#8 User Charges Liberate Local Governments
Defence Pensions, Measuring Net Power, Inter-India Migration, and more
PolicyWTF: Unaffordable defence pensions
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
On Thursday, nearly 800,000 French people protested and disrupted key services across the country in opposition to proposed pension reform. The modestly aimed reform merely aims to consolidate 42 different pension schemes, with variations in retirement age and benefits, into a universal points-based system.
These developments reminded me of how India too is running headlong, ignorantly and avoidably, into defence pensions trouble. Sample this: In FY 2019-20, out of every 1 rupee budgeted for defence, 25 paise will go towards paying pensions alone, a total of ₹1.12 lakh crores. In comparison, only 22 paise will be used for procuring weapons.
Contributing to this increase is the implementation of the One Rank One Pension (OROP) — a defined benefit scheme that resets periodically based on current employee compensation. By agreeing to this demand, the government has committed itself to a perpetually growing liability without a revenue-raising plan to support this expense. In 2015-16, before the OROP was introduced, defence pension expenditure was at ₹54,000 crores. By FY 2019-20, it had more than doubled. Sane & Shah estimate that the net present value of this future liability is nearly 50% of India’s GDP (ignore the stock-vs-flow issues for now).
If I have convinced you that this is a big enough problem, let’s investigate the solutions. Interestingly, India managed to solve its pensions burden problem for non-defence government employees quite smartly. Starting from 2004, the Union government moved its incoming employees in ministries other than the Ministry of Defence to the National Pension System (NPS). NPS is a “defined contribution” scheme, where the pension is paid out of a corpus the employee creates using their own savings in contrast with a “defined benefits” scheme that was prevalent until then.
Why did this move didn’t see the kind of protests in France, you ask? This actually is a masterstroke in public policy stakeholder management. The government did two things. One, the NPS was made applicable only to new recruits which immediately disarmed powerful unions of existing employees. And two, government contribution to the employee pension was seen as a salary hike of 10% by the incoming employees.
So, implementing NPS for incoming defence personnel is the most obvious solution to our current problem but that has a few difficulties (more on this, in this paper). Instead, Gen Prakash Menon and I propose a model for operationalising lateral hiring in other forces within India’s national security system to reduce pension outflow while continuing OROP. We call it the Human Capital Investment Model for India’s National Security System.
Meanwhile, keep a close eye on how the protests in France impact the attempted pension reforms.
A Framework a Week
Tools for thinking about public policy
This week’s framework is an insight from the world of public finance, known as the Wicksellian Connection. The term was coined by Albert Breton based on an idea proposed by Wicksell more than a hundred years ago. The term describes an intuitive idea — the taxes you pay should be closely linked with the services you receive. This clear linkage between expenditure and revenue decisions is known as the Wicksellian connection.
In most Indian cities, we know that this Wicksellian connection is completely broken. There is almost no coincidence between the three circles of budgetary policy: those who decide, those who benefit, and those who pay. Most of the taxes are collected by Union and state governments while spending decisions are to be carried out by local governments. In such a system, there is no way to link the amount of taxes you pay to the local services you get. You are always left wondering: why is the street outside my house always broken even though I keep paying more and more taxes every single year.
Economists Bird & Slack write that there is a way to strengthen the Wicksellian connection in the context of local governments. To bring together the circles of deciders, beneficiaries, and payers, thy advocate three measures:
“Wherever possible, charge”: Financing local services through appropriately designed and implemented user fees provides not only the funds to supply such services but also information on which services should be provided, in what quantity and quality, and to whom.. When consumers are not explicitly charged for consuming a service, the implied value they attach to the last unit they use is approximately zero. When no charge is imposed for a service more of it will be consumed than people would be willing to pay if faced with the real costs of providing the service. Under-pricing -- the free (or subsidized) provision of services – results in over-consumption and all too often leads to subsequent ill-advised investment in more of the same.
A value-based property tax: where user charges are not possible due to the nature of the service provided (such as arterial streets, utility lines, public transit, and recreation facilities), the value people attach to such services should be reflected in property values.
Budgeting and Accountability: unless local governments have some significant degree of freedom to alter the level and composition of their revenues neither local autonomy or local accountability is meaningful. Local governments should not only have access to those revenue sources that they are best equipped to exploit --such as residential property taxes and user charges for local services -- but should be permitted and encouraged to exploit these sources… Accountability works in part through electoral democracy. If local electors do not like what their local government does, or does not do, they can (try to) throw the rascals out at the next election. If they do not do so, local electors should, in a properly designed system, bear the consequences of their inaction. The freedom to make mistakes, and to bear the consequences of one's mistakes, is an important component of local autonomy in any country.
You can find the paper here. It’s an easy and interesting read.
Matsyanyaaya
Big fish eating small fish = Foreign Policy in action
Even though power is a central variable in analysing international relations, we’ve got it all wrong when it actually comes to measuring it. How to get that right is the basis of Michael Beckley’s paper Power of Nations: Measuring What Matters. This paper had several aha! moments and I recommend it to anyone interested in International Relations. The fundamental insights are as follows:
Net disposable power measures are better than gross power measures such as gross domestic product and military spending, that tally states’ wealth and military assets without deducting the costs they pay to police, protect, and serve their people.
Using GDP x GDP per capita as an estimate of the net approach, war and dispute outcomes involving great powers over the past 200 years can be predicted more accurately than those based on gross power indicators. Here, the second term GDP per capita accounts for the costs.
This paradigm of power predicts that China’s rise is overestimated. The net approach suggests that China lags far behind the United States and ‘looks set to do so for the foreseeable future’.
India Policy Watch
Insights on burning policy issues in India
I find India Migration Now’s work on internal migration in India fascinating. For example, this chart from their Twitter handle on inter-state migration flows in India based on the 2011 census is just brilliant.
The key insight from this chart for me was this: an indicator of revealed preferences for migration should be the difference in the positions of a state as a sink and source for migration. Higher the difference, higher is the state’s ability to attract migrants net of emigrants. For example, NCT of Delhi ranks 34th when the ‘sinks’ of migration flows are arranged in ascending order. As a source of migration, it’s rank is 22, giving it a net positive score of 12.
Using this measure throws up interesting results. UP doesn’t seem all that bad on this count. Even though a large number of people emigrate from here, it is also home to large numbers of migrants from the neighbouring states of Bihar and MP. The one outright poor performer on this count is Bihar.
NCT of Delhi, Gujarat, and Maharashtra appear to be the toppers on this net migration score. Interestingly, Kerala, Tamil Nadu, and AP - all three have negative scores contrary to popular imagination while Karnataka fares marginally better.
These results should force us all to reflect on the common-sensical opposition to migration. Overall, migration is a key mechanism for social mobility. Government policies should enable free migration instead of blocking it. In any case, India’s cultural and language barriers already moderate migration flows.
HomeWork
Reading and listening recommendations on public policy matters
[Podcast] JP Narayan and Amit Varma’s chat on Indian politics is unmissable. Inspirational and reflective in equal measure.
In JP’s podcast episode, he refers to two editions of The Economist on India before 1991 and since 1991. These are great reads as well and should be included in all policy courses on India.
Is Inequality Inevitable? Wealth naturally trickles up in free-market economies, a model suggests. So this article challenges my biases. I’m still educating myself on the model.
PRS’ monthly policy review for November 2019 is out. Gives a great overview of the laws under repair.
That’s all for the week, folks. Read and share. 再见 👋