget has caused a furore.

Political parties of all hues have taken to the streets and blocked trains to protest the fairly steep hike in charges. Already, the government seems to be back-tracking, and there is talk about implementing the proposed increase in phases instead of in one go.

In this month’s guest post, Nishit argues that all subsidies need to be curtailed, and better targetted at the financially weaker sections of society. Incidents of subsidised LPG for domestic consumption being diverted to commercial enterprises, expensive fuel-guzzling SUVs using subsidised diesel, MNREGA funds filling politicians’ pockets prove his case.

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The Rail subsidies are being whittled away. Read my last post:

http://money-manthan.blogspot.in/2014/06/bold-and-welcome-move-by-goverment.html

Let us go into subsidies and what they mean. Subsidies are basically grants from the Government that allows financially weaker sections of the population to live a decent life with dignity. That should be the only guiding principle of subsidies. Over a period of time, that meaning got lost and it became an entitlement raj. Everyone and his grandfather queued up for subsidy. Where does the subsidy money come from? It comes from the revenue collected by the government. So, ultimately funds meant for development go towards subsidies and we are left with poor infrastructure.

LPG subsidy for 12 cylinders in a year means that a family of six consumes 1 cylinder every month and government bears a loss of Rs 5oo per cylinder. That translates to Rs 6000 ‘free lunch’ per year. If there are six members in a family at least two will be earning. If the entitlement of subsidised cylinders was reduced to 6 per year, there will be a straight 50% subsidy cut. That means a saving of Rs 3000 per year per LPG connection.

Same goes for petrol and diesel. The argument is: diesel is subsidised otherwise inflation will go up. Once market rates become effective it cannot go up infinitely. Over Rs 1 lakh Crores saved on subsidies can be used to build better roads, thus giving productivity gains. Classic example is truck drivers using expressways across the country. Earlier they could make 4 trips, now they make say 7 trips thanks to new trucks and better roads. The extra money spent is earned back multifold.

Now, take the MNREGA scheme. People are paid for a minimum of 100 days of labour. There is no accountability for what kind of work is done and who does them. If people were trained to work as road labourers, paid more, one could get the roads built and the people gain a skill. They would be able to get a job in the private sector building roads.

There is a saying: teach a man to fish and you feed him for life, give him fish to eat and you feed him for a day.

Rail subsidies operate in the same way. If the railway earns a rupee it spends almost 90 paisa on salaries and just to maintain status quo. Where is the money to invest in Infrastructure?

Summing up, subsidies are not bad in principle. They are essential to protect the financially weaker sections of society. The target audience needs to be clearly identified. Otherwise, financially well-off people enjoy subsidies not meant for them.

Tailpiece: Looking at the subsidy ‘gift’, I switched from a Petrol car to a Diesel car last year. My running cost per Kilometer has dropped from Rs 8 to Rs 4. I rest my case.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Who is paying the price for oil subsidies?

It costs about the same to produce a litre of petrol and a litre of diesel. In developed countries, the price of petrol and diesel at a filling pump is almost the same. Why is it different in India?

The logic goes like this. Diesel is used by locomotive engines of goods trains. Diesel is also used by trucks for transporting goods. By keeping the price of diesel artificially low, transportation cost of goods are kept low – otherwise inflation would be even higher. Prices of kerosene and LPG cooking gas are also kept artificially low because these are fuels of everyday use by the ‘aam aadmi’ (that means: vote bank).

Government-owned oil marketing companies are dependent on government subsidies to survive. But the consequence of subsidy payments is a burgeoning fiscal deficit. Ultimately, it is you and I who will pay the price through direct and indirect taxes. In this month’s guest post, Nishit exposes the government’s faulty oil subsidy policy and suggests an alternative to level the playing field for middle-class vehicle owners.

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Today, I write about Petrol and Diesel subsidies and what a rip-off the so-called subsidies are. For Petrol, the share of the taxes is about 46% and for Diesel it is 32%. This means for the Rs 76 one pays at the pump, Rs 35 are taxes and Rs 41 is the actual cost of Petrol. There are multiple levels at which the rip-off happens.

1. Every time petrol prices are hiked by the government, the taxes are also hiked as they are a percentage of the total petrol price. If the government was so concerned about easing the problems of the common man then the tax should be a fixed amount so that the hikes would not include hikes in the taxes.
2. The Oil companies had claimed an under-recovery of Rs 8 on every litre of petrol sold in March 2012 when crude oil prices were ruling at 125 dollars to a barrel. Since, then crude oil prices have fallen by 21% and the rupee has weakened by about 10%; which means a net drop of about 11%. If the prices in March were Rs 70 + Rs 8 under-recovery then a fall of 11% means the price of petrol should be back to Rs 70 right now whereas we are paying Rs 76.
3. The Government claims that the fiscal deficit is increasing due to subsidy on petroleum products but the tax collection has always been more than the petroleum subsidies. For example in 2008-2009, the government collected Rs 1.45 lakh Crores as taxes and spent about Rs 1.05 lakh Crores as subsidies.
4. This has been the story for other years as well.
5. Diesel car sales have gone up by 15% and Petrol car sales have gone down by 11%. The government claims that only 15% of diesel is consumed by Diesel cars and SUVs. Even if it is only 15%, why should people who can afford cars worth Rs 5 lakhs and much more get subsidised fuel which the Petrol vehicle owners are not getting?
6. LPG is being sold at Rs 400 less than its market price. In this case also, there is no limit on the number of cylinders a consumer can buy. A person who needs subsidies will definitely not consume more than 4-6 cylinders per year. A simple way to plug this anomaly is to ensure that the gas cylinders are booked only through the Oil companies and the dealers are used only for delivery purposes to avoid misuse and end the subsidy above 4-6 cylinders a year.
7. Since it is almost impossible to enforce dual pricing of Diesel for trucks and cars, a more rational argument would be to jack up the excise duty on Diesel cars and use the same amount to subsidize petrol. This will have a twofold benefit. More people will switch to Petrol based cars and the demand for the more subsidized Diesel will fall. Currently, the break-even for buying a Diesel car is roughly 40000 Kms; by increasing the excise duty and pushing the break-even point to 60000 Kms, demand will peter out. This is because most folks replace cars every 5 years and do not drive more than 12000 Kms every year.

Thus, the issue of Petroleum subsidies is at multiple levels and the government refuses to take even simple steps to resolve it. Politically toughest is the equalisation of taxes on Petrol and Diesel. The simplest and the politically easiest would be imposing additional excise duty on Diesel cars. People buying diesel cars do not form a significant percentage of the voting population. However, small cars and two-wheelers mostly run on petrol, and their owners form a larger percentage of the voting population. Their interests are being sacrificed at the altar of political expediency.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)