For richer, for poorer

The United Progressive Alliance-2 government of Manmohan Singh-Pranab Mukherjee has introduced major reforms in economic policies in India, which may have a much more far-reaching impact on our economy than the 1991 economic reforms of Narasimha Rao-Manmohan Singh. The reforms introduced today are clearly with a social purpose. They will stimulate economic growth but at the same time try to look after the social development programmes which affect millions of the poor and underprivileged.

Until now, these policies were related to expenditures on employment guarantee, Bharat Nirman, food security, social security and pension schemes. But last week the finance ministry introduced a major change in our taxation system, which brings us back to the fundamental principles of reforms for economic growth reaching out to the common man. The latest example of that is the notification about exemption of savings-related instruments from direct taxes. They were introduced as part of setting up a new tax code for direct taxes. But the principles go far beyond procedural changes, raising questions about the basis of direct taxes, whether they should be income or expenditure and how the system is going to use increased saving through increased productive investment keeping up the rise in growth of income.
The Direct Tax Code proposes major tax incentives for savings, through exempt-exempt taxation (EET) method of taxation of saving where contribution towards certain amount of savings in instruments that can be invested in socially desirable projects as deductible from income. Then the accumulation of accretions to those sums remain exempt from any tax incidence so long as they remain invested. But all withdrawals from this fund at any time are subject to tax at the applicable marginal rate of tax, as such withdrawals are potential expenditures on consumption, i.e. non-saving or non-investments. Even these have been simplified now because of the transaction cost of relating expenditures to specific saving instruments. As long as they are maintained with permitted saving intermediates, such as provident fund, superannuation fund, life insurance and new pension system, the accretion to these deposits will remain untaxed till they accumulate in their accounts.
In short, practically all savings are now exempted from income tax, which would essentially be imposed on expenditure (i.e. income-saving) on consumption, but it does not have any effect on expenditure on investment. This is essentially reviving the old system of “expenditure tax” popularised by the famous Keynesian economist, Nicholas Kaldor, in the 1960s. The idea was that income earned by individuals should not be penalised by taxes, which should be directed towards expenditure in a progressive scale, so that those who spend more on consumption are primarily richer and therefore should be made to pay more than the poorer people to finance socially desirable investments.
When this expenditure tax scheme was introduced by Kaldor, it was regarded as a revolutionary change not only because it changed the notion of taxable income but also because it gave a direct push to non-consumption and productive investment, where these savings were to be deployed and provide stimulus to economic growth. The problem remained with treatment of these savings and the detailed procedures which were increasingly found to be intractable. It is for the same reason that Kaldor’s proposal for India, made in 1956 with the active interest of Prime Minister Jawaharlal Nehru, could not go far. Successive budgets tried to introduce procedural changes trying to approximate savings to expenditure on productive investment. Most of these efforts proved to be impracticable.
But the principles of expenditure tax became a basic part of development literature. In the ’50s and ’60s that literature was concerned mostly with capital formation expanding more the productive potential of the economies through capital investment. Since economic policies could not be used to reduce overall demand, a policy to increase savings had to be complemented by policies to increase investment. Gradually, it became clear that such policies would have to be related to promoting public investment, which were treated as autonomous or mostly guided by principles of public goods or social infrastructure, the returns from which mostly remained unmarketable for private investors. If public investment is not expanded to overcome the shortfall of private investment, the total savings of the economy would be higher than the total expected investment. That would repress domestic demand and income.
I suspect that this particular feature of expenditure tax, which implicitly favoured programmes of public investments that was the cause of the neglect of Nicholas Kaldor’s proposal in capitalists economies. Instead of making attempts to devise saving instruments which will directly expand the productive capacities or expenditure in socially desirable schemes that increase social incomes, the policymakers in the capitalist countries chose to stick to the incentives in the market system through expanding expenditure on consumer goods production, meeting the requirements of the private sector.
It does not mean, however, that any scheme to promote savings would have to be necessarily connected with increasing public investment. In a growing economy the requirements for financing private investment will continue to grow and increased supply of savings through market principles would still be an effective instrument to channel those savings to productive investment.
But the usefulness of expenditure tax or increased savings in a developing country like India goes far beyond any possible dichotomy between private and public investment. There is such a huge deficit in infrastructure investment, both physical and social, that it is hard to imagine that there would be an excess of saving over investment that will depress domestic demand. If private investment is not forthcoming, public investment should cover the gap with the help of increased revenue or accretion to specifically designed savings funds. This would be true even if the country is going through financial repression. It is always possible to design investment programmes which would be justified over their lifetime through increased social revenue, even if the private returns in the immediate future are not commensurate with social benefits.
All these, of course, raise fundamental questions about the purpose of economic growth or reforms and the design of public investment. The jury is still out on the merits and disadvantages of the different schemes of tax and expenditure reforms. The finance minister’s latest proposal will reopen those discussions.

Dr Arjun Sengupta is a Member of Parliament and former economic adviser to Prime Minister Indira Gandhi


Why shall one save?

Why shall one save? Inflation is a tax on savings. When there is an inflation of 10%! 7 food inflation and banks post Offices are giving
negative interest why one shall save? I do not know how we can get rid of these political parties the bureaucrats.

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