Deeper analysis of negative i.tax

["Dr. Sanjeev Sabhlok" <sanjeev@sabhlokcity.com>]

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Greater analysis, answering many questions on this topic is now at:

../debate/notes.html

entitled, "THE CONSTITUTION OF INDIA AND POVERTY:A PRELIMINARY ANALYSIS."
(Word version)

There is only one major issue that I have not addressed there, the question
from Prof. Nirvikar Singh:

"What about the political acceptability issues for what you propose? Can
the policy be formulated to be acceptable to legislators and implementers,
and to work in practice?"

The text version is below. Please critique it thoroughly. Grateful for your
interest in this crucial topic. Sanjeev

THE CONSTITUTION OF INDIA AND POVERTY:
A PRELIMINARY ANALYSIS.

Dr. Sanjeev Sabhlok, 24.5.2000 (for discussion)

1.	Introduction
Rarely is an attempt made to understand the constitutional role of
Government in terms of poverty alleviation and the large number of
programmes which are currently in place, allegedly to minimize poverty. In
this note I compare the actual position on the ground with the
constitutional commitments and implications, and show that the Government
can do much more, more fairly, and with less expenditure.

2.	Equality under the Constitution
Our Constitution guarantees equality of opportunity under the Preamble. In
addition, Article 39(c) specifies that the State shall attempt to secure
"that the operation of the economic system does not result in the
concentration of wealth and means of production to the common detriment".

No matter how many differences exist amongst competing ideologies with
regard to the action to be taken to reduce inequality, nobody would deny
that elimination of poverty is the first definitive step towards achieving
this goal. Both status and opportunity are significantly compromised when
there is chronic hunger in a household. When even one such family is hungry
in India while others are not, that constitutes an untenable level of
inequality. All other implications of inequality are secondary. Bonded
labour, child labour, oppression of the weaker sections, etc., arise from
this complete lack of control over economic resources by those below the
poverty line. Indeed, my research also shows  that poorer parents are less
likely to want to educate their children, thus setting up the famous
"vicious cycle of poverty".

But for unfathomable reasons, in policy circles, we speak less of
elimination of poverty than income redistribution including asset
redistribution. The concept of equality leads us to the progressive income
tax system, land reforms, rural development programmes, etc., and stops
there. Unfortunately, a close look at these programmes shows how miserably
they perform with regard to achieving the basic principles of
constitutional equality.

3.	Rural Development Programmes
	The fundamental weakness of programmes like IRDP is that these distinguish
or select amongst the poor. Too few people are selected each year for the
subsidies provided under IRDP, and even under ideal conditions (of no
leakage of funds and complete success in achieving productive income by the
poor), it would take well over a few hundred years to eliminate poverty in
India. In reality, given the high administrative cost, enormous leakages
and corruption, the poor frequently become further indebted, exacerbating
their poverty.

	On comparing with the Constitutional provisions on equality, a fundamental
implication is that the State cannot distinguish amongst the poor. The poor
cannot wait for two hundred years for the benevolence of the Rural
Development Department or others to reach them. Every year, without fail,
it is the obligation of Government to eliminate poverty, irrespective of
caste, tribe, sex or age.

In fact, it is unjust, even atrocious, for the Government to subsidize the
well-being of the middle-classes, who are today given the benefits of huge
subsidies in power, transportation, PDS, etc., while poverty continues
unabated across the country.

	The utilitarian principle makes the welfare implications of current
policies even more clear. The marginal utility of a rupee to the very poor
is much higher than to those above the poverty line. In other words, each
rupee spent directly on the poor provides the greatest total utility and
welfare to the country than by spending it on those richer. Accordingly,
the negative income tax scheme (NIT), as per Annexure I, which completely
eradicates poverty and provides a basic level of human dignity, is the most
justifiable, based on all definitions of equality, whether neo-classical,
utilitarian, Marxist, or any other.

Subsidies to any one above the poverty line should only be envisaged after
all the poor are lifted above poverty line. None, even entrepreneurs of IT,
can be subsidized until poverty is eliminated. Our Constitution does not
allow it.

