India’s Public Finances, Explained

Grand Tamasha

In this episode of Grand Tamasha, host Milan Bajnov interviews researchers Sarthak Pradhan and Pranay Kotas Thane about their new book, 'Fiscal

Key takeaways

• The 'Gabbar Singh' theory describes a government acting as an extraction machine that provides minimal services in exchange for taxes.
• India's tax system suffers from 'hyper multi-objective optimization,' where trying to achieve too many social goals simultaneously leads to economic distortion.

Main topics

• Public Finance Principles
• GST and Indirect Taxation

Notable quotes

When government is spending, we think this money is there somewhere the government can spend. But when people are reminded that there are opportunity costs for this, then people do change their preferences.

Conclusion

The episode serves as an essential primer for understanding the econom

Transcript preview

Speaker 2 (0:00) Anabashar. Speaker 3 (0:01) The most unpredictable. Speaker 2 (0:03) Becomes a headline. The most volatile. Speaker 3 (0:05) Outrageous behavior. Unsubstantiated narratives. A battle of personalities. Speaker 1 (0:11) Welcome to Grant the Masha, a co-production of the Carnegie Endowment for International Peace and the Hindustan Times. I'm your host, Milan Bajnov. Few subjects are as central to the functioning of government or as likely to make the average citizen's eyes glaze over as how governments collect and spend the public's money. But public finance shapes nearly every interaction Indian citizens have with the state. How much tax revenue will my state receive from the center? Will my local government have the resources to invest in the urban amenities that I value? And how can I distinguish between an expensive freebie and a purposeful targeted cash transfer? A new book, Fiscal Fables, A Citizen's Guide to Public Finance, demystifies India's public finances for a lay audience and explains public finance concepts using relatable stories and examples. The book is co-written by two public policy researchers, Sarthak Pradhan and Pranay Kothasthane. Sarthak is a fellow at the Daksha Shila Institution, an independent center for research and education in public policy. He also serves as assistant editor of the Indian Public Policy Review. Pranay is deputy director at Takshashila, where he chairs the high-tech geopolitics program. He co-writes Anticipating the Unintended, a weekly newsletter on public policy, and co-hosts Pulyabhazi, a Hindi-Urdu podcast on politics, policy, and technology. To talk more about their new book, I am pleased to welcome them to Grand Tamasha. Sarthak, Pranay, congrats on the book, and thanks for taking the time. Thanks, Milan, for having us here. Speaker 3 (1:33) Thanks, Milan. Glad to be back. Speaker 1 (1:36) It is good to back. We were joking before we started that we've had Pranay on, I think, three or four times each time for a new book, which is setting some kind of record. I want to ask you about this new book, Fiscal Fables, because it starts with, I think, a very simple premise, right, which is every active citizen in India, I mean, for that matter, really anywhere in the world. should care about public finance. So if you have one of our listeners kind of in an elevator and you have to make your kind of entry level elevator pitch, how would you make the case that this matters to them? Sure. Speaker 3 (2:16) Yeah. So the first reason is because it is your money. And that's really the most important reason. But despite it being our money. it's a well-documented fact that there is something called opportunity cost neglect. So this is a study by two Scandinavian researchers where they asked public health experts that will you spend some X euros, X thousand euros on a particular public health program? Most of them said yes, of course. I mean, who will say no to a well-meaning... public health program. But then they were asked in the second round that, you know, this is the actual cost of that particular public health program. Would you still spend this? And then you see a 10 % drop in the number of people who were going to say yes to this public health program, right? So in our private spending, We understand opportunity cost very well. So when you say, I'll buy a one lakh rupee new iPhone, you instantly know that there goes your next Goa trip, right? Because it's opportunity cost. But we don't do that when it comes to public spending. When government is spending, we think this money is there somewhere the government can spend. But when people are reminded that there are opportunity costs for this, then people do change their preferences. So that's really the core reason why we need to know public finance. Broadly, public finance just means the quantity and quality of government spending and seeing how that impacts outcomes, what are the results of that, so on and so forth. So that particular idea is about something which is underappreciated. The other reason is, Milan, you... follow Indian politics very closely. And most of the political discussions are also related to public finance in one way or the other. So whether