The govt needs to focus on economic growth and not taxes

There is a myth perpetrated by the government that higher tax collection will create economic growth. The problem is that they’ve got the causality wrong. Increased tax revenue is the result of economic growth and not the cause of it. The economic variable that the government should, therefore, attempt to maximise is economic growth and not tax collection. 

Consider the analogy of water in a bucket as representing the total amount of money in the economy. Taxation, then, is a hole in this bucket which takes water (money) out of the larger bucket (economy) into a smaller bucket (government). Taxes therefore merely represent a transfer of water from one bucket to another. But, moving water from one bucket to another does not increase the amount of water — the total amount of water is still the same. In other words, taxes only move money from one bucket into another, but do not create new wealth.  

Let’s be clear: Eliminating black money will not make India richer. All that will happen is a transfer of water from one bucket into another. In other words, a transfer of money from the private sector to the government. And if history and evidence are any guides, the private sector is likely to invest its own money more wisely than the bureaucrats and politicians in government. The money is, therefore, more productive if it stays and circulates in the big bucket than if it is taken out in taxes and spent by the government.

I am not advocating that people don’t pay their taxes. I am simply busting the myth that collection of additional taxes from the private sector will somehow create prosperity. It won’t. In fact, no country in history has ever taxed itself into prosperity.

Why then, do we continue to hear statements like “Taxman watching Diwali spending on social media to find black money” or, “Taxman using deposit deluge to snare evaders,” or “ Taxman tightens norms for MNCs.” These threatening statements put out by the government are counterproductive. Scared consumers don’t spend, and fearful businesses don’t invest, and without private sector consumption and investment, the economy will not grow.

The government’s constant threats on black money are hugely detrimental to economic growth. 

An unwise tax policy (http://www.dnaindia.com/analysis/column-india-requires-out-of-the-box-thinking-on-tax-reforms-2547424) and a government obsessed more with black money than the creation of growth, will unfairly tax those who create wealth, and in the end, make everyone poorer. What may appear obvious is often an illusion in a complex ecosystem like the economy where behavioural responses like greed, fear, loss of confidence are far more relevant than the obvious and measurable responses. 

The government does have legitimate needs for funds, but instead of focusing only on increasing revenue, it should focus also on decreasing spending and shifting priorities from consumption to investment. The government keeps getting bigger in both size and scope. And the larger it gets, the more it wastes. The central government has 51 ministries — more than twice more than any other country in the world. Each ministry means more VIPs, more bureaucrats, more government employees, none of whom add much productive wealth to the nation. They are simply holes in the bucket that waste the water. A senior bureaucrat once candidly told me that if you “eliminate half the ministries and half of all the useless regulations that come with these ministries, you could cut down waste and abuse by more than half, and double the country’s GDP.” 

Take the sports ministry for example. India has a sports ministry at both the federal level and in each state. Despite this plethora of sports ministries, the entire nation of 1.25 billion Indians has won fewer medals in Olympic history than one American swimmer Michael Phelps. And America does not have a single sports ministry either at the federal or state level. In fact, the US government does not spend one single penny on sports — it is all managed in the private sector.  

The most significant problem holding India back from achieving its potential is the massive level of government involvement in all aspects of society. No political party ever talks about this. This is partly because the political elite doesn’t want to reduce the size of the trough that feeds them, but also because the people that elect these politicians have become dependent on them. So the system carries on. New governments come and make a few changes at the margin. But no one has the courage or the commitment to make the institutional changes the country needs. 

Hopefully, a set of political leaders will soon emerge who will ask the question: What is the role of the government and what it the minimum size of government that can effectively perform that role? Because unless we reduce the power and reach of the state and increase economic freedom, India’s economy will remain mired in the 4-7 per cent range, which is not enough to provide jobs to the 12 million people that join the workforce every year.     

The author is Managing Director, Center for Environmental & Economic Policy. Views expressed are personal.