It is Budget time again, and I am still hoping that one of these days, we will dispense with this closed-door tamasha of policymaking. The practice is still the same as that in colonial times and this near 200-year longevity should hint at how outdated the system is. The practice is in the interests of TV and the IAS babus who make policy.
Our GDP growth has surprisingly and inexplicably slowed down. World growth is expanding, even the IMF says so, so why is the global star slowing down? This should be the first bit of accountability that is required from our monetary and fiscal policymakers. In various articles over the years, and recently, I have pointed out that our monetary policy (high real policy rates) was dangerously close to the policy errors and the ensuing slowdown in 2018-19 (before the shock of Covid). In this article, I want to point to the inexplicable policy of high rates of personal income and overall taxation — a policy I believe is responsible for the slowdown along with our Deep-State-inspired policy of high tariffs on manufactured goods and the same source-inspired policy on the closing of foreign direct investment (FDI).
I want to expand on my comment about a deep state. First, who makes policy? Major industrialists, senior IAS babus, and their friendly influencers in the media. In all the justified criticism of government policy on FDI and high tariffs on manufactured goods (and the uncalled-for decision to remove the most-favoured nation status for Switzerland — who are Nestle’s competitors in India? Should we ask CII?), I have yet to find mention of the true authors of such policies. Notice that the list does not include policy experts outside of government, a common and universal practice in mature democracies. Both PMs — Manmohan Singh (MMS) and Narendra Modi — explicitly argued for more lateral entry, and failed. What is revealing is that MMS as finance minister succeeded in seeking and implementing the advice of non-IAS experts — but failed as PM when ostensibly he had more freedom to make good policy. Deep State at work.
I will now present evidence of how messed up our fiscal policy (taxation) has been. First, why this obsession (kolaveri?) with bringing down the fiscal deficit, not via growth, but via increased taxation? On several counts, this obsession needs to be questioned. Will it bring down inflation caused by food inflation? That would be a laughable goal, if not tragic. Maybe it will bring about enhanced growth. Doubly laughable.
Now the evidence. First I will present international evidence on the ratio of personal income taxes to GDP (X-PIT) and then evidence on the ratio of all taxes to GDP (X-TAX). I know many Indians think they are unique, that the same red blood does not flow through them as that of 6.5 billion others in the world. Let us accept that the most comparable countries in the world are the non-advanced countries — we want to get there, but we are not there yet, and unless we make policy corrections, we won’t be there even in 2047.
Regarding personal income taxation, the Indian government’s own data and projections suggest that X-PIT will reach 3.9 per cent of GDP in FY2025. How exceptional is this “performance”? Very. Outside of the advanced countries, there is no regional average that even comes close – Eastern Europe is the highest, at 3.4 per cent in 2019, the last full year before the pandemic. Post-2019 data are available for very few countries. The experts on growth just love to compare our growth performance with China or Vietnam. Bangladesh has fallen off the map after its crisis — the last IMF information for Bangladesh is available for 2016 when X-PIT was 0.85 per cent. No typo there. Growth stalwarts China and Vietnam are also much lower than India — X-PIT of 1.1 and 1.8 per cent respectively. Korea is somewhat higher than India at 4.8 per cent, but likely lower in the post-2019 period. Brazil and Mexico are at 3 and 3.4 per cent of GDP respectively.
One objection to the above analysis on personal income taxes is that countries find other taxes to make up for their revenue needs. A fair objection, which is why we will now look at the ratio of all taxes to GDP.
The situation is no better if one looks at X-TAX; maybe even worse. The latest FY 2025 ratio for India is likely to reach upwards of 19 per cent of GDP. The advanced country average was 25 per cent of GDP in 2019, likely lower today. East Asia is at 13.5 per cent, with China and Vietnam at 15.9 and 14.7 per cent respectively. Both Korea and the USA had direct tax collection much higher than India. For the overall tax ratio, the two economies are nearly identical to India — Korea at 20 and USA at 19 per cent. The average per capita income in these two countries is more than eight times that of “poor” India. Obviously, not much “compensation” by other countries for PIT collection. In India, it is up and away for all tax collection.
Don’t think that this excessive taxation is costless. It leads to excessive and wasteful government spending (freebies as articulated by PM Modi.) It also leads to discomfort among the middle classes who pay most of the taxes — this discomfort is a likely explanation for the surprising decline in popularity of the BJP and Modi in the national election seven months ago. It is also responsible for the decline in GDP growth — high taxes, no foreign investment, and high real interest rates. What did the Deep State think would happen?
The role of the IMF and World Bank, and other international experts, needs to be examined in some detail. Who provided this tax advice, and why? There has been a discussion about the lopsided recommendations of the GST Council, advice that at least generated some humour with regard to sugar and popcorn. The income tax collection records, however, are no laughing matter. For close to 20 years the governments have talked about direct tax reform. Talked, and badly acted. The time for remedial action is now, tomorrow, or latest by February 1.
In my next few articles, I will document how much is right in India, about job growth and gender equality. And how much is wrong with policies enacted not by people, but by the Deep State.
The writer is former executive director, IMF. Views are personal.
