The affordability of free electricity

Defined as “Politics without Romance” by James Buchanan, the Public Choice Theory, attempts to apply economic methods to the tenets of political phenomenon in society.  It believes in the overlap between political science and economic issues, which has thus revolutionized the art of democratic decision-making. Public policy has always juggled these two disciplines, and their thorough knowledge is invaluable in tackling policy hiccups. The Public Choice Theory emphasizes the use of key economic tools to deal with traditional problems of political science. It takes into account the following pragmatic assumptions: 

● Government players are as “self-interested” as market players 

● People have limited knowledge and benevolence 

● People try to economize as much as possible 

Many policy loopholes largely abide by the rationale laid down by the Public Choice Theory. Incentives are a suitable tool used to plug such loopholes. What makes a policy effective are the tangible benefits it provides to various stakeholders through incentives. Based upon assumptions made by the Public Choice Theory, policymakers find it easier to streamline relevant incentives to formulate an apt policy. Let us look at how this theory functions in reality.

The Aam Aadmi Party’s (AAP)  key polling tactic has been to provide free and subsidized services. These provisions have been the cornerstone of the party’s manifesto since its conception in 2012 that they have honored, making amendments in October 2022. Let us first explore Delhi’s power subsidy scheme. 

The Delhi government provides subsidies on three key services: electricity, water, and bus rides for women. The subsidy structure is given as follows for electricity: 

● Up to 200 units of electricity provided free of cost 

● 210 to 400 units of electricity subject to a 50% subsidy (up to Rs 800) 

● Households exceeding this quota of free electricity must pay the amount normally applicable 

Unlike most subsidy provisions that serve only a target audience, this scheme serves all Delhi residents regardless of their income level. It not only benefits those with a genuine lack of financial resources but also well-to-do households. The AAP government has been criticized for distributing “freebies” as electoral bait. These subsidies have massively impacted the state government’s budget, weighing it down with pending subsidy bills and unpaid power bills, increasing the overall electricity supply cost. The Delhi government’s expenditure on subsidies increased by a whopping 92.38 % between 2015 and 2020 from Rs 1,867.61 crore to Rs 3,592.94 crore. The revenue surplus has come down from approximately seven crores in 2015 to five crores in 2020. 

Besides the heavy monetary consequences of a rather generous subsidy policy, another stone remains in the shoe: the free rider problem. Free-Riding is an economic concept of market failure that occurs when people benefit from goods or services they do not pay for. This heightens the risk of over-providing goods and services. Free-Riding is commonly witnessed with public goods as they provide non-excludable benefits (i.e., benefits applicable to everyone).

We can witness this issue starkly in Delhi’s free electricity provisions applicable to all societal levels. Hence, households with the adequate financial privilege to afford unsubsidized electricity can now free-ride on the state government’s financial resources. 

According to a 2019 study, over 80% of households benefit from the power subsidy scheme in Delhi. Furthermore, around 28% of Delhi’s population lives in slums and unwarranted colonies,  a genuine beneficiary of power subsidy schemes. Hence, a striking number of high-income households do not spend a rupee on electricity despite being able to afford it. Thus, high-income households free-ride upon subsidiary benefits. 

Let us look at a similar case study. A study published in the Energy Journal (2016), analyzed the provision of subsidized energy in Canada and assessed the extent of free-rider rates involved within these subsidy schemes. The study drew the following conclusions: 

● Around 50% of total expenditures under the Canadian subsidy and tax credit programs showcased free-riding. 

● Over 80% of grant recipients were those who would have chosen an identical furnace at the time of replacement. 

● The grant regressively affected the income distribution because a substantial portion of the grants was received by middle- and high-income households 

● Hence, such grants are not optimal for improving residential energy efficiency. 

The consequences of the subsidy models of Canada and Delhi mirror each other. In May 2022, Arvind Kejriwal declared an amendment in power subsidy provisions making it applicable only to those who choose to opt into it. He addressed the liabilities of the free-rider phenomenon in a press briefing- 

“We get an appreciation for the Delhi government’s free electricity scheme from all sections of the society. But, over the years, people have suggested that instead of providing subsidies to financially strong households, the money be used for schools and hospitals. Considering their demand, all consumers will be given a choice to opt for the scheme from October 1. Based on their choice, we will provide free electricity to those families who wish to seek the benefit of the scheme.”

Hence, power subsidies have been rationalized since October 1, 2022, ensuring only those who voluntarily apply for the subsidy may receive its benefits. Karthik Ganesan, fellow, and director at the Council on Energy, Environment, and Water, said, “This is a good first step to rationalize subsidy. It might require a little more than merely asking people to opt-in but put the onus on the consumer to establish the need for subsidy and then allow an opt-in.” As this is a quota-specific subsidy, it also incentivizes beneficiaries to use electricity judiciously to avoid exhausting their subsidized power quota.  This is a huge advantage as opposed to the lavish overconsumption of electricity by free-riders who could otherwise afford electricity at normal rates. 

With the policy’s shift on low-income groups, another policy loophole arises, the  “concentrated benefits and dispersed costs” issue. This issue arises when the benefits of a given policy are concentrated on a specific group, while the costs to finance these benefits are highly diffused/dispersed amongst many people. 

Likewise, in this case, low-income households are the targeted beneficiaries of electricity subsidies. These subsidies are largely financed by taxpayers’ money collected from all citizens residing in Delhi. As such resultant costs get diffused everywhere, the negligible increase in taxes hardly concerns well-off individuals. The worst-case scenario that results here is that there exists collective disapproval of hiked tax rates. However, because the hike is minor and evenly dispersed across a state’s populace, the affected taxpayers are not strongly incentivized to raise complaints against relevant authorities. Take a micro-scale example; if there is an increase in taxes by Re 1, whose proceeds go to the state government, the government consequently collects over one crore worth of additional revenue. Here, it is not worth complaining against the loss of an additional rupee although it is resented to some degree. 

The individual benefit earned trumps the individual cost imposed on every taxpayer. This idea can be a significant boon in Delhi’s subsidized power issue: 

1. Delhi’s large population: 

The main source of financing power subsidies comes from taxes collected from the general public. Hence, the government needs to “disperse” electricity taxes to ensure a minor raise in taxes. About 50% of Delhi’s households fall in the middle and upper-class categories (i.e., monthly expenditure in the range of Rs 10,000 to Rs 50,000 and above). The costs of power subsidies can spread over half of the households of Delhi, which is a large populace. Such classes can conveniently handle a slight tax hike without  serious financial crunches. 

2. Stringent Tax Collection: 

Spreading tax collection as much as possible can prove effective when tax collection norms are kept strict. Tax evasion is a rampant issue in India. It has deprived the government of a large amount of funds for financing essential public goods and services. Placing stringent checks to prevent tax evasion can expediently finance the government’s subsidy-induced expenses. 

The provision of subsidies holds the promise of re-election for a political player, the AAP, in Delhi’s case. It primarily benefits lower-income groups by lifting a large portion of monetary commitment off their shoulders. Although this subsidy comes at the cost of increased taxes derived from the general population, the effectiveness of dispersed costs and how they can be magnified is noteworthy.

The power subsidy provision in Delhi is galvanized by the AAP’s motive to gain political power. The provision’s enthusiasm was such that the affordability of providing free electricity weighed heavily on the state government’s budget. Hence, the question remained- is free electricity truly affordable?

After being subjected to intense scrutiny, power provisions were amended to become pragmatic and feasible for the state budget. Consequently, the free rider problem in Delhi stands resolved, without imposing financially subversive consequences on the general taxpayers’ bracket.

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