Wednesday, Oct 22, 2014

Minimum government, maximum risks

Acknowledging and owning up to financial reality may paradoxically result in a positive response from the much-feared rating agencies. Reuters Acknowledging and owning up to financial reality may paradoxically result in a positive response from the much-feared rating agencies. Reuters
Written by Jaithirth Rao | Posted: June 10, 2014 12:57 am

Tough decisions made by Modi in Year 1 will pay off handsomely in Year 5.

Conventional wisdom is that the new government should focus on reducing the fiscal deficit. This writer would like to take a contrarian view. Ronald Reagan ignored the deficit hawks . He went for bold tax cuts and increased fiscal deficits. Reagan’s gamble paid off. The American economy acquired vigour. Growth became the new story, albeit with a time lag. At the end of four years, Reagan was re-elected. The Modi government should perhaps imitate the Reagan administration.

The thing to remember is that voters are swayed by inflation and growth in the period just before an election. The new government should focus not on inflationary risks now, but on the likely inflation and growth rates five years from now. Taking risks in the first couple of years may turn out to be worthwhile as a solid growth engine for the economy is set in motion.

On tax revenues, the government can take bold steps: First, there is no need for miserliness with the states in terms of giving them so-called compensation to persuade them to sign up for the GST. A few tens of thousands of crores in payment to states to cover estimates of losses through the GST, as well as generously settling earlier VAT and sales tax claims, would be a masterstroke. The previous government nickel-and-dimed the states to the detriment of the speedy implementation of the GST. States are likely to use these funds to cover up their battered balance sheets; the combined fiscal deficit of the Central and state governments is unlikely to explode. Second, the government can announce that it will fundamentally change the present incentive systems in the tax departments by not prescribing any targets to officers or teams for tax collection. Government officials must be seen as duty-bound to implement the law fairly via-a-vis all tax-paying citizens. It should not be the job of government officials to hound citizens for taxes. This measure will be criticised on the grounds that this will lower  tax collections.

Au contraire, as the venerable Todar Mal (the revenue minister of Sher Shah and Akbar) would have told us, a fair, non-rapacious tax system will in the long run lead to revenue maximisation. Short-term losses, if any, will seem insignificant. Third, the government should make a one sentence announcement that the notorious “Vodafone” amendment will be made a prospective one. This will again be criticised for the implied loss of tax revenue.

Gore Vidal observed that in Mauryan India, the state knew how to extract revenues from citizens gently, painlessly and seemingly effortlessly. Kautilya knew that the goose that lays the golden eggs must not be killed. It continued…

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