Inflation tax over and above the oil tax

The aggregate private consumption has fallen to the extent that in the April-June quarter this year it was at a level that was last seen in April-June 2017-18. If disaggregated, there are reasons to believe that the consumption of the poor and the middle class has fallen, and not just stagnated over the last few years. 

The usual perception is that the low consumption is entirely due to the difficulties in the economy that are related to Covid-19 or at best these are related to the slowdown in the growth process even before we were hit by Covid-19. However, there is another important reason. It is the tax policy. We have a massive oil tax and then a separate large inflation tax. 

The huge tax on oil has become familiar. For some time now, the overall tax rate on petrol and diesel has roughly been anywhere in the range of 75 to 125 per cent. The direct effect of this on the public may not be much but the indirect effect and the overall effect can be substantial. The oil tax is unlike, say, the income tax, which is progressive as the income tax rate rises with the income. In case of oil, the tax charged is the same whether it is bought by the rich, the middle class, or the poor. So, relative to their income or consumption, the tax is higher for the poor and the middle class than it is for the rich, making the oil tax regressive. 

Besides the oil tax, we have also, what economists call, an inflation tax, which is again very high now. The inflation tax is an implicit tax “paid” by people when the real value of their cash balances keeps getting depleted due to inflation. And, often the nominal interest rates do not keep pace or are not allowed to keep pace with inflation. If disaggregated, the inflation tax falls disproportionately on the less well-off and the less well-informed. The affluent and the more well-informed Indians are less affected as they tend to use less cash balances and even choose to borrow at low interest rates. The inflation tax then tends to be, like the oil tax, regressive.

The reason for considering the oil tax and the inflation tax together is simple. The high oil tax has contributed to the inflationary process, which has been sustained by the Reserve Bank of India (RBI) for fear that if it does not “participate”, the slowdown in the economy may get aggravated. It is obvious but interesting that in the process of merely sustaining the higher inflation due to high tax on oil, it does need to issue additional money. This matters. Why?
 

As we know, the cost of issuing money for the RBI is minimal. The money issued can finance investments on which the RBI “earns” a lot. So, its profits or surpluses are high and it is able to pass on the so-called dividend income to the Government of India (GoI). But this is actually inflation tax, given that the additional money issued sustains, if not causes, inflation. In recent times, this is related to the massive oil tax. The latter and the inflation tax are going somewhat together but they are not the same. Inflation tax is over and above the oil tax. 

In 2020-21, the taxes on oil for the GoI were about Rs 3.4 trillion, the so-called dividend income from the RBI was about Rs 1.33 trillion on an annualised basis, and the taxes on income were about Rs 4.59 trillion, according to the revised estimates. So, the collection for the GoI from the oil tax and the so-called dividend income from the RBI were together more than the entire income tax collection! With so much regressive tax being collected from the public, it is hardly surprising that the consumption has been substantially affected. 

Why did the GoI collect such large taxes? Besides the reasons related to Covid-19, some welfare schemes, the past oil bonds, etc. an important reason appears to be the loss of revenues due to a reduction in the corporate tax rate and the rise in expenditures due to the production-linked incentive schemes. These policies may promote a shift away from the so-called unorganised sector, but it is not clear if they will give a substantial push to economic growth at a time when the consumption demand is not growing —thanks in part to the inflation tax and the oil tax. We are pushing growth on the one hand and discouraging it on the other. Relatedly, growth is being pushed at the expense of the less privileged. It is time to change gears.

The writer is an independent economist and adjunct faculty, Indian Statistical Institute