4.	Land Reforms
Before we proceed to advocate the negative income tax scheme as the
principle method of poverty elimination, we must find out why direct asset
re-distribution through land reforms has failed in India and whether such
asset distribution could possibly fulfil the constitutional obligation.
Land reform in India has been perennially beset with the moral hazard
problem whereby transfer was more likely to be of low yielding assets (poor
quality land). Despite this, most of these assets were relatively of higher
value than the assets possessed by the poor to whom these were to be
transferred. Given our political-administrative structure, rent-seeking
behaviour found its way into this value differential. In the end, land
reforms remained primarily on paper. But I believe that land reform would
have still fallen far short of the massive requirement of asset transfer
for the final elimination of poverty even under ideal conditions. Finally,
and more importantly this strategy suffers from the fundamental defect of
violation of property rights and thus of liberty, and therefore should be
abandoned.

Negative income tax faces none of these problems, for it transfers national
wealth from all sources, without discrimination, to all the poor, every
year. Given the small size of the individual transfers, rent seeking is
also not likely to enter in this area.

5.	Micro-credit
Negative Income Tax (NIT) is not related to the continuance of commercial
micro-credit and micro-insurance programmes. Once negative income tax comes
into force, micro-credit can continue as before, perhaps on a much more
commercial basis, where each project is evaluated strictly on merit since
there will be no subsidies to credit.

6.	Human Capital Formation
It is likely that the application of the negative income tax scheme would
give a major boost to human capital formation as poor parents would be able
to invest more in the education of their children, and need their services
marginally less than before, in managing their productive assets such as
land and cattle.

7.	Welfare Schemes
	In addition to the above, there are a large number of schemes being
implemented in the states in order to provide certain basic minimum
services to the people. For example, in Meghalaya, the Rural Housing Scheme
provides for CGI sheets worth Rs.10,000 each to about 4,000 families each
year, in order to help upgrade the thatched roof of their house. This has
the following defects: (a) It helps a few of the poor, not all, and (b) It
provides assistance much in excess to that which would have lifted the
concerned family above poverty line; i.e. it provides excessive assistance
to too few. Such schemes have to be completely abolished. Once a family is
lifted above the poverty line through the NIT, the constitutional
obligations of Government with regard to equality practically come to an end.

7.	The long-term cure of poverty
I must add explicitly and make clear that under no circumstance do I argue
for the direct income transfer approach as the permanent solution to the
poverty problem. It is only with reference to the existing subsidy route
that I feel direct transfers are more efficient and constitutionally
justifiable. My view is that most of the poverty we continue to see in
India is system induced. That is one more reason to compensate the
perennial losers generated by our system.

In the medium and long run there is no better mechanism than good
governance and sound economic policies . System reform will help bring down
absolute poverty successively through the years. In particular, market
reform will eliminate barriers to trade in agriculture, generate demand for
skilled labour and absorb surplus rural labour, and enable basic goods to
reach at the doorsteps of the poor who will then be able to purchase the
same. Simplistically speaking, growth will break the backbone of poverty.
Strategies to promote growth are in no way less important than the direct
transfers envisaged here. What direct transfers will ensure is that we do
not have to carry the needless burden of acute poverty on our shoulders,
and go around the world begging bowl in hand.

8.	Conclusion
Objections received so far to the Negative Income Tax scheme have been
dealt with in Annexure I. Further debate and analysis on this note will be
much appreciated. If benefits are fully evaluated and objections disposed
of, NIT could then be adopted as the only Constitutionally valid scheme of
income re-distribution. It will save us many thousands crores, and make
equality, quaranteed under the Constitution, a reality.

Since Meghalaya is a small and relatively well-administered State, it is
suggested that Rs. 40-50 crores can be allotted for this State to launch a
Pilot Project for direct elimination of poverty, after due preparation. It
may be mentioned here that the middle classes in Meghalaya are hugely
pampered. Public sector undertakings in fields such as electricity, hotels,
buses, housing finance, etc., are making losses which possibly exceed the
amount required to eliminate poverty in Meghalaya. If we add the other
forms of pampering of the rich and middle classes in the name of the poor,
and the wastage of funds allegedly spent on poverty alleviation (I am not
counting the leakages to the wealthy through contractors), the amount
available which can be fruitfully spent to eliminate poverty. Elimination
of poverty will also ease social tensions and reduce the amount required to
be spent on Police.


