Taxes must be low in low-trust India

But politicians are using taxpayer funds to get elected, making a low-tax regime difficult

A Morgan Stanley report notes 10 big changes that India has seen over the last decade, nine of which were presided over by Narendra Modi. Among these changes are the growing formalisation of the economy, better real estate regulation, efficient welfare transfers, supply-side reforms, the bankruptcy code, flexible inflation targeting, a higher individual commitment to long-term retirement savings, and lower corporate taxes.

The changes mentioned above will deliver sub-par results when we have a democracy that is perpetually in election mode and political thinking is short-term in nature. This is despite visible political stability, with 10 years of the United Progressive Alliance followed by (an expected) 10 years of Modi at the Centre. Many parties at the state level have also been in power for many terms, but this stability has been fiscally destabilising. Politicians are financing their election or re-election campaigns at public expense, as we saw recently in Karnataka.

Even Mr Modi, normally a fiscal conservative, knows that “revadis” are unavoidable. As accusations of jobless growth continue to be levelled against the Centre, the prime minister has been distributing public sector job offers in various states. And this when both the Centre and states do not need any general expansion in government jobs. What we need is higher investment in specialist and expert functions, whether it is in the army or government. At some point, an Agniveer equivalent in public sector jobs will become fiscally inevitable.

While the 10 positive changes mentioned in the Morgan Stanley report are worth celebrating, success brings its own challenges.

For example, the rapid digitisation of the economy, which is beneficial for tax collection efficiency, ease of doing business and reduction in subsidy leakages, eviscerates and bifurcates the job markets into high-skill and low-skill areas. It also slows the re-emergence of a job-enhancing informal sector.

The political mindset that needs change is on jobs. The challenge is to enhance opportunities for people to generate livelihoods through entrepreneurship, both big and small. The Mudra scheme went some distance in this direction, but the key to any rapid expansion of livelihood opportunities lies in making the state less intrusive in people’s lives. A big state is a tax on the people by its very existence, for it creates friction in economic activities.

Another example is the reduction in welfare leakages, which makes it easier for politicians to promise —and deliver — revadis. Earlier the voter could remain relatively cynical about the promises made by political parties (because leakages were rampant); now they know that politicians will make the payoffs. This creates a self-reinforcing negative cycle of election wins and revadi expansion.

As retention of power, or dislodging the incumbent, becomes the core focus of every political party, the effort will be to squeeze more taxes out of the people to pay for the promised freebies — as we saw recently in the move to extract tax from credit card spends abroad. The attempt to close every alleged loophole in tax rules is indirectly a move to enhance taxes for some or all citizens, even without accounting for “private forms of taxation” (i.e, speed money paid to get work done with state agencies).

Political and public mindsets must change if growth is to be sustained without compromising on basic social safety nets, public health and education.

First, the state must consciously curtail its growth, and non-state actors, community organisations and charities should be encouraged to fill the gaps in welfare. This implies that while personal taxes must be cut, the resources for welfare must be raised through private agencies — something that a corrupt Left-liberal system will try to scuttle.

Second, as mentioned above, the focus must shift from public sector job creation to entrepreneurship and self-employment. Technology or no technology, enhancing livelihoods is as important as creating an environment for jobs. This implies that the informal sector, and a formal middle sector — the equivalent of Germany’s Mittelstand — must become the main engines of jobs and livelihoods.

Third, as a corollary to the above, we must thus rethink our approach to taxation. In a low-trust society like India’s, high personal taxes are a strict no-no. People will accept high taxation only as long as they see where their money is going, and especially whether it is going to “people like us”.

 No amount of talk about equality and brotherhood will erase the reality of the social group, which is about identifying who is “us” and who is “them”. Tax policies must allow for different communities to raise resources and fund their own people. This way communities will foster meritocracy among their own and expand social safety nets. The state must focus only on those social groups that can’t help themselves.

Fourth, there has to be a rebalancing between essential government jobs and non-essential ones. When the state grows in the wrong areas, the tendency will be to grow bureaucracy rather than citizen-centric services relating to law and order, public health and education. The steady and consistent decline in the pursuit of meritocracy in educational and public sector institutions is a nudge to seek greener pastures abroad. India has not paid a price for this brain drain as it still has a large pool of talented engineers and managers who cannot go abroad. But, at some point, this could become a pain point. No economy can grow consistently if its most talented people no longer want to live here. Since 2011, some 1.6 million people have given up Indian citizenship, both for getting ahead in life and to avoid the everyday hassles of living in India. Some of these pain factors are reducing, but not fast enough to accommodate the aspirations of the millions who join the middle and upper-middle classes every year.

The big-state economic paradigms that evolved with the Great Depression must now give way to a more expanded understanding of state partnership with non-state players. The state must restrain itself, while communities must step up to the plate. A politically-feasible way to do this is to freeze the size of the state in the areas where it should not be growing, which will automatically spur livelihood expansion in non-state spaces. And by non-state actors, we do not mean agenda-driven activists like George Soros, but genuine community-based charities and organisations.

The future does not belong to an ever-expanding state, both in India and abroad. That is, if we want to survive as a species in relative harmony.

The writer is editorial director, Swarajya magazine