it is, you know, Sarvashikshan Abhiyan Funds not going to Tamil Nadu, or it might be a fiscal federalism issue, or it might be the spending on NREGs, they are all related to public finance issues. But many of these discussions happen. without public finance principles being used. And that is something which really irks both of us, Sarthak and I. So we thought we should be having a public finance discussion using those principles, right? For example, public finance is able to tell us that if you want to increase spending on a particular domain, this kind of transfer works better. Whether a cash voucher works better or whether a direct transfer works better. All these are well identified in public finance. So those are the things that we wanted to surface. And that's why this book. Speaker 2 (5:10) So I also have a few points to add here. Now, when it comes to public finance, it applies government's spending on different kinds of things. As citizens, many times you cannot exit a government's fiscal choices. So again, that is also one of the reasons why you should be using your voice because whatever the government is providing, you have to deal with it. In many instances, the private players might not provide for it. The markets will not provide for it. Additionally, Governments typically have an incentive to not make the true cost of something transparent. They will have an incentive to keep it opaque. Every politician would like to spend more, but it has consequences. It has consequences on you. It might have consequences on future generations. Irreversible consequences in some cases. So if we understand public finances better, We can deal with these kind of things. We can understand these things better. And also, we have repeated this again and again in our book. When government spends one rupee, the cost of that is around three rupees for the entire society. This is what Dr. Vijay Kelkar, Dr. Ajay Shah, they also talk about in their book. Speaker 3 (6:28) So we were just looking at the total government spending. If you include all levels of government, roughly we spend 100 lakh crore rupees a year, which means it is around 68,000 rupees per person, right? So every year, you're giving 68,000 rupees to the government. So we better identify what that money is going to. And the other favorite stat I have is many people in India think US is a capitalist country and, you know, China is a communist country or so on and so forth. So US must not be spending a lot on their citizens. But which is absolutely not the case because there's a Wagner rule which states that actually the government spending as a percentage of GDP. increases is almost directly proportional to the GDP per capita of that country. So as you become richer, citizens demand change, citizens demand more of the government. And despite it being a communist country or a socialist country or a capitalist country, government spending as a percentage of GDP only grows. That's the empirical observation over the last 100 years. US, for example, is roughly 38 % of the GDP of the US. That's why we need to be worried because India is in that trajectory where we are moving from 27 percent GDP of is the total government spending. So we need to be very cautious about how this spending increases or whether that spending is even required or not. So this is the right time, I thought, for us to think of these questions. Speaker 1 (8:06) I mean, I think just to go back to where you started in the kind of origins of this book, right? I mean. Presumably one reason that you wrote this book is because you feel like this understanding isn't there. And in part, perhaps that stems from a belief that ordinary Indians have that it's not really their money to begin with. Right. It's someone else's money and it's kind of monopoly money. And then the government is kind of playing with it and they get what they get or they don't get what they get. You know, Arvind Subramaniam, others have talked about this, and I think they've called it something like representation without taxation, right? Because the income tax, direct tax paying base is so small. Is that what you would attribute this sense of apathy or ignorance, if I could call it that, to that, you know, people just don't see in their day to day lives, given it's a vast population and such a small pool of direct taxpayers, that this is really something that is. affects them at a kind of one-to-one level? Speaker 3 (9:03) Possibly. I think the reason might more be related to, so in any case, people do understand they are paying indirect taxes, right? So they know, they feel the GST impact or any indirect tax impact whenever they are filling petrol on a daily basis. But I guess the chain breaks because our local governments are fiscally not empowered at all. And hence people are not able to connect. How does my spending connect with what is happening in my ward or my locality? So that this in public finance, we call it the Vixellian connection. So how much does the overlap between who decides who benefits and who pays? So if you imagine three circles, the more the overlap between the three, the better public finance delivery is. I think that is sort of broken in India at various levels. So because of that, people only rely then on no public service provision there. We are only relying on government to provide private transfers or private goods. And we settle at that low level equilibrium. Speaker 1 (10:13) I want to, before we get into some of the main chapters, I want to just ask you, and Sarthak, maybe I'll start with you. The book talks about. these four competing visions of the purpose of government. And it argues that, you know, these visions exist in theory, in books and in articles, but on any given day, you can actually see all four visions of the purpose of government on display in India. And I wonder, as a way of getting into the conversation, if you might tell us kind of what these visions are and concrete ways in which they show up in everyday life. Yeah, so the book Speaker 2 (10:50) talks about four different visions. The first one is the Gabbar Singh theory. Now, what it implies is in this particular model or vision of the government, the government is more of an extraction machine. And the role of the government is quite limited, just like what Gabbar Singh and Shorley used to do. Used to go from one place to another, will loot people. The same thing, it has been, this is something which we have derived from Manikar Olson's stationary bandit concept. In this kind of a vision, the government provides some services. For instance, it might be providing safety to its people and it is going to protect people in its jurisdiction from other bandits, from other Gabbar Sikhs. Speaker 2 (11:38) government for it to sustain, for it to flourish, thrive, it will require resources. So it extracts resources from its people in the form of taxes. So this is one theory where the government provides some minimal services and they are basically extracting from the people. The second theory is the Robin Hood theory. Just like Robin Hood used to take resources from certain section of the population and it used to give it to those who were maybe from the poor socio-economic background. The same thing applies here. Progressive taxation can be an example of this. You are basically taxing the poor, taxing the rich more and the resources are being given to people who are at the bottom of the social hierarchy or the economic hierarchy. But in reality, that might not be the case. Often what happens is those who are well off, they have different kind of ways to avoid paying taxes. So maybe in reality, it will be the people who are not able to evade taxes, the middle classes, they are the ones who are taxed and not necessarily they get the benefit. The third kind of vision is more of an academic vision, I would say. This is what Musgrave talks about. Musgrave says that there are three things governments typically do. One is allocation of goods and services. But again, it should not be any type of good. Those goods which markets can't provide for, for instance, public goods, law and order, national defense, these are public goods. Markets do not have any incentive to provide for these goods. So government should allocate these goods. There are certain goods which have societal benefits. I mean, the individual who is consuming that good benefits. but it also benefits others in the society. For instance, if I take a vaccine, I am benefiting myself. I am getting protected from a virus, but others also tend to benefit because of that. So these kinds of goods, again, government should allocate or it should finance. Private players can provide for it. Government can subsidize this. So allocation is one function. The second function is redistribution. Every society has some notion about what is fair. So based on those notions, what is fair, it can redistribute incomes, maybe from the rich to the poor, from states which are doing, from regions which are doing well to regions which are not doing well. And the third role is stabilization. So Musgrave talks about these three things. So government should be doing these things. And the last one is the Bukhanans. Speaker 2 (14:13) or Buchanan's vision. Here, he identifies government not as just one entity. Government constitutes of different kinds of actors. There are politicians, there are bureaucrats, there are, again, voters also. They all have their own incentives. So, they all have their incentives, they have their own self-interest, they work as per their own interests. And again, Not necessarily what are the other roles that we thought about, right? That government should be, will ensure redistribution in this particular manner. That might not happen. There might be regulatory capture. There might be rent seeking. So these are the four different visions we talk about. And on any given day, you will find all these things playing out in the Indian context. For instance, there will be a welfare scheme, which is basically the Robin Hood theory. There might also be... a highway being constructed, which is part of allocation of meritorious goods. There can be different kinds of subsidy targeted towards