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Avoiding tax policy blunders
February, 04th 2016

The recent announcement that the government of India is setting up a Tax Policy Research Unit (TPRU) is an extremely welcome one. Till some 60 years ago, the economics syllabi in universities included “public finance” as a special subject. Unfortunately, under the influence of Keynesianism and post-Keynesianism, this important subject got subsumed into the broader and more vaporous discipline of macroeconomics. The study of taxation is a very important part, not only of economics, but also of political science. Taxation, in a large measure, defines the relationship between the state and the citizen. It forms the basis of associational political loyalty and can drive citizens towards productive and law-abiding behaviour or towards non-constructive and even lawless behaviour.

The TPRU is going to be asked not only to look at the impact of a new tax measure on immediate state revenues, but its medium- and long-term impact on the behaviour of economic agents and its impact on the economy and on the body politic in holistic terms. If we had such a research unit in place years ago, the country could have rightfully expected to know that imposition of a 97% marginal income tax rate would inexorably and inevitably lead to the creation of a large untaxed “black” economy which, once inaugurated, will not disappear for decades on end. All of us are living under the curse imposed by a finance minister so long ago. The fact is given, the prevailing ideologies of the then ruling clique, the 97% tax rate may have been imposed anyway. But if a sound and intelligent TPRU had pointed out the long-term baneful consequences, then at least the rulers of the day could not make the claims that they did not know, that they were not told and that they were not warned. In more recent times, the unit could and would have pointed out that a retrospective tax law brought in to negate a lawful judgment of the highest court in the land, would have far-reaching considerations going beyond the immediate one of discouraging investment (a disastrous consequence to start with), but also would hurt the long-term credibility of a fair and non-predatory state and loss of faith by the citizenry in the institