Dangers of Free Tax Gifts – Economic News

-By Chinmay Joshi

The recent India Development Update: India’s Trade opportunities in the Changing Global Context by the World Bank predicts a positive outlook for India. It estimates India’s real GDP growth to be 7.0% in 2024-25 and 6.7% in 2025-26 and 2026-27. However, there are some worrying signs in the next period due to several domestic and external factors. This is also reflected in the latest monetary policy statement issued by the MPC-RBI, which projects real GDP growth to moderate to 7.2% in 2024-25 from 8.2% recorded in 2023-24. Moreover, the economic growth prospects for Q1 2024-2025 have weakened with real GDP growth registering a growth rate of 6.7% as against 8.2% in Q1 2023-2024 as per the recently released National Income data by National Statistical Office (NSO), MOSPI, GoI for Q1 2024-2025 on 30th August 2024, significantly lower than the latest MPC-RBI estimate of 7.1% in Q1 2024-2025.

The bleak future growth estimates, upcoming elections in various states and political compulsions to formulate pro-poor policies are some of the reasons that have prompted the central and state governments to adopt several expansionary fiscal policies in recent days. It is an undeniable fact that adoption of appropriate supportive fiscal policies is essential when immediate relief is to be provided to the poor, downtrodden and underserved sections of society to enable them tide over urgent situations. Such financial support has certainly come as a great relief to the weaker sections of society, especially during natural and health calamities like the Covid-19 pandemic. However, it is also worth noting that the continuation of such free fiscal support, popularly known as ‘freebies’, in normal times will have significant adverse consequences on the national exchequer as it may put a heavy burden on the government’s budget.

The fiscal support extended in recent months in the form of provision of free foodgrains for 5 years starting January 2024 under the ‘Pradhan Mantri Garib Kalyan Anna Yojana’ (PMGKAY) to over 80 crore people by the Central government; the ‘Mukhyamantri Majhi Ladaki Bahin Yojana’ in Maharashtra; the ‘Mukhyamantri Ladli Behna Yojana’ in Madhya Pradesh; free electricity, free water, farm loan waiver schemes in various states, among others, could have a potentially devastating impact on government coffers. For instance, the scheme under PMGKAY is expected to cost the Central government around Rs 11.80 lakh crores over 5 years, while the scheme in Maharashtra is expected to cost the state government Rs 46,000 crores per year.

Giving away free stuff can have a negative impact on the fiscal deficit, especially in the absence of adequate revenue generation. This requires the government to finance such schemes by resorting to additional borrowing. The continued growth in borrowing will have a detrimental impact on government finances, manifesting itself in the form of increasing capital burden as well as interest, worsening the primary balance. The negative effects resulting from these deficit indicators can drive the government into a vicious cycle of deficit and debt. This will have further negative repercussions on debt sustainability in the face of rising public debt.

Despite the leeway given to policymakers to stimulate the economy, there is a risk of rising inflationary pressures as the adoption of expansionary fiscal policy measures in the form of freebies provides people with monetary or non-monetary resources. The rise in disposable income will lead to an increase in aggregate demand in the economy. Moreover, the existence of a mismatch created by the growth in aggregate demand vis-à-vis the less than proportional growth in aggregate supply has the potential to raise the price level in the economy. In this context, it is worth noting that India has been experiencing a persistent rise in inflation, although there have been some signs of a positive trend in the last few months. Moreover, high levels of inflation are eroding consumer spending, as reflected in private final consumption expenditure (PFCE) which declined from 6.77% in 2022-23 to 4.02% in 2023-24, while the share of PFCE in GDP declined from 58.0% to 55.8% during the same period, as per NSO, MOSPI and GoI estimates.

Free gifts cause a drop in people’s productivity as they increase their sense of dependence on the government. In this regard, it is important to note some of the findings of the RBI’s report on sovereign finances: risk analysis published in June 2022, which indicates that free gifts are detrimental to the credit culture, have a distorting effect on prices, discourage private investment and reduce labour force participation. Taken together, this will ultimately have negative consequences for economic growth. The continued extension of fiscal support through free gifts to a large section of the population also suggests that there has been little success in ensuring equitable, sustainable and comprehensive economic growth.

It is imperative that policy makers objectively assess the costs and benefits of such expansionary policies so that resources are used for more productive purposes. Every effort should be made to extract maximum benefits by ensuring optimum utilization of such policies, besides minimizing the opportunity costs resulting from such freebies. Policies should also be directed towards creating capital assets that are key in generating employment opportunities; emphasizing education and healthcare facilities; increasing emphasis on R&D, innovation and adoption of newer technologies that will yield benefits in the long run, rather than focusing on short-term gains.

Well-targeted and cost-effective freebies during a crisis will certainly be a boon to the economy, but extending and prolonging such policies for short-sighted political gains will overshadow the economy and may land it in trouble. Therefore, timely withdrawal of such fiscal stimulus becomes very important. It is important to remember that freebies should be used only for “ad hoc” purposes and not become a political instrument or tool to help create an optimistic picture of the economy. In this context, it is worth recalling the words of Nobel laureate Milton Friedman: “There is no such thing as a free lunch.”

(Chinmay Joshi is an assistant professor of finance and economics at Bhavan’s SPJIMR, Mumbai.)

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