 ANNEXURE I
THE NEGATIVE INCOME TAX (NIT) SCHEME

1.	The proposal

Preliminary analysis of poverty elimination in India through direct
(negative) income tax is available at
../debate/Notes/poverty-tax.xls (Excel document)
linked at ../debate/notes.html. Analysis shows that
ALL poverty in India can be eliminated by targeting payments to the poor at
a cost is approximately Rs. 26,000 crores annually,  @ Rs.650 per capita
average annual payout to those below poverty line [this cost is subject to
further verification and is likely to be lower].  Currently, subsidies
exceed this requirement by a wide margin and ought to go immediately.

2.	Methodology of implementation

If it is conceded that direct elimination of poverty is at least
theoretically a more economical option than giving subsidies to various
activities which frequently are vulnerable to leakages,  then the first
question before us becomes: what practical methodology can be used for the
direct elimination of poverty in India? There can be more than one
alternative strategy for implementing the desired direct transfer. One such
is proposed below.

2.1	Underlying Mechanism

Underlying this mechanism of direct transfer is the filing of income tax
returns by all households across the country. It may be pointed out that
another positive spin-off of this methodology is that income tax
collections in the country will increase as the wealthier farmers begin to
pay tax, reducing the net cost of poverty elimination. Since the income tax
department is currently ill-equipped to handle such a large scale
operation, the task can be delegated through an MOU to State governments,
which usually command a vast army of civil officials at the village level.

2.2	Identification of the Poor

State Governments possesses a considerable complement of "field" staff,
such as village level workers belonging to the Education, Land Revenue,
Agriculture, Food and Civil Supplies, Rural Development, and other
departments. On a similar pattern to the Census Operation, an Income Tax
operation can be organized each year by the State Governments. It is
suggested that the voters list be used as the basis of the identification
process, as was done in Dhubri District in 1986-87 and beyond by me, as
Project Director, DRDA (details are in the book, "Dhubri Advanced
Information System", published by D.R.D.A. Dhubri in 1988). Suitable, easy
to fill forms can be designed to capture the required information. A
specialized training programme will have to be organized thereafter. It is
necessary to bear in mind that perfection cannot be expected in the
estimation of household income, and suitable proxies may have to be used.
Also a crosscheck in the field would have to be made by senior officers.
The data so collected can be transferred into computers at the Block level
(where computers are now being made available through the Ministry of I.T.)
or at the Sub-Divisional/District level, or given to private data entry
operators for entry, if necessary, in a prescribed software.

2.3	Payments to the poor

The computerized data and forms can then be sent to the Income Tax Office
at the State Capital where it will be a matter of a few hours or days to
process the data and identify not only the poor but to "net out" transfers
needed at the household level, and issue a printed statement to the banks
at the State headquarters, with authorization to credit the accounts of
such persons in the amount necessary to bring the concerned family just
above the poverty line.

Nationalized banks today have tens of thousand of branches operating widely
across the nation. Virtually all branches have the experience of dealing
with the illiterate poor. Many of them operate old-age pensions, rural
development loans, and other accounts. There is also no difficulty in
principle in banks and field functionaries of the State Government helping
all the poor in the country open accounts with designated Bank branches.
Further, discussions with Bankers indicate that there is no leakage/
corruption at the Teller's window, i.e.,  the Banks are not likely to cheat
at the time of disbursing this money to the account holders.

3.	Addressing various concerns

The matter has been discussed over e-mail with various persons, including
Dr. Pronab Sen, Advisor, Planning Commission, and Swaminathan S. Anklesaria
Aiyar, Consulting Editor, Economic Times. Dealt with below are a few of the
concerns raised, along with a possible response.

3.1	Recalculation of Poverty Lines:

Dr. P. Sen feels that "all direct transfers will have to be netted out,
preferably at the individual or household level, and the poverty lines will
have to be recalculated to correct for all forms of commodity subsidies,
particularly food subsidies."

Thus poverty lines will have to be recalculated to correct for all forms of
commodity subsidies. Depending in the methodology used to calculate the
poverty line, this should be done, but in no way does it detract from the
basic argument in favour of direct transfer. The poor, howsoever defined,
must be lifted by specific targetting, above the poverty line.

3.2	Estimation of the change in production and hence in resources available
for consumption at the field level:

Dr. P. Sen also feels: "the short run effects of removal of other
subsidies, ie. those on production goods, would need to be estimated as far
as production is concerned, and then on consumption expenditure. This is
not a trivial exercise at all."

The major production subsidy relevant to the poor is fertilizer subsidy. It
is quite likely that the bulk of this subsidy is availed by those above
poverty line. The marginal reduction in income of these people can have two
adverse effects: (a) A few villagers might directly fall below the poverty
line and (b) less money would circulate within the village, thus marginally
reducing the price of goods and services offered by those below the poverty
line, thus enhancing their poverty. The overall impact on the incomes of
the poor 40% of the population is likely to be very small, though.

But note carefully that direct transfer being made at the end of the year,
the actual income in the preceding year is to be considered, rather than
the prospective income. This leads us to the following strategy. Let all
subsidies continue as usual in Year 1. The possible ill-effects of
elimination of subsidy would not be observed during Year 1. Let the survey
of Year 1 income be done at the beginning of Year 2. Subsidy is eliminated
in Year 2. By June-July of Year 2 the direct transfers would have all taken
place. While the vast majority is lifted above the poverty at the beginning
of Year 2, some new poor might emerge in Year 2. These poor would be at the
upper fringe of those below poverty line. In Year 3, all would be finally
and completely lifted out of poverty, on a regular basis. Even if subsidy
is removed in Year 1, when we have not succeeded in eliminating poverty for
50 years, one more year of a slightly higher poverty will not matter so
long as all poverty is subsequently eliminated.

Since the adverse impact of removal of subsidies can be made to be minimal,
and the positive effect of direct transfer is enormous, the concern against
direct transfer is not sustainable.

3.3	Magnitude of administrative effort:

Shri Aiyar points out that "Ideally, every Indian should have a personal
identification number (like the social security number in the USA) which
has to be mentioned for all important purposes like voter registration,
driving and other licences, taxes, bank accounts and the like. That creates
a  system that can  keep track of the poor and discover leakages and fraud.
It is an enormous administrative undertaking, and fraud is rampant even in
the US. Of course, the leakages are surely higher in various subsidy
schemes in India, where the non-poor probably get 80 per cent of all
benefits."

This is essentially correct. If we are to introduce and maintain a negative
income tax programme, a large administrative effort is needed. However, as
already pointed out above, State Governments are perfectly capable of
providing the necessary administrative infrastructure for  identification
of the poor. Even after subsidies are eliminated and departments such as
Food and Civil Supplies, Agriculture, Rural Development, etc., partially
disbanded, there would still be more than adequate man power to carry out
the operation at minimal expense. There is therefore no need, in my view,
to contemplate the creation of another organization on the pattern of the
Social Security Administration of USA.

The Income Tax Department can independently verify about 1% of the total
cases, to ensure cross checking and to impose penalties on those who have
filed excessively incorrect returns. As far as assigning an ID No. is
concerned, that can also be delegated to the State Governments, and a Smart
Card suitable for Indian conditions created which would serve the
multifarious purposes mentioned by Mr. Aiyar (Dr. Seshagiri, retd. DG, NIC
had worked on its conceptualization 10 years ago).

3.4	Crowding out of private transfers:

Sh. Aiyar feels that "The second non-trivial issue is that poor people get
money today from relatives and extended social groups (like the biradari).
Once the centre steps in, these private transfers to the poor will dry up.
Some research suggests that private transfers can be quite appreciable. I
would hate to destroy private forms of distress alleviation and substitute
it by a leaky bureaucratic effort."

While not directly commenting on the research which apparently exists in
the area of private transfers to the poor and with which I am unfortunately
not familiar, I suspect that many of these transfers create unequal
relationships, more on the pattern of bonded labour, and in any case these
transfers are possibly contingent on the expectation of realization of
future services (as in the jajmani system) or function as implicit
insurance contracts. My suspicion is also that these private transfers vary
across communities. There could be some, such as the Sikhs where these
transfers help alleviate poverty considerably, as also in certain tribal
areas. However, on average, given the magnitude of the problem of poverty
in India, I suspect that such transfers have played a minimal role in
alleviation of poverty. Had it been otherwise, the percentage of the
population below poverty line would not have remained practically static
for so many decades.

On the concern about drying up of these transfers, on commencement of
direct disbursal of transfers from Government, the case is much less
strong. The indirect transfers allegedly made to the poor at present,
through various subsidies, exceed by far the direct transfers which are
being now envisaged. Therefore there is (possibly an absurd)
counter-argument that private transfers might actually increase. While not
discounting Mr. Aiyar's argument entirely, I believe that the negative
effects, if any, of the possible drying up of such private transfers can be
easily mitigated, as in the case of the negative effects of withdrawal of
fertilizers subsidy, as discussed in 3.2.

3.5	Local bodies:

Sh. Aiyar feels: "Every gram panchayat can be give given a cash allowance
for relief to the five poorest families. There will have to be open
discussion at a gram sabha on who are the most worthy beneficiaries. This
was indeed tried in the old Antodaya scheme. It's less ambitous than you
negative income tax scheme but much easier to implement. It will reach
people who cannot participate in rural employment programs (the aged, very
young, sick and crippled). I suspect this might alleviate half the existing
poverty without totally destroying private transfer mechanisms."

There is no dispute whatsoever in involving Gram Panchayats in the process
of identification of the poor. However, to give relief to only a few is not
satisfactory solution. Poverty has to go. Period.

3.6	Politics and bureaucracy:

Sh. Aiyar feels, "The real problem in focusing subsidies on the poor in
democracy. Democracies are majoritarian, not egalitarian. A subsidy that
reaches only the bottom 30 per cent will have less popular appeal than a
subsidy which reaches 70 per cent of a targeted section of the population
like farmers or urban dwellers. What economists call "leakage to the
non-poor" is not leakage at all from the politician's viewpoint, but
accurate targeting!"

In my firm opinion, far greater barriers in the way of implementing NIT
would arise from the bureaucracy which dislikes giving up its empires in
the fields of fertilizer, PDS, power, transportation, etc., than from the
politicians. For 50 years, the Planning Commission, representing the vested
interests of a grossly inflated bureaucracy, has not once advised
politicians about the implications of such direct transfers. When the
so-called experts are busy defending the current system, our attempt to
blame politicians for possible resistance to a programme which was never
proposed to them, would be grossly unfair. I believe that the politician
who first comes out with this scheme of direct transfers would gain
longevity and popularity. I am convinced that resistance would primarily
come from senior bureaucrats and not from Ministers.

3.7	Effect on work incentives:

There is another area of concern which could arise consequent to direct
transfers: that of reduction in the work incentives of the poor. There is
surely a small percentage of the poor who are not poor because of natural
causes or due to our socialistic policies, but because of their own vices
and bad habits. I do not deny that a small segment of the country's
population would perennially remain poor, much on the pattern of drug
addicts of USA. To minimize the possibility of adding to this 'natural'
population of the poor, the Income Tax Department should phase out the
negative income tax over the years. Thus Mr. X receives 100% of the
transfer needed to bring him above poverty line in Year 1, but would
receive successively smaller percentages over the subsequent years.

3.8	Rationality and Misuse of cash grants:

One of the objections to the NIT could be that the very poor are unable to
decide for themselves what is good for them. Additionally, due to the power
differentials within households, at least some of the cash could be
transfered into purchase of alcohol, thus increasing poverty.

The reply is two fold. Except for the difference in knowledge, i.e., a
difference in the utility function, as well as a difference in the
opportunity set, there is no difference in the optimizing behaviour between
the rich and the poor. The poor have managed to survive for decades in free
India at levels of support from government which can at best be described
as minimal. To doubt their rationality will be extremely unfair to them.

Second, the analysis of food-stamps in USA1 shows that the program in no
way benefits everyone to the extent desired. There is a roaring market for
food-stamps in USA in which the "excess" food-stamps are sold at 80% of
their value to others. Except in the rarest of cases, therefore direct cash
grant is far more beneficial.







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