IAS Gyan

Daily News Analysis


12th December, 2022 Economy

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  • The Rs 532,446.79 crore spending on subsidy in 2022-23 would be the second highest after the Rs 706,006.53 crore of 2020-21.



  • A subsidy is a benefit given to an individual, business, or institution, usually by the government. It can be direct (such as cash payments) or indirect (such as tax breaks). 
  • Subsidies include all grants on current account made by the government to depress the price of any good or service below its economic cost. 


How are subsidy areas determined?

  • Government expenditure, particularly in a welfare state, is classified into three categories - general services, social services and economic services.
  • The first includes fiscal and administrative services like justice, jails, and police, which are in the nature of pure public goods.
  • The last two categories include a range of goods and services, which are not purely public and where the users are identifiable and user charges can be levied. For example, roads and power. Budgetary subsidies arise when the budgetary cost of providing such goods and services exceeds the recovery made from the users of the good or service.
  • Governments make such goods and services available to users at costs lower than what was expended to produce and/or provide them because social benefits of doing so exceeds the aggregate of private benefits to individual consumers.
  • For instance, compulsory and free elementary education, a subsidy provided by the government, aids the social development and uplift of the poor and the socially depressed classes by making such education easily accessible to them. Subsidies are financed either from tax or non-tax revenue, or result in a deficit.

Advantages of Subsidies

  1. Lowering prices and controlling inflation

They are especially applicable in the area of production cost inputs such as fuel prices, particularly when global crude oil prices are rising. Many countries subsidize fuel costs in order to keep prices from ballooning.


  1. Preventing the long-term decline of industries

There are many industries that should be kept alive and functional, such as fishing and farming because they are essential to support a population. Many new and fast-growing industries may also benefit from being subsidized.

  1. A greater supply of goods

Governments want to increase the access of their population to Goods & Services such as Water, Food, and Education. They, therefore, provide an incentive that could be in the form of a tax credit or even straight-up cash. Markets that have positive externalities are usually the ones that receive such benefits.


Disadvantages of Subsidies

  1. Shortage of supply

Though one of the advantages of subsidies is the greater supply of goods, a shortage of supply can also occur. This is because lowered prices can lead to a sudden rise in demand that many producers may find very hard to meet. Ultimately, it can lead to very high demand that causes an increase in prices.


  1. Difficulty in measuring success

Subsidies are usually effective and helpful. However, if the government were to make a report of its success in using subsidies, it would be a different story. This is because it is hard to quantify the success of subsidies.


  1. Higher taxes

How will the government raise funds to use for subsidizing industries? Of course, by imposing higher taxes. So, it is the general population and corporations who provide the means to enable the government to subsidize industries.


What is the Indian subsidy regime like?

  • Broadly speaking and purely at the level of the central government, there are three major types of subsidies --- food subsidies (for farmers and the poor who avail the public distribution system), fertilizer subsidies (for farmers), and petroleum subsidies (for the poor and the middle class, on kerosene and LPG, which they directly consume or diesel which fuels the transport industry that carries essential goods and thus has an impact on their prices).
  • These are clearly visible in the government’s budget document. Apart from these, there are also minor subsidies such as on interest rates and subsidies in the provision of social and economic services mainly healthcare and education.
  • In social services, the Centre’s participation is limited. Most of the social sector expenditure pertains either to the Union Territories that figure in the Union budget, or are in the nature of departmental transfers to state governments.

Why has the regime of subsidies been such a contentious issue in India?

  • The benefits from subsidies can be maximised only when they are transparent, well-targeted, and suitably designed for effective implementation without any leakages.
  • Various studies have shown how the proliferation of subsidies in India is an outcome of undue expansion of government activities in the provision of goods and services that are not pure public goods.
  • Subsidies result from the government’s inability to recover its costs adequately in many of these activities. Critics have blamed this on the ill-considered use of subsidies by political parties for electoral ends and have been arguing for reduction of some subsidies and the phasing out of others.
  • Those who support the continuing of subsidies, however, argue that the focus on reducing subsidies only comes about because of the government’s failure to raise tax revenues.
  • The report Central Government Subsidies in India: A Report, 2004, brought out by the ministry of finance, has advocated reduction of MSP for farmers, the removal of the present two-tier system of prices in the public distribution system, along with a system of food coupons for below poverty line population.
  • It has also recommended that fertilizer prices be raised and LPG and kerosene subsidies further reduced. In fact, their prices have been already raised recently since the UPA government came to power.

Understanding Subsidy Rationalisation with an example

The government-appointed Dalwai Committee on doubling farmers’ income suggests that money saved by rationalizing subsidies may be reserved exclusively for the agriculture sector.

According to the ICRIER model, if public money is spent on agriculture research and development, and building roads, instead of being spent as subsidies on fertilisers, power or irrigation, marginal returns in terms of number of people brought out of income poverty or higher agri-GDP growth is expected to be almost 5 to 10 times more. For example, for every million rupees spent on agricultural research, 328 people are pulled out of poverty. In contrast, the same amount spent on power subsidies brings only 23 people out of poverty. 

Wrapping it up

  • For years, India has debated the extent and nature of subsidies the government should provide. An attempt to bring down the subsidy bill to close to 2% of GDP had prompted the unwinding of subsidies on fuel products like petrol and diesel.
  • As a result, the share of fuel in the government's total subsidy bill has reduced to just 3.9% as of the budget estimates of FY22.

Food now accounts for 72.4%, while fertilizer accounts for 23.7% of total subsidies.

  • The government has already introduced a direct benefit transfer scheme to plug leaks in subsidies and other welfare schemes to ensure the benefit reaches the poor directly. Subsidy Rationalization is the way ahead.
  • The over-riding goal of subsidy rationalization is to address fiscal imbalances in order to improve, not only the production system's efficiency but also the efficiency in allocation.