How Much Tax Should a Government Collect?

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Higher tax should also translate into a higher development and social security. Are we also doing that, asks Tarun, in the weekly column, exclusively in Different Truths.

I must credit demonetisation with one thing, it helped me start as a columnist in Different Truths. How? It provided such a rich fodder to my brain, so many questions popped up, that I became a columnist. Traditional economics was unable to answer whether demonetisation would help the economy, or not. After much water has flown down the Yamuna, opinion is still divided about the costs and benefits to the economy. So to explore so many economic aspects, I started to research and write the column.

The latest topic came to me when a police constable remarked, “The government needs to increase taxes because it needs to do development of the country”. I spoke impulsively, “But if all the money goes to the government, how will private investment, (which seems to have dried up in India), take place?” Interestingly, this same remark came from a good friend, a consultant in a top business analysis firm. I was intrigued. How come a specialist and a common man are speaking the same language?

That set me thinking. How much tax should a government collect? About three to four years back, the tax to GDP ratio in India was around 10 percent. After various government measures, it has increased to nearly 18 percent. This has helped the government in reducing fiscal deficit. A lower fiscal deficit is helpful to reduce inflation and bring down the interest rates. But, higher taxes also affect consumption and investment demand, since people are left with lesser money in their pockets. This results in a slowdown in the economy.

Thus, we see, the tax has two issues – government finances, and GDP growth.

Let me digress a little bit. There’s a tribe in the Andaman Islands called the Jarawas. They still live in a prehistoric manner. They don’t wear clothes or eat processed foods. They depend entirely on nature and are fiercely protective of their culture. We can safely assume their GDP is zero, and so is the tax on them. And they are happy with their system, as they fight any invasions on their island. They are not touched by modern development, have no market economy. Assuming they were to start on a development path today, they would need all the amenities like roads, etc. That is when they shall need to pay taxes. The higher amenities they need, the higher taxes would be paid by them.

By this example, we can understand that higher taxes should imply a higher level of development. In the USA, the tax to GDP ratio is 26 percent, and the social security system, as well as the infrastructure there is a very high-quality one. In some Scandinavian countries, we have a higher ratio, upwards of 40 percent, but the programmes there take care of cradle to grave of every individual.

It is amply clear that higher tax should also translate into a higher development and social security. Are we also doing that? The Higher development would mean a more industrialised nation. The government share of the GDP is nearly 15 percent, and it is already collecting 18 percent tax. It is getting a huge amount, much more than before. While there are a lot of programmes that the government is running, we need to see distinct changes now in the scale and quality of those projects. The infrastructure in terms of roads, ports and governance should also be improved. The social security should also go up. The total indebtedness of the country should go down.

Let’s see how India scores on those parameters. As per the latest report of UNO, released in March 2017, India ranks 131 on the Human Development Index. In 2010, India had a rank of 135. We have improved by four ranks. The Human Development Index is a composite statistic of life expectancy, per capita income indicators and education. So, we see that a higher tax collection has resulted in some improvement in the HDI.

Infrastructure has got increased attention over the years. Infrastructure includes power, roads, bridges, dams, ports, affordable housing, drinking water, sewerage etc. The infrastructure sector has got increased budgetary allocations lately. The share of investments in infrastructure as a percentage of GDP has gone up from 8 percent in 2010 to 9 percent in 2017. Though higher, this increase still doesn’t explain the 80 percent increase in tax revenue.

And lastly, we come to the fiscal deficit, the third component which is affected by tax revenue. The gross fiscal deficit of the centre and states combined was 9.3 percent in 2010. That same has come down now to 6.9 percent in 2017. This is heartening, as it puts less pressure on inflation, and consequently, reduces interest rates, and makes the economy more robust. However, lower fiscal deficit also lowers the availability of funds for investments, and hence future production capacity suffers as a consequence.

Thus, we see that through tax collection has gone up a lot, many things which were supposed to take place, as a result of higher taxes, have not been that visible. While some progress is visible, still, more should show as a result of the higher sacrifice of a common man. While there may be a time lag between collection of taxes, and the results, it is high time that that time lag is reduced, or if possible, eliminated. The government should refrain from increasing tax base more until the already huge kitty begins to show some results. This would be a just reward for the short-term pains of demonetisation and GST implementation.

©Tarun Gupta

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Satyam Shivam Sundaram defines the belief and philosophy of Tarun Gupta, a Delhi-based businessman, with a passion for learning. He tries to locate the common thread in all learning – as Einstein identified energy as the base thing – and find creative, interdisciplinary solutions to problems, with special focus on economics. Behavioural economics is his special interest, which encompasses emotions as well as economic choices when identifying problems and the solutions.