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FE Editorial : Take left
November, 20th 2008

Nothing typifies the high noon of policy heterodoxy in the current economic crisis than the seeming political unity around oldfashioned Keynesian economics with a twist-spend your way out of recession with a mix of public spending and tax cuts. Orthodoxy on the Left would normally prefer government spending while the orthodox right would prefer tax cuts. However, there is a convergence this time around with almost everyone, including in the US and UK, favouring both simultaneously. What is more surprising is that the Left (typified by the Democrats in the US and Labour in the UK) has done a better job of selling tax cuts to the general public.

Consider the essential difference between John McCain and Barack Obamas tax-cut plans. While both would reduce the average tax burden, Obamas plan raises the taxes of the richest (those earning more than $227K a year) while reducing the taxes of those earning lessnotably, in terms of reducing their taxes as percentage of after-tax income. It is the lowest income groups who benefit most from Obamas plan. Assuming that these groups have higher marginal propensities to consume from additional income than richer groups (and thats a reasonable assumption), putting proportionately more money into their hands will boost the economy faster. Also, taxing the richest groups more assuages worries about a secular deterioration of the deficit. McCains plan had wanted to reduce taxes for the richest as well and proportionately less for the lowest income groups. Another part of the debate on taxes and spending is underway in the UK. Again, the Labour governments plan to cut proportionately more taxes for the lower income groups while retaining spending programmes is more popular than the Conservative plan to reduce taxes and reduce spending (or keep tax rates steady and increase spending) in the interests of fiscal prudence. In times of bust, that it is okay to run a deficit is the political-popular mantra. What about India? Given our limited tax base and fairly low rates of income tax and corporate tax, a direct tax cut may not achieve much by the way of increasing consumption. In Indias case, spending programmes that can be quickly implemented plus indirect tax cuts seem a better option. Note, in India, left-of-centre parties or groups have cut headline tax rates more than the BJP.

 
 
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