One of the recurring themes of Indian public expenditure and budget making in the last decade is the fiscal rigidities making it difficult for governments to change policies and priorities. In the Union budget, interest payments, defence expenditure, transfer of resources to States and wages are more or less inflexible, and there is no room for manoeuvering. It is now axiomatic that subsidies cannot be removed without incurring high political and social costs. Similarly, in States too repayment obligations, wages, administrative costs, expenditure on ongoing schemes and projects, state’s share in centrally sponsored schemes etc are inflexible, leaving little room for innovation. Again subsidies are hard to cut. The result is less than adequate social expenditure and poor quality infrastructure. As early as in 1992, Dr Manmohan Singh as Finance Minister lamented the shackles imposed by these fiscal compulsions. The only two changes subsequently are, defence expenditure shot up significantly in recent years, and wage expenditure of both the Union and State increased greatly with the acceptance of Fifth Pay Commission recommendations. Economists, analysts and politicians owe it to the country to evolve mechanisms to break this logjam. However, there are realistic and effective options still available. But we need courage and skill to exercise them and achieve tangible results. Let us take subsidies as an example. For fiscal 2002-03, major union subsidies account for Rs 37,392 crore. Food subsidy alone will cross Rs 21,200 crore. Power subsidies and losses (which will eventually be subsidized) in States will probably account for Rs 40,000 crore. And there are other subsidies in States too. Is there a way of reducing these subsidies, retargeting them without inviting massive social unrest and political opposition?Obviously it is not easy. Desubsidization anywhere in the world has always been painful, and politically risky. The peanut quotas and resultant subsidies increase the price of peanut butter in the US significantly. And yet, these quotas withstood Reagonomics and Gingrich revolution. The rise of Solidarity in Poland is linked in no small measure to the rising food prices from 1970 onwards, eventually precipitating the collapse of communism in Eastern Europe. The sudden increase in the administered prices of food in December ‘70 led to riots in the Baltic cities of Gdansk, Gdynia and Szczecin, and Gomulka was ousted from power. His successor, Edward Gierek had to again raise food prices in 1976, leading to violent strikes in Warsaw and Radom. Fresh price rises in 1980 touched off nation wide strikes, and that was when solidarity was created at the Lenin Shipyard, Gdansk under Lech Walesa’s leadership as an independent, self managing trade union. The rest is history.But there are ways of reducing subsidies in a politically acceptable way. Let us suppose the administration of food subsidy (the consumer part of it) is transferred to local governments. We can actually quantify the amount of subsidy based on the food grain offtake and price differential at the local level. Then the Union or State can ask the local government to retarget the subsidies to reach the deserving poor and cut down on leakages. This will work if the subsidy amount so saved is made available to the local government for other desirable activities, say infrastructure building or social expenditure. Once local government is assured of additional resources based on performance (cut in subsidies), it will have an incentive to reduce subsidies and unlock these resources. The money saved can thus be used for schools, drains, water supply, roads, health centres and sanitation. Since there is a clear link between subsidy reduction and alternative public goods and services, a powerful local constitutency will be built favouring reduction in subsidies. In centralized administration, there are only losers in subsidy reduction, and no corresponding gainers. But once it is decentralized, and savings are alternatively deployed, the same family which loses a subsidy will gain directly through better public goods and services. Or there will be as many or more gainers as losers. We will then have achieved two objectives. Subsidies would be reduced, and expenditure is directed towards more desirable goals. This principle can be applied to several subsidies – food, agricultural power, irrigation etc. The key to desubsidization is creating alternative stake-holders or alternative stakes at the local level. This is possible only when we are willing to go outside the box, and redesign institutions. A centraized democracy cannot exercise painful options, because people perceive all pain and no gain. If the taxes raised or resources saved are perceived to go to a centralized, callous administration, or to fill the huge hole called fiscal deficit, then people are unlikely to accept desubsidization calmly. What appears to be a criminal waste for an economist or administrator is often the real income which sustains a poor family. When a family has to make do with reduced income, it makes choices willingly because all members know where the money is going. It is easier to accept privation if you have alternative gain, or if your loved ones get something in return. This applies to individuals, families, and societies as well. But to apply these lessons, we need to redesign the Indian state and reinvent the citizen-centered government based on the principle of subsidiarity. Our fiscal crisis and governance crisis are inseparable, and need to be addressed together.