Hidden costs of in-kind subsidies

Thanks to elections, politicians are now discussing about Universal Basic Income; how does UBI compare with LPG subsidies,  subsidised medical care, etc?
(Express Illustration)
(Express Illustration)

Amidst elections, there is talk of implementing models of the Universal Basic Income (UBI). Budget 2019 introduced Rs 6,000 per year assured income support for small and marginal farmers. While the Economic Survey in 2016-17 had discussed UBI as a new paradigm for the country, social insurance in India has mostly taken the form of in-kind subsidies—for example the Public Distribution System, subsidised medical care, LPG subsidies, fertilizer subsidies, etc.

However, the current policy discussion by some political players, seem focused on providing an UBI in addition to the existing in-kind subsidies without any rationalisation. This is likely to put a heavy strain on the fiscal situation of the nation. In the light of this debate, we compare in-kind subsidies against an UBI on a previously unexplored dimension.

We highlight here one particular benefit of UBI over in-kind subsidies. This finding is based on our paper “In-Kind Transfers as Safety Nets for the Poor: Do they Expand or Contract during Economic Shocks? Evidence from India”. We find that in-kind subsidies fail to perform the job of a social safety net for the poor when they most need it. 

The paper finds evidence that when the beneficiaries of in-kind subsidies are hit with economic distress, the usage of in-kind subsidies reduces and conversely during economically good times, the usage of the in-kind subsidy increases. This runs counter to the policy objective of the state providing succour to those in need when they need it the most. On the other hand, unconditional cash transfers (UBI also belongs in this category) in the form of pensions show no change based on the economic situation of the recipient.

Let’s take the LPG subsidy in India as a representative in-kind subsidy. The premise of the finding is quite intuitive—when the ability of a beneficiary to consume an in-kind subsidy is strongly interlinked with their ability to consume a non-subsidised commodity then the behaviour described earlier will manifest itself: low usage during bad times and more usage during good times. 

LPG cylinders are used as cooking fuel in India. The household’s ability to consume the subsidised fuel is dependent on the household being able to buy food to cook —most of which, like milk, pulses, egg, fish, meat, etc., are themselves non-subsidised. Hence when the household’s ability to purchase these food items is curtailed (as during an economic distress), they tend to consume less of the subsidised fuel too —less food to cook means less fuel is consumed. The opposite happens during economic prosperity—more non-subsidised food can be bought and hence more of the subsidised fuel is consumed.

The results of the paper point to a significant impact during times of economic distress—usage of  LPG subsidy declines by almost 70 per cent. On the flip side, during economic prosperity the usage of in-kind subsidy increases by almost 30 per cent. This is an unrecognised cost of in-kind subsidies: they decline when they are needed the most and become prominent when least needed.

The phenomenon described above can be illustrated with an example. Consider a low-income household of three-four members with a monthly income of, let’s say Rs 7,000. Of this assume, that the food expenditure is around 20-30 per cent—that is around Rs 1,500 to Rs 2,000. The market price of LPG cylinders is around Rs 660 and the subsidy amount given on this is around Rs 160. Assume, for the purpose of this example, that the LPG cylinder would last the household around two-three months. So, the average monthly subsidy utilisation by the household is around Rs 65.

Now imagine this household being hit by an economic shock. Consider that the monthly income of the household drops to zero due to a sudden bereavement of the earning member of the household. It is more than plausible that the food expenditure would also drop. Let’s assume a 30 per cent drop in the food expenditure. The quantum of food consumption may not drop as much as the expenditure—let’s say due to the purchase of lower quality food or subsidised food grains.

But it will still drop to some extent. Assume a 15 per cent drop in the amount of food that is cooked. Assuming a proportionate reduction in the LPG used for cooking, the LPG subsidy utilised drops by Rs 10. So while the household would have benefited from an increase in support, the structure of the subsidy has resulted in a net decrease in value to the household. As opposed to the in-kind subsidy, a cash transfer of Rs 160 per month (the same value as the in-kind subsidy) would be independent of the economic condition of the beneficiary. 

The findings also translate to other in-kind subsidies whose utilisation is linked to the consumption of other non-subsidised goods. For example, subsidised fertilizer.  The farmer can make use of the subsidised fertilizer only when he can purchase farming implements, electricity, pumps, etc., many of which may be non-subsidised. 

The only exceptions to this behaviour are schemes like food stamps or food canteens. For example, the Amma Unavagam canteens that provide subsidised meals may not fit into this mold— since the beneficiary’s ability to eat at the canteen is not constrained by his ability to consume any other non-subsidised item.

We hope to contribute to the current discussion on the unconditional cash transfer by focusing on a cost of in-kind transfers that are absent in the case of UBI and make no case for introducing an UBI in the absence of a rationalisation of the existing in-kind subsidies.

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