Not taxing the rich hurts the poor

Even the blinkered BJP government sees the need for a fiscal policy that would stimulate the economy by increasing government expenditure; but it does not know how to finance such expenditure.

Spending more by borrowing is frowned upon by international capital, and our government, notwithstanding its much advertised “hyper-nationalism”, does not have the gall to defy the dictates of globalised finance. The question of enlarging government expenditure by borrowing therefore does not arise.

At the same time, it is loath to tax capitalists, whether through a wealth tax or through a higher tax on profits; because the government’s entire raison d’etre lies in providing them with all manners of tax concessions in lieu of which it gets generous financial support from them. The professed belief is that putting more resources in their hands will increase investment.

This belief however is mistaken for two obvious reasons. First, the effect of tax concessions in increasing post-tax profits is offset by the reduction in profits owing to reduced demand due to curtailment in government expenditure. Secondly, Capitalists invest more not when they get larger profits; they invest more only when demand increases.

Hence no amount of tax concessions will induce them to add to capacity and invest more if demand is not increasing. Tax concessions in this case, while they might benefit particular corporate groups, will simply be pocketed by them, without making an iota of addition to capacity.

But this erroneous claim that tax concessions to capitalists boosts investment is used to justify such concessions. And on these very grounds, larger taxes on capitalists are ruled out. What the BJP government, unable to enlarge fiscal deficit and unwilling to increase taxes on capitalists, has chosen to do therefore is to finance larger government expenditure by increasing indirect taxation.

Direct taxes on the working people are difficult to administer (since there are so many of them), and it does not add to aggregate demand: the boost to demand by government expenditure, financed in this manner, is offset by the reduction in demand through reduced consumption by the working people, a point which even the BJP government perhaps understands. So, the recourse on higher indirect taxes.

But, after the shift to the Goods and Services Tax, the indirect tax rates for most commodities now are a matter for the GST Council to decide; the union government’s hands therefore are to an extent tied. There is however one milch cow which is left out of the ambit of the GST and that is petro-products. The union government therefore has latched on to this commodity, on which it has decided to increase indirect tax-rates, as a means of raising revenue.

Its fiscal policy has thus become extremely simple: raise revenue by imposing indirect taxes on petro products, and by privatising public sector enterprises; spend whatever can be garnered while keeping the fiscal deficit in check so that global finance remains satisfied.

Privatising public sector enterprises however has not fetched much until now, since the private corporate bodies know that if they wait a bit longer, they would get an even better deal. So, taxes on petro products have been the most common way of revenue mobilisation with which the government hopes to revive the economy.

This however has two obvious limitations. First, despite the huge burden it imposes on the people, the revenue generated from this single source is not adequate to enlarge government expenditure to the requisite extent. In the current year’s budget for instance, the total nominal government expenditure is supposed to increase by less than one per cent over the pandemic year 2020-21(RE) which means a fall in real terms.

Obviously, no revival of the economy is possible if government expenditure is expected to fall, especially when capitalists’ investment cannot increase, as it is limited by the paucity of demand, and total consumption in the economy follows rather leads an increase in income.

The belief, that an increase in government expenditure financed by an equivalent increase in indirect tax revenue can always increase aggregate demand and hence output and employment, is erroneous. An indirect tax on wage goods is similar to a direct tax on wages; it has a demand contracting effect.

On the other hand, an indirect tax on investment goods or goods for capitalists’ consumption, can have an overall demand-expansionary effect, since capitalists can always maintain their real purchases of the taxed commodities by running down their cash balances or by borrowing from banks, while the added expenditure by government would raise demand and output.

Now, the question is: Should an increase in excise duty on petro-products to be categorised as an increase in indirect taxation of a wage good or of a luxury good? The government pretends that petro-products like diesel and petrol are consumed by those owning cars and other motor vehicles, and are therefore in the nature of luxury goods, so that a rise in their prices cannot be claimed to hurt the poor.

But this is completely wrong. Petro-products, rather like electricity and coal, are used not just for private consumption but for a variety of other uses: for public transport and as an input into agricultural production, which provides the most elemental necessity of all, namely food grains.

Since an increase in input cost at any stage must reflect itself in the form of higher prices of the final good, petro-product price-hikes must cause an increase in the prices of a whole range of final goods including those consumed by the poor. If the final prices do not rise, then that can only be because the profit-margins of the petty producers, like farmers, are squeezed to accommodate higher input costs without a rise in the final price.

One of the reasons for the rise in prices of late, despite the economy being severely demand-constrained, is the cost-plus effects of the rise in petro prices. Government policy therefore is directly responsible for the recent spurt in inflation.

In the face of this spurt, the obvious ploy of the Reserve Bank is to keep the interest rate high; and the high cost of credit, especially for the petty production sector, hurts the poor even more, either through a further impetus for price rise, or for further squeezing the petty producers, making them unviable.

Thus, the government’s fiscal bind is taking a heavy toll on the Indian economy. (IPA)