Restoration of sound taxation principles should be govt's next big reform

A huge fuss is being made about higher fuel prices. Sonia Gandhi has even written a letter about it to the prime minister. She has called it ‘extortion’. But her knowledge of history and economics — and more importantly economic history — is nothing to write home about. So, unlike the Congress party, we can ignore her safely.

 
What we cannot and must not ignore, however, are four simple facts. Indeed, it’s because economists know these facts that they are not supporting the Opposition on this issue. They know the government is right.

 
The four facts that need reminding are as follows:

 
One, petrol prices in India tend to double every 10 years. You can check this out yourself. Often they do so suddenly.

 
Two, over the past 50 years the rate of taxation (or excise duty in the case of petrol), has tended to vary between a low of 48 per cent and a high of 58 per cent. Within this, the share of the Centre has been remarkably stable at around 40 per cent.

Third, as the International Monetary Fund (IMF) tells us, the vast majority of countries use, and have always used, petroleum taxes to increase revenue. The reason is that the demand for it is highly inelastic.

Indeed, this practice is based on one of the staples of public finance. It’s the few countries that don’t tax petrol at a high rate that are stupid. The US leads the way and is not an exemplar. What China does only China knows – or, as is increasingly more likely, even it doesn’t.

Fourth, this is fourth time since 1947 that petrol prices have risen so sharply. The reactions have always been the same, howls of protest. The first time was in 1973 after the first oil shock when the Organization of the Petroleum Exporting Countries (OPEC) quadrupled the per-barrel price. The second time was just six years later, in 1979, after the Iranian revolution. The third time was in 1990, when Saddam Hussain invaded Kuwait. And the fourth time was in 2003, when the US invaded Iraq.

On each occasion, there was a loud protest. Consumption declined for a few months. Then it went back up and kept rising till the next big and sudden increase.

The mystery of course is why we don’t use the exchange rate to tax imports. That would be politically less unpopular.

This proved, if proof was needed, that it’s foolish not to tax things the demand for which is inelastic. This, by the way, was the reason why salt used to be taxed till Gandhiji recklessly opposed it and the salt tax was abolished after Independence.

As an aside, let me say that I think it should be restored. Good public finance practice requires it. The 5 per cent GST rate should be applied. Or, at any rate, the states should find a way of taxing it. If no one else, at least the doctors will approve. But I know this is a pipe dream. So let’s leave it by acknowledging that it’s yet another violation of a sound principle of taxation.

And this brings me to the central point of this article: Mr Modi must make the restoration of sound principles of taxation his next big series of reforms because Indian tax practices are so hugely counterproductive.

Committee after committee since 1956 has pointed out the myriad ways in which Indian taxation practices lead not only to poor economic outcomes, but they also don’t help revenue objectives. So, the point for Mr Modi is this: the right to tax may be a sovereign right but the right to tax stupidly is a political privilege that needs to abolished. 



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