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Universal Basic Income in Developing Countries: Issues, Options, and Illustration for India

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WP/18/174
Universal Basic Income in Developing Countries:
Issues, Options, and Illustration for India
by David Coady and Delphine Prady
©International Monetary Fund. Not for Redistribution
© 2018 International Monetary Fund WP/18/174
IMF Working Paper
Fiscal Affairs Department
Universal Basic Income in Developing Countries: Issues, Options, and Illustration for India
Prepared by David Coady and Delphine Prady
July 2018
Abstract
This paper discusses two common arguments for the adoption of a UBI: that it can be a more
effective way of supporting low-income households when existing safety net programs are
inefficient, and that it can generate broad support for structural reforms. Using India as an
illustration, the paper discusses the trade-offs that need to be recognized in adopting a UBI in
these contexts. It shows that replacing the 2011 Public Distribution System (PDS) with a UBI
results in welfare losses for many low-income households, although much of this can be reduced
by returning the PDS operational losses and the fiscal savings from excluding the highest-income
groups to households as higher UBI transfers. In contrast, replacing inefficient energy subsidies
raising energy prices to efficient—could simultaneously deliver unambiguous distributional gains,
help address fiscal pressures, and improve energy efficiency with associated environmental and
health gains. Realizing such reforms would, of course, require careful communication and
implementation to address political and social barriers to reform.
Keywords: Universal basic income, safety net reform, efficient energy pricing, distributional gains
JEL Codes: H23, H53
Author’s E-Mail Addresses: dcoady@imf.org; dprady@imf.org
IMF Working Papers describe research in progress by the author(s) and are published to elicit
comments and to encourage debate. The views expressed in IMF Working Papers are those of the
author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF
management.
©International Monetary Fund. Not for Redistribution
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Contents Page
Abstract ................................................................................................................................................................................. 2
I. Introduction ..................................................................................................................................................................... 4
II. Replacing an Inefficient Social Safety Net .......................................................................................................... 5
III. Building Support for Structural Reform: Efficient Energy Pricing .......................................................... 10
IV. Energy Subsidy Reforms In India in Recent Years ....................................................................................... 12
V. Summary and Conclusions .................................................................................................................................... 14
References ......................................................................................................................................................................... 16
Figures
1. PDS Coverage, Targeting, and Generosity Across Deciles ............................................................................ 7
2. Gains and Losses from Substituting a UBI for the PDS .................................................................................. 8
3. Gains and Losses from Substituting a UBI for the PDS (with Efficiency Gains)..................................... 9
4. Energy Subsidy Across Deciles ............................................................................................................................. 11
5. Energy Subsidy Targeting and Generosity Across Deciles ......................................................................... 12
6. Gains and Losses from Substituting a UBI for Energy Subsidies ............................................................. 13
Appendix
1. PDS and Energy Subsidy Estimates .................................................................................................................... 18
Appendix Tables
1. Average Budget Shares for Rice, Wheat, Sugar, and Kerosene ............................................................... 18
2. Average Budget Shares for Energy Products .................................................................................................. 20
Appendix Figures
1. Average Household PDS Subsidy ........................................................................................................................ 19
2. Average Household Direct (D) and Indirect (I) Effects of Energy Subsidy ........................................... 20
©International Monetary Fund. Not for Redistribution
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I. INTRODUCTION
The idea of a universal basic income (UBI) is attracting growing attention among academics,
policy makers and the wider public. This paper discusses two common arguments used to
motivate the adoption of a UBI. First, it is often argued that the UBI can be a more effective way
of supporting low-income households when existing income support programs are inefficient
and the source of these inefficiencies (such as administrative constraints) cannot be easily
addressed over the short term. Second, it is argued that the UBI can play an important role in
generating public and political support for the implementation of structural reforms in support of
economic growth by mitigating the adverse impact of these reforms on households, especially
low-income and middle-income households. This paper discusses these two motivations using
India as an illustration, highlighting the important trade-offs that need to be carefully managed if
a UBI is adopted in these contexts.1
The potential advantages of adopting a UBI in India to replace existing food and energy
subsidies have been widely debated in recent years. For instance, in January 2017, a full chapter
of the 2016/17 Economic Survey (Government of India, 2017a) was devoted to a discussion of
the merits and challenges of adopting a UBI as an alternative to the existing system of food and
energy subsidies.2 These subsidies are typically characterized as fraught with inefficiencies and
inequities. Numerous studies have documented their incomplete coverage of the poor, the
extensive leakage of benefits to the rich, significant operational inefficiencies, and high potential
for fraud and corruption. However, reform of these subsidies is hindered by concerns for the
possible adverse impact on households, especially low-income households. This paper evaluates
how the adoption of a UBI could potentially help address the shortcomings of existing subsidies
as well as the underlying concerns about the adverse impact of their removal on low-income
households, and discusses the trade-offs that arise in replacing them with a UBI.
The paper starts by discussing the adoption of a UBI as a substitute for the Public Distribution
System (PDS), which provides income support to households through price subsidies for wheat,
rice, sugar and kerosene consumption. It then discusses the introduction of a UBI as part of an
ambitious structural reform program centered around increasing energy prices to efficient levels
that reflect the true social cost of energy consumption, associated with domestic pollution,
congestion and global warming.3 Reflecting data availability, our analysis is anchored in
2011 using the Indian 201112 National Sample Survey (NSS), which suffices given the illustrative
nature of the analysis. However, to provide a real world context and flag potential administrative
and political challenges that may arise in adopting a UBI and ensuring it has universal coverage,
1 For a discussion of the differing principles underlying various arguments in favor or against a UBI, see IMF
(2017a); and Atkinson (2015) and Emery, Fleisch and McIntyre (2013) for broader discussion of the potential role
for a UBI and implementation challenges.
2 Khosla (2018) provides an overview of UBI proposals in India, along with a critical assessment of estimates and
policy recommendations in Government of India (2017a). Other papers on UBI in India include Davala and others
(2015), Joshi (2016), Government of India (2018), Drèze (2017), and Sandefur (2017). See also IMF (2017b) for a
review of different options and associated fiscal cost.
3 For an analysis of alternative reform options to adopting a UBI, including a targeted (and possibly conditioned)
cash transfer program, see Abdallah and others (2015)
©International Monetary Fund. Not for Redistribution
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the paper also discusses the numerous important subsidy reforms that have more recently been
introduced in India and recent safety net reform initiatives. A key feature of the analysis in the
paper is the focus on fiscally neutral reforms to help bring out the important trade-offs between
various policy objectives and to abstract from other possible concerns about the adoption of a
UBI, such as the unintended crowding out of growth enhancing public expenditures (e.g., public
investments in infrastructure, education, health and nutrition; Sen 1992). In all simulations, the UBI
has a simple design whereby every individual in the population receives an unconditional uniform
cash transfer, with the common transfer level set to fully exhaust the fiscal gains from subsidy
reforms.
II. REPLACING AN INEFFICIENT SOCIAL SAFETY NET
The public distribution system dates back to the 1960’s when it aimed at containing food prices
and ensuring food access to urban consumers through a system of ration cards that entitled
holders to a fixed quantity of food and fuel (kerosene) at subsidized prices through a network of
Fair Price Shops (FPSs). Subsequently, the system was scaled up to also cover the rural
population. It was also extensively reformed on several occasions. In 1992, the Revamped Public
Distribution System (RPDS) was launched to strengthen coverage in very remote areas with high
concentrations of poor households. In 1997, the Targeted Public Distribution System (TPDS) was
launched, replacing the existing PDS, and states were required to formulate and implement
effective arrangements for the partitioning of households into above and below the poverty
linethe former holding an above-poverty-line card (APL) entitling them to lower quantities of
subsidized food than the latter holding a below-poverty-line card (BPL). In 2001, an additional
layer of targeting was added to reach the poorest of the poor with larger benefits, designated as
the "Antyodaya Anna Yojana” (AAY).
In 2013, the implementation of the National Food Security Act (NFSA) transformed the TPDS, in
principle disconnecting eligibility and entitlements to PDS subsidized goods from poverty status
(i.e., ostensibly a shift from a welfare approach towards a rights-based approach). Under NFSA,
the PDS should cover up to 75 percent of the rural population and up to 50 percent of the urban
population, with every eligible beneficiary entitled to receive five kilograms of food grain at a
highly subsidized price, but with higher entitlements for AAY families.
The operation of the TPDS requires extensive government interaction along the complete food
chain. Under the TPDS, the Central Government, through several ministries and agencies
(including the Food Corporation of India), is responsible for procurement, storage, transportation
and bulk allocation of wheat, rice, sugar and kerosene to State Governments. The Central
Government sets the quantities that each state must supply to the central pool, the quota that
each state is entitled to draw from it, and the minimum price to be paid to traders and millers for
the quantities supplied to the system. The State Governments are responsible for actual
procurement, the identification of eligible families, issuing of ration cards, setting of ration prices,
and supervision of the functioning of FPSs.
©International Monetary Fund. Not for Redistribution
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Our analysis below is based on the 201112 National Sample Survey (NSS), i.e., prior to the
introduction of the NFSA.4 It also adopts a national perspective that abstracts from the wide
disparities in the implementation of the PDS across different Indian states before 2013 (Basu and
Das, 2015). Indeed, between 2011 and 2013, certain states bypassed the distinction between APL
and BPL holders, in effect largely expanding the PDS coverage. For instance, 90 percent of
households consume rice from the PDS in Tamil Nadu where the state enforces a near-universal
PDS, while around 45 percent of households consume PDS rice in Maharashtra where the state
enforces stricter eligibility criteria, including a lower income threshold and exclusion of certain
socio-economic categories like government employees. Furthermore, certain states have reduced
the price of subsidized goods below the prices issued by the central government, generating
wide variations in the generosity of implicit income transfers. For instance, these subsidies can
reach around 220 rupees/month/household in Tamil Nadu where the state PDS grain was free in
2011, compared to around 60 rupees/month/household in Maharashtra.
Although the functioning of the system varies widely across states, systemic inefficiencies have
been extensively documented. The Indian Ministry of Finance estimates that 36 percent of total
PDS allocation never reaches final beneficiaries because of “out-of-system” leakages along the
procurement-transportation-distribution chain (Ministry of Finance, Government of India, 2017a).
More specifically, taking kerosene as an example, there is an estimated 41 percent gap between
the total PDS subsidized kerosene allocation by the Central Government and actual household
consumption as captured by the 201112 NSS (Ministry of Finance, Government of India, 2016).
Furthermore, despite its broad coverage of the population, sizeable under-coverage of lower-
income groups still exists under the PDS. Based on NSS 201112, approximately 20 percent of
households in each of the bottom two income quintiles do not receive any benefits (Figure 1a).
At the same time, a large proportion of higher-income deciles receives PDS subsidies, with the
richest 40 percent of households receiving 35 percent of total PDS subsidies (Figure 1b). Because
of this under-coverage and leakage, most income deciles receive similar shares of total PDS
benefits, which would also be the outcome under a UBI program. Therefore, substituting a UBI
for the current PDS would be expected to generate only a mild tradeoff between coverage and
targeting of the bottom income deciles.
Figure 1 also shows how the performance of the PDS compares to a UBI in terms of coverage,
targeting and progressivity. A UBI would outperform the 2011 TPDS program in terms of
coverage of lower income groups (Figure 1a) since, by design, it covers all households. However,
improved coverage under the UBI comes at the expense of a slight deterioration in benefit
targeting and generosity at the bottom (due to greater leakage of benefits to top income
groups; Figure 1b and 1c). A UBI would leave benefit progressivity virtually unchanged (Figure
1c).
4 See Appendix for the methodology underlying the benefits households receive from PDS and energy subsidies.
Net benefits from reforms are calculated as the level of the UBI minus these subsidy benefits.
©International Monetary Fund. Not for Redistribution
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Figure 1. PDS Coverage, Targeting, and Generosity Across Deciles
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure. Coverage of PDS proxied by the percentage of households reporting they hold and
use a ration card. Targeting is defined as the distribution of total PDS spending across income deciles. Generosity is the average
share of PDS subsidy in household total expenditure, among all households in a decile.
©International Monetary Fund. Not for Redistribution
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Replacing the PDS with a UBI would redistribute benefits within as well as across income deciles.
On average, 50 percent of households in the bottom four income deciles would face a 6 percent
welfare loss, while the other 50 percent would gain 3 percent (Figures 2).5 However, to the extent
that the elimination of the PDS would also eliminate its inherent operational (so-called “out-of-
system”) inefficiencies, and that these result in public expenditure savings, these savings could be
returned to households as a more generous UBI and this in turn would help to mitigate the losses
incurred by some households in lower income deciles. It has been estimated that 36 percent of
PDS total spending never reaches the intended households (Ministry of Finance, Government of
India, 2017a) due to the existence of “ghost beneficiaries” and the large illegal diversion of
subsidized goods resold on the open market. That is, out of every 100 Rupees spent on the
program, only 64 reaches households. In conjunction with the switch to cash (as opposed to in-
kind) transfers, the ongoing use of the improved identification technology of the Aadhaar
biometric citizen registry could be instrumental in realizing these additional efficiency savings.
Figure 2. Gains and Losses from Substituting a UBI for the PDS
a) Share of Losing/Gaining Households b) Average Losses and Gains
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure. Average losses and gains are computed among losing and gaining households.
Figure 3 demonstrates the impact of recycling the estimated expenditure savings of 36 percent
through an increase in the UBI, equivalent to a 55 percent increase in the uniform transfer (i.e.,
36 divided by 64). This would have the effect of reducing the number of losers in the bottom four
income deciles to below 40 percent, bringing down the average share of losers in the bottom
four income deciles from about one half to a third (Figure 3a). The increase in UBI generosity
would also reinforce the gains for other households, on average from 3 to 5 percent in the
bottom four income deciles (Figure 3b).
The losses for some households could also be further reduced by relaxing the objective of
universality by somehow excluding the top income groups from the UBI.6 For example,
reallocating UBI transfers going to households in the top three income deciles, on top of the
5 Note that the households with the largest losses will, by design, be those who had the largest benefits under
the PDS.
6 This possibility has also been discussed in the context of the UBI in India (Ministry of Finance, Government of
India, 2017a). An alternative would be to increase income tax rates at the top of the income distribution.
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efficiency gains, would result in a 42 percent increase in the per capita level of UBI for the rest of
the population and reduce the proportion of losers in the bottom four deciles by 28 percent
(from an average of 50 to 22 percent).
Figure 3. Gains and Losses from Substituting a UBI for the PDS (with Efficiency Gains)
a) Share of Losing/Gaining Households b) Average Losses and Gains
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure. Average losses and gains are computed among losing and gaining
households.
Further analysis of the losers at the bottom of the income distribution could help design specific
programs targeting these households. Losing households at the bottom four income deciles
receive larger PDS subsidies, around 45 percent higher than the level received by other
beneficiary households. The probability of being a loser in the bottom four deciles varies
substantially across states, with a higher probability in the states of Delhi, Manipur, Gujarat,
Daman and Diu, and Nagaland. Urban and large households with a greater share of youth and
elderly also appear to have a higher probability of losing from the PDS transformation into a UBI.
Other programs, such as a targeted conditional cash transfer (CCT) program that links benefit
eligibility to households investing in the education, health and nutrition status of their children,
could further help to address these losses.
The transformation of the current in-kind PDS program into a universal cash transfer would also
entail administrative and political implementation challenges that need to be carefully
considered. While a cash transfer system is likely to be much simpler to administer than the PDS7,
especially with the recent rolling out of the Aadhar identity system nationwide, it would still
require ensuring an effective network for transferring money directly to households across the
country.8 The Indian authorities could build on their recent experience in transforming Liquefied
Petroleum Gas (LPG) price subsidy program. In 2014, in a number of pilot districts, the
government replaced the existing LPG subsidy program based on the distribution of subsidized
7 See Currie and Gahvari (2008) for a review of arguments advanced for in-kind vs. cash transfers.
8 Increased take-up costs for households in remote areas without bank access, and transition costs (e.g.,
disruption, learning about a new system, changes in consumption behaviors, etc.) from dismantling an old
program, should be accounted for in the communication strategy, and the design of complementary measures to
address these issues (Khera, 2014).
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LPG cylinders with a cash transfer scheme (the PAHAL Scheme, or Direct Benefit Transfer for LPG
(DBTL) program), leveraging increasing household access to bank and mobile services, coupled
with the Aadhaar biometric identification.9 The objective was to eliminate ghost beneficiaries
through better identification of actual consumers and to discourage diversion of subsidized LPG
to the market for higher prices. Prior to the reform, beneficiary households were entitled to
purchase annually up to twelve subsidized LPG cylinders from designated supply depots. Under
the new regime, beneficiaries pay the market price for their LPG but receive the price difference
between the market and subsidized prices as a direct transfer to their bank account.
Unlike a UBI, this reform requires not only the effective identification of LPG consumers but also
the quantity consumed. In 2015, the DBTL was expanded to all districts in India and by 20167
the share of LPG subsidies allocated through the DBTL program was reported to be 58 percent.
To reduce the cost of the program and improve its targeting, the government publicly
encouraged well-off households to give up their subsidy entitlement (the so-called “give-it-up”
movement), with the option to switch back to the subsidy one year after giving up. While this
initially created additional fiscal space, the number of consumers switching back to the subsidy
after giving it up is increasing as unsubsidized LPG prices trend upwards.10
III. BUILDING SUPPORT FOR STRUCTURAL REFORM: EFFICIENT ENERGY PRICING
Despite recent reforms aimed at phasing out energy subsidies, energy prices in India are still
below their efficient levels. Efficient pricing of energy products (gasoline, diesel, coal, LPG and
kerosene) requires that consumers (i.e., households and firms) face a price that reflects three
different components: a supply cost (i.e., the opportunity cost to a country of supplying the
energy product to consumers), a standard consumption tax to contribute towards revenue-
raising objectives, and a Pigouvian tax to internalize energy consumption externalities (Coady
and others, 2017). Coady and Hanedar (2016) estimated that in India the following price
increases would be required to reach efficient energy prices: gasoline (67 percent), diesel
(69 percent), kerosene (10 percent), LPG (67 percent) and coal (455 percent).11 These are of
9 This replaced a smaller-scale pilot DBT program rolled out between 2013 and 2014. PAHAL-DBTL is part of a
broader policy, launched in 2013, whose stated objective is to “cut out middlemen to put more into the hands of
beneficiaries” through gradually shifting current subsidies, grants, and other social assistance schemes to direct
budget transfers (DBT) to beneficiary bank accounts. There are currently 1,132 schemes from 74 Ministries that
are planned to transition to DBT, out of which 462 from 57 Ministries already did. For further details, see
https://dbtbharat.gov.in/scheme/dbtapplicablelist
10 The decrease in the take-up of the “give-it-up” option is symptomatic of the incomplete reform of LPG subsidy
under PAHAL. Indeed, since the LPG price subsidy is simply replaced by a monetized price subsidy, the benefit
amount still depends on the quantity consumed (up to 12 cylinders) discouraging households from curbing
overconsumption.
11 Differences in retail and efficient prices are estimated as of June 2015; household income savings are estimated
based on their consumption patterns as reflected in the 201112 NSS. Therefore, our distributional analysis is
anchored in 2011, and the price difference estimates are anchored in June 2015 and do not account for later
energy price reforms. The price increase indicated for kerosene refers to the price gap on the unsubsidized
kerosene market, which accounts for a very small fraction of the total kerosene consumption as the bulk of it is
consumed through the PDS program. The reform of the kerosene subsidy based on using the supply (or
©International Monetary Fund. Not for Redistribution
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course very large price increases so that such an ambitious reform would have to be carefully
designed and implemented to address reform challenges.12
Energy subsidies benefit households through two distinct channels: a direct channel as energy
products directly consumed by households (for cooking, heating, lighting and private transport)
are cheaper; and an indirect channel as other goods and services consumed by households,
which use energy products as an input, are lower due to lower production and distribution costs.
Figure 4 shows the distribution of these subsidy benefits based on 2011 consumption patterns.
These are substantial and regressive. On average, household subsidy benefits are equivalent to
around 10 percent of their total expenditures, with wealthier households benefiting more (on
average, 11.5 percent of total expenditures in top three income deciles) than poor households
(on average, 9 percent in bottom three income deciles). Reflecting different consumption
patterns across the income distribution, while the indirect benefits from low coal prices are
relatively neutrally distributed across deciles, the indirect benefits from low electricity prices are
regressive while those from low diesel prices are progressive. Around one quarter of total
subsidy benefits come through the direct effect and are highly regressive.
Figure 4. Energy Subsidy Across Deciles
(Percent of total household expenditure)
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure. Effects among consuming households.
Energy subsidies are therefore a very inefficient way of providing income support to the poor.
Richer households benefit disproportionately from these subsidies reflecting the high underlying
income inequality and the fact that they consume a relatively high share of total energy
consumed: while households in the bottom four income deciles receive 17 percent of total
energy subsidies, households in the top four income deciles receive 69 percent (Figure 5a).
Replacing these subsidies with a UBI in a budget neutral way would therefore result in a
opportunity) cost is therefore encompassed in the discussion of the PDS reform and its transformation into a UBI
in Section I.
12 See Clements and others (2013) for a discussion of these challenges and reform options to address them.
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substantial redistribution of benefits from higher to lower income groups and a substantial
increase in benefit generosity for lower income groups (Figure 5b).
Figure 5. Energy Subsidy Targeting and Generosity Across Deciles
a) Percent of Total Spending b) Percent of Total Household Expenditure
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure.
Whereas households in the bottom three income deciles receive only 9 percent of energy
subsidies, they would receive 30 percent of UBI transfers. Average benefit levels for lower income
groups would also be substantially higher under the UBI than under energy subsidies. On
average, for households in the bottom three income deciles, a UBI would represent 25 percent of
their total expenditure, around three times more than current energy subsidies representing
around 9 percent of total expenditure. However, while over 90 percent of households in each of
the bottom four income deciles gain from the switch to a UBI, the losses of the small share of
households who lose is sizeable (Figure 6). On average, 2 percent of households in the bottom
three income deciles would incur a substantial average welfare loss of 11 percent. By definition,
these are households that receive large subsidies under the current system and therefore are
very energy intensive. To the extent that households can reduce consumption of goods with
relatively high price increases (including reducing wasteful use of energy), the welfare losses from
these price increases will be lower and the net welfare gain from switching to the UBI higher.
Complementary policies to facilitate more efficient energy consumption by households can
reinforce behavioral change to help further reduce the welfare impact on all households,
including the poor.
IV. ENERGY SUBSIDY REFORMS IN INDIA IN RECENT YEARS
As indicated earlier, over recent years the government has implemented substantial energy
subsidy reforms.13 Gasoline prices have been liberalized since 2010. Starting in 2013, diesel prices
13 Note that although recent reforms have reduced the gap between consumer prices and efficient prices, the
issues discussed in the above analysis are still relevant. For a broader cross-country discussion of the magnitude
of energy subsidy reforms and the welfare impacts of reforms see Coady and others (2017) and Coady, Parry and
Shang (2018). Note also that the issues addressed in this paper are also likely to be relevant for other potential
subsidy reforms in India, such as fertilizer subsidies.
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were increased by a half rupee per month until they reached international parity, and have been
fully liberalized since January 2015. Since June 2017, gasoline and diesel prices at the pump are
changed daily according to a revised automatic pricing formula that sets consumer prices,
instead of twice a month under the previous regime. The government also used the fall in oil
prices to offset the price decline at the pump with higher taxes. Currently, petrol and diesel are
taxed once by the central government through a central excise tax and then again at the state
level through a value-added tax. Excise duties, levied by the central government on petrol and
diesel, have been increased nine times since November 2014. The Minister of Petroleum and
Natural Gas has proposed to bring petrol and diesel under the goods and services tax (GST) that
was introduced in July 2017 and which would replace both central excises and the local VATs.
Figure 6. Gains and Losses from Substituting a UBI for Energy Subsidies
a) Share of Losing/Gaining Households b) Average Losses and Gains
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure. Average losses and gains are computed among losing and gaining
households.
In 2017, the government committed to gradually phase out LPG subsidies by April 2018 for
domestic consumers, by increasing the cost of LPG cylinders by four rupees/month (Ministry of
Finance, Government of India 2017b). All households are entitled to a cash transfer (DBTL)
corresponding to the price difference between the subsidized and unsubsidized LPG cylinder
prices, up to twelve cylinders a year.14 This simply changes the nature of subsidies from in-kind to
cash, although this can also help to cut-out the potential for fraud by middlemen. With fixed
administrative prices, the size of subsidies is determined by changes in market LPG prices.
Elimination of subsidies will require reductions in the gap between administrative and market
prices and the eventual removal of government price intervention, e.g., in a gradual manner as
with diesel.
Indian authorities have assessed the opportunity of using digitalization and increased financial
inclusion (JAM) to substitute cash transfers to food and energy subsidies (Ministry of Finance,
14 It is not clear whether the DBTL has been increased to offset recent price hikes (International Institute for
Sustainable Development, 2015).
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Government of India, 2016).15 According to this assessment, priority should be given to current
subsidies with high levels of leakages (to increase efficiency gains) and with a high degree of
central government control (to limit coordination costs among different interest groups along
the supply chain). The implicit energy subsidies analyzed in this paper meet both criteria and
could therefore be part of an ongoing reform effort that uses JAM to better reach low-income
households and provide the support they need.
Although there have been many recent changes, the distributional results presented in this paper
would still hold true even if the fiscal space freed through terminating the PDS program and
energy subsidies would be smaller. Nonetheless, there are other genuine concerns regarding the
introduction of a UBI in India that this paper does not address16:
There may be several policy priorities (for example, to increase public spending in health
or education, or to reduce the fiscal deficit) competing for financing. The desirability and
level of a UBI in such a context of scarce resources has to be assessed against other
governmental priorities and the potential for greater revenue mobilization.
Many vested interests in the status quo can make it difficult to reform long-lasting and
well-known programs.
Direct cash transfers may be difficult to implement and the risk of excluding poor
households remains, even under universal schemes. In this respect, phasing in a UBI
through the gradual introduction of categorical cash transfers such as social pensions
and child benefits could be an efficient way to transition from subsidies to (broad) cash
transfers (Khera 2016 and Drèze 2017).
V. SUMMARY AND CONCLUSIONS
This paper discusses two common arguments used to motivate the adoption of a UBI: (i) that it
can be a more effective way of supporting low-income households when existing income
support programs are inefficient, and (ii) that it can play an important role in generating public
and political support for the implementation of structural reforms in support of economic
growth. Although the empirical analysis uses data for India to illustrate the trade-off involved, the
discussion has broader relevance for countries considering similar reforms.
The paper starts by discussing the adoption of a UBI as a substitute for the Public Distribution
System (PDS), which provides income support to households through price subsidies for wheat,
15 Centralized cash transfer to individuals requires identification, banking coverage, and effective access to cash
after transfer. Since 2014, Indian authorities have launched large-scale initiatives, commonly referred to as the
JAM trinity”, to master these necessary steps: i) identification with the Aadhaar biometric ID system, covering
nearly 99 percent of the population aged 18 and over in 2017; ii) banking coverage with the Jan Dhan scheme
helping household open a bank account, reaching an average banking coverage of 46 percent across Indian
States, lower in rural states; iii) the use of mobile penetration average penetration lower than 56 percent only in
2 states.
16 For a broader discussion of the potential role for a UBI and implementation challenges, see Atkinson (2015)
and Emery, Fleisch, and McIntyre (2013).
©International Monetary Fund. Not for Redistribution
15
rice, sugar and kerosene consumption. It then discusses the introduction of a UBI as part of an
ambitious structural reform program centered around increasing energy prices to efficient levels
that reflect the true social cost of energy consumption. Both reforms are designed to be budget
neutral.
While the replacement of the PDS with a UBI would help to address under-coverage of low
income households under the former, this gain would come at the expense of a slight increase in
leakage of benefits to higher income groups. In addition, a sizeable percentage of existing PDS
beneficiaries would lose from the reform, including many low-income households. The number
of losers and the magnitude of their losses could be reduced by recycling the efficiency gains
from avoiding the “out-of-system” losses throughout the procurement, storage and distribution
stages as a higher UBI benefit. Alternatively, by excluding higher income groups from the UBI,
these savings could similarly be recycled. In addition, other more targeted programs could help
protect poor households adversely impacted by the reform.
In contrast, replacing inefficient energy subsidiesraising domestic energy prices to efficient
levelswould deliver unambiguous distributional gains as well as strong incentives for
improving energy efficiency with the associated environmental and health gains. The very high
leakage of benefits under universal energy price subsidies means that the equal sharing of these
subsidies under the UBI would deliver significant income gains for low-income households,
financed by losses for the highest income households. These welfare gains will be even higher to
the extent that higher energy prices incentivize energy consumers (households and firms) to
decrease wasteful energy use and improve their energy efficiency. Only a few low-income
households lose from the reform, albeit some significantly. However, to the extent that such
losses reflect wasteful use of energy, higher energy prices provide a strong incentive to reduce
this waste and therefore the adverse welfare impact of energy price reforms. Complementary
programs can also focus on facilitating energy-saving behaviors by consumers, especially low-
income households.
©International Monetary Fund. Not for Redistribution
16
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Grail: Efficient and Equitable Fiscal Consolidation in India”, in Inequality and Fiscal Policy,
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©International Monetary Fund. Not for Redistribution
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©International Monetary Fund. Not for Redistribution
18
Appendix 1. PDS and Energy Subsidy Estimates
PDS and energy subsidy estimates and incidence analysis are based on data from the most
recent publicly available National Sample Survey (201112 NSS) which covers the whole of the
Indian Union, and records data on expenditure of more than 100,000 households sampled for
the survey. For the analysis, expenditure is used as a proxy for income. As survey information is
collected at the household level, household expenditure is divided by the number of household
members to obtain the welfare indicator (expenditure per capita). Deciles are based on per capita
household expenditure, with each decile representing 10 percent of the population. Subsidy
estimates assume that demand does not respond to price changes and therefore estimates
should be interpreted as short-term welfare effects following price increases.
Estimates of PDS Subsidy
PDS subsidies for rice, wheat, sugar and kerosene are estimated as the additional expenditure
households would have to incur to keep their consumption level constant if these prices were
increased to market price levels. Market prices are computed as the average of prices paid across
all households in the same income decile and geographical region for non-PDS rice, wheat, sugar
and kerosene. For each PDS good the subsidy is computed as:
PDS Subsidy = PDS quantity x (market price PDS price).
Table A1 shows average household budget shares of each PDS-subsidized good as well as of
market-purchased consumption across each income decile. Appendix Figure 1 shows the average
PDS subsidy received by households in each income decile.
Appendix Table 1. Average Budget Shares for Rice, Wheat, Sugar, and Kerosene
(Percent of total expenditureall households)
Rice
Wheat
Sugar
Kerosene
Decile
PDS
non-PDS
PDS
non-PDS
PDS
non-PDS
PDS
non-PDS
1
1.8%
9.2%
0.8%
4.8%
0.4%
1.6%
1.3%
0.4%
2
1.2%
8.8%
0.6%
4.3%
0.3%
1.7%
1.0%
0.4%
3
1.1%
8.3%
0.5%
4.0%
0.2%
1.7%
0.9%
0.4%
4
0.9%
7.7%
0.4%
4.0%
0.2%
1.7%
0.8%
0.4%
5
0.8%
6.9%
0.4%
3.7%
0.2%
1.7%
0.7%
0.3%
6
0.7%
6.5%
0.3%
3.4%
0.2%
1.6%
0.6%
0.3%
7
0.6%
6.0%
0.2%
3.1%
0.1%
1.5%
0.5%
0.3%
8
0.5%
5.3%
0.2%
2.8%
0.1%
1.4%
0.4%
0.3%
9
0.3%
4.5%
0.1%
2.3%
0.1%
1.2%
0.3%
0.4%
10
0.1%
2.8%
0.1%
1.4%
0.0%
0.7%
0.1%
0.3%
Total
0.7%
6.2%
0.3%
3.2%
0.2%
1.4%
0.6%
0.4%
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure.
©International Monetary Fund. Not for Redistribution
19
Appendix Figure 1. Average Household PDS Subsidy
(Rupees/month – all households)
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure.
Estimates of Energy Subsidies
Energy subsidies for kerosene, coal, LPG, gasoline and diesel are estimated as the additional
expenditure households would have to incur to keep their consumption level constant if these
prices were increased to efficient price levels. Households would have to pay higher prices for
energy they directly consume (i.e. direct effect), and higher prices for other goods and services
that use energy products as inputs and would therefore cost more to produce (i.e. indirect
effect).
For each energy product, the direct effect of efficient pricing is computed as:
Direct Effect = Budget Share x Percentage Price Increase
Price increases of goods other than energy products reflect increases in diesel and coal prices
and are estimated using the model developed by Coady and Newhouse (2006), which assumes
that increases in energy production costs are fully passed forward onto the domestic output
prices of goods and services. For each product consumed by households, the indirect effect of
efficient pricing of coal and diesel is then computed as:
Indirect Effect = Budget Share x Percentage Price Increase
Total energy subsidies are the sum of direct and indirect effects. Appendix Table 2 shows average
household budget shares of each energy product by income decile. Appendix Figure 2 shows
household monthly total energy subsidy in rupees by income decile.
0
50
100
150
200
250
Bottom
2
3
4
5
6
7
8
9
Top
rupees/month
Deciles
Rice Wheat Sug ar Ke ro se n e
©International Monetary Fund. Not for Redistribution
20
Appendix Table 2. Average Budget Shares for Energy Products
(Percent of total expenditureall households)
Decile electricity PDS
kerosene kerosene coal LPG petrol diesel
1
1.9%
1.3%
0.5%
0.1%
0.4%
0.1%
0.0%
2
2.0%
1.0%
0.4%
0.1%
0.6%
0.3%
0.0%
3
2.1%
0.9%
0.4%
0.1%
0.7%
0.4%
0.0%
4
2.3%
0.8%
0.4%
0.1%
0.9%
0.6%
0.0%
5
2.4%
0.7%
0.3%
0.1%
1.1%
0.8%
0.0%
6
2.5%
0.6%
0.3%
0.1%
1.3%
1.1%
0.0%
7
2.7%
0.5%
0.3%
0.1%
1.5%
1.5%
0.1%
8
2.9%
0.4%
0.3%
0.1%
1.9%
2.1%
0.1%
9
3.0%
0.3%
0.4%
0.0%
2.1%
2.7%
0.1%
10
3.0%
0.1%
0.3%
0.0%
1.7%
3.7%
0.3%
Total
2.5%
0.6%
0.4%
0.1%
1.3%
1.6%
0.1%
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure.
Appendix Figure 2. Average Household Direct (D) and Indirect (I) Effects of Energy Subsidy
(Rupees/month – all households)
Source: Authors’ estimates based on Indian 201112 NSS.
Note: Deciles of per capita total expenditure.
©International Monetary Fund. Not for Redistribution
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