#14 Today's Deficits Are Tomorrow's Tax Hikes

Huawei in India's 5G, Creative Accounting, and Kingdon's Schema

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PolicyWTF: The Art of Creative Accounting

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

The Budget Season is upon us. The Union government is likely to breach the fiscal deficit target of 3 per cent set in The Fiscal Responsibility and Budget Management (FRBM) Act, 2003. Regardless of the exact figure that finally comes out, remember that What You See Is Not What Is. The reported deficit is actually an underestimate because of a phenomenon called creative accounting.

Just as individuals manipulate their income tax returns, governments also manipulate their income and expenditure statements. This is the art of creative accounting — ‘accounting practices that may follow the letter of the rules of standard accounting practices but deviate from the spirit of those rules with questionable accounting ethics’. The Union government does it in the following ways:

  1. By delaying payment of subsidies to Food Corporation of India. To operationalise food subsidy, FCI procures grains on the government’s behalf. The payment due to FCI in the current financial year is pushed to the next year’s budget. In the meantime, FCI borrows from other sources. This borrowing gets reflected in FCI’s balance sheet, not in the government’s. Voila! The fiscal deficit has been reduced.

  2. By getting Union government schemes financed by state-owned enterprises instead of the government directly. Again, this financing is not a part of the budget itself. For example, Govind Bhattacharjee writes in this excellent piece:

    the Accelerated Irrigation Benefits Programme was financed by NABARD, and capital projects in the rail and power sectors were financed by Indian Railway Finance Corporation and the Power Finance Corporation, respectively.

  3. By forcing public sector units to pay the governments in advance. Regardless of their profits, governments force oil companies to declare dividends ahead of the budget. This money gets reflected as income in the government budget. Voila again! The fiscal deficit has been contained. For context, the government is seeking ₹19,000 crore dividend this year from oil companies. Another variant of this cheating is this:

    some payments like railway freight for the next year are collected in advance from public sector units such as Coal India and NTPC as current receipts.

  4. By changing the definition of deficits. Not all borrowing is bad. If the fiscal deficit is used for capital expenditure it is sustainable up to a point for a growing economy (Domar Rule). What’s evil is borrowing to finance the day-to-day running of the government. Hence, the FRBM Act required the government to make the revenue deficit zero in a specified time period. But why should the government comply? So, they changed the goal post itself in 2011 using a fraud called effective revenue deficit. Effective revenue deficit subtracts from the expenditure side a portion of central grants to state governments used for capital spending. Voila! What a masterstroke.

For more on such tactics, listen in to this episode Anupam & I recorded a while back. Take the deficit numbers with a pinch of salt. And never forget: today’s deficits are tomorrow’s tax hikes.

A Framework a Week: Kingdon’s Three Streams Schema

Tools for thinking about public policy

There’s a powerful narrative in India that policy changes happen only in times of crises. Kingdon’s schema tells us that even a crisis does not ensure reform. Instead, the schema says that the policy window is open for a brief period only when three separate streams of problem, solution, and politics come together.

  1. The Problem Stream: Without an acknowledgement that the problem exists, it can never reach the decision-making agenda of the government. A crisis is a type of problem that forces the government to acknowledge the issue. But it cannot, by itself, cause change. For that to happen, two other conditions need to be satisfied simultaneously.

  2. The Solution Stream: There should be a range of solutions to choose from. Government is unlikely to pick up a policy problem for decision-making unless there are pre-existing solutions in place.

  3. The Political Stream: This comprises of the public mood, dominant societal narratives, election results, and global trends. Change in governments is a great opportunity for reform. No wonder that the most challenging reforms are often picked up earlier in the term.

For an excellent application of this schema in the Indian context, read RV Vaidyanatha Ayyar’s Public Policymaking in India.


Big fish eating small fish = Foreign Policy in action

So Huawei and ZTE have teamed up with multiple telecom operators and submitted applications for 5G trials in India. Lt Gen Prakash Menon and I write in The Telegraph that allowing this is a strategic mistake.

India’s position on the Huawei question should be closer to that of the US and Japan (a ban from 5G critical infrastructure) rather than that of Kenya or the Netherlands (a conditional yes to Huawei). That’s because China is, after all, India’s adversary and its biggest strategic challenge. Given this situation, handing over critical communications infrastructure to companies closely connected with the Chinese party-state does not make any strategic sense.

Even if Huawei is serious about commitment to mitigate security concerns, bestowing an adversary with geopolitical leverage is a poor strategy. Just like India is unlikely to give control of its major ports infrastructure to any Chinese company, our critical communications infrastructure also needs to be guarded.

(Image source: Christoph Scholz on Flickr)

From the economic angle, it’s probably true that banning Huawei and ZTE will result in some economic costs to India and Indians. To reduce this impact, India can consider a two-fold strategy. When it comes to critical network infrastructure, Chinese companies could be banned. On the other hand, India could welcome Huawei/ZTE 5G mobile phones with open arms because cheap 5G phones will benefit crores of Indians.

What needs to be internalised is that the question of 5G network infrastructure is too important an issue to be left to a DoT decision alone. It requires a holistic assessment of security, economic, and strategic concerns and must be taken by the cabinet committee on security. In our view, strategic concerns far outweigh the economic benefits and security fears.

Read the full article here.

India Policy Watch: Democracy vs Republic

Insights on burning policy issues in India

Our democracy is working fine. It’s our republic which has taken a severe beating. On this republic day, let’s just understand the difference between these two terms.

Democracy literally means the “rule of the people”. In reality, it can be defined as the rule of the majority. What constitutes a majority can vary – two-thirds or three-fourths or sometimes even a shade above 50% – but at the bare minimum, democracy means that whatever the majority agrees to will be carried out by the State. In a pure democracy, therefore, the majority rules in all cases, regardless of the consequences for individuals or for those not in the majority. For example, the city-states in ancient Greece were democratic, and so, it was within the laws of the State for Socrates to be killed through a majority sanction. Centuries later, in the JNU case, if a majority of people support the arrest of a student because what he said is “seditious”, it would not violate the principles of democracy per se.

What, then, prevents a majority from using its coercive power against individuals or groups with lesser power all the time? It is the Indian Republic. The Indian Republic prohibits the majority from running roughshod on the basis of its numerical strength. In a Republic like India, the Constitution limits the power of governments and groups, in order to protect the individual’s rights. It is the Republic that grants fundamental rights to individuals to live, work and even protest.

Unfortunately, far too often, the idea of the Republic is disregarded for the idea of democracy. We think of our State as a democratic one instead of as a democratic republic.


Reading and listening recommendations on public policy matters

  1. [Podcast] In this Planet Money episode, the hosts ask economists gathered at the AEA conference one question: what's the most useful idea in economics? Some answers: opportunity cost, comparative advantage, marginal thinking, and lump labour fallacy. Four ideas anyone working in public policy must know.

  2. [Paper] Premature Imitation and India’s Flailing State: Shruti Rajagopalan and Alex Tabarrok argue that presumptive laissez-faire is the optimal form of government for states with limited capacity and also the optimal learning environment for states to grow capacity.

  3. [Book] Twitter and Tear Gas: Zeynep Tufecki’s landmark book on the role of digital media in protests.

  4. [Podcast] In a Puliyabaazi on ये Republic क्या बला है?, we discuss - what does it really mean to be a Republic?

That’s all for the week. If you like this newsletter, please do read and share.

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