governance, political economy, institutional development and economic regulation

The “Jaitley-Modi” team is working out to be invincible. Who, amongst the chattering classes, would have conceded, even as late as May 1, that Modi could transform himself from a hands-on, salt-of-the-earth, provincial, micro manager,  into a suave opinion maker, at perfect ease trading handshakes (though not yet air kissing) with the international jet set? Is he modeling his public profile on Vajpayee; the genial poet? Is Jaitley his Advani- the brusque implementer and dreaming aspirant for succession?

Indians wish Modi a long and stable tenure in Delhi, as the boss. We similarly approve of Modi’s knack of choosing the right person for the job. We admire his sense of timing, his courage and his fortitude.

But there are some things JaMo need to do pronto to walk the talk.

First, they need to tax capital higher. India inc. hates such suggestions and most growth wallahs will agree with them. But the fact is India’s share of taxes in total government revenue is too low. There is a hole of around Rs 3000 billion between what the government earns every year and its’ recurrent expenses. Yes, it is true that collecting money is not as important as using resources well. But who amongst India inc. actually behaves that way. Do they stop looking at their headline to grow their bottom line? Of course not. They make the consumer suffer for their inefficiencies if they can get away with it. In regulated markets with low levels of competition they manage to do just that. So must government.

One way of filling this hole is to tax incomes at a higher rate. This is very inefficient and inequitable. Why should a person be penalized for working harder and earning more money?

It makes more sense to tax consumption, across the board, at low rates, rather than income. After all if an individual earns more and saves her earning shouldn’t she be rewarded and the profligate spender penalized? Well, not quite. High tax rates encourage evasion. If consumption is taxed at penal rates, it will just be driven underground and result in welfare losses all around, except for the profits of the “evasion management mafia” that springs up with every new regulation. Anything above a tax rate of 10% is a sure inducement to even petty evasion.  

But what of the poor? Is it fair for the government to tax a poor man, the same as a seth (rich man) for the bread they consume or the tea they drink?

Yes it is. The correct way of discriminating between the two, is to send money back to the poor person, to neutralise the consumption tax she paid on her purchases. Cash transfers, based on the Aadhar platform, leveraged with a Poverty Card linked to the UID, so no one can fudge their identity or double dip, are an ideal medium particularly if the cash transfer is done by upgrading  the 150,000 Post Offices into “payment banks”, as the insightfully gifted Raghuram Rajan, Governor RBI, wants to do.

It is a myth that the poor, or the farmers, are not taxed. Every individual pays at least 5% to 10% of her cash consumption as tax, through “invisible” indirect taxation like excise and sales tax. The poor should be directly compensated for this fiscal support they provide to the nation.

Second the government should tax consumer durables higher. Taxing them at low rates implicitly discriminates against labour and in favour of capital. If washing machines are cheap and water unmetered, that is the option any householder would prefer rather than employing a “bai” to do the same job, with less water and no electricity, but with more time spent on personnel management. But in an economy where barely 2% of the labour force is skilled to a level of international competitiveness, should double digit tax incentives for capital be driving out low skilled, poorly paid jobs?

Third the government should tax capital gains higher. The tax exemptions on disinvestment income from sale of equity are so liberal today that it is possible for a very rich woman to pay no taxes at all on her “income (capital gains)”, by the simple expedient of having a rolling portfolio of equity investments, a part of which are sold and partially reinvested, after holding the equity for a year.  

We have artificially pegged our destiny to the stock markets. The BJP is most prone to falling into this trap, because of its class base, which is most active and has benefited the most from capital markets. The markets are a good measure of investor sentiment but a fickle barometer of economic fundamentals. This is why they need to be “managed” and wooed, to perform.

Chidambaram had mastered this art. It worked for a while, but eventually the markets tired of even him and looked for new “tricks”. Jaitley, being an imaginative and innovative thinker, is sure to dish out some of these. But it would be a mistake to misread the success of “tricks by the outreach team” with substantive achievements on the ground.

On the ground, what matters for growth, is to reduce the Fiscal Deficit, particularly by increasing the tax to revenue ratio. We cannot afford revenue holes funded through debt. There will be trade-offs to be made in the process, between sequencing expenditure control and enhancing revenue.

The guiding principle, for these operational trade-offs, must be the objective of avoiding market distortions to the extent possible. Reduce tax exemptions. Disinvest public sector equity aggressively, whilst simultaneously freeing these companies from political backroom control, as Piyush Goyal (Power Minister) seems to want to do. Tax at low rates but across the board. Freeze all babu “real” salary enhancements. Pump in catalytic volumes of investment to kick start manufacturing; infrastructure development (particularly Railways and Minor Ports) and reduce the subsidy burden in a phased manner to one third of existing volumes by 2019.   

Even unbeatable political combinations need the force multiplier of forward looking development principles. Hope the JaMo teams’ social media analysts are picking this up.

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Comments on: "The JaMo; an unbeatable combination" (1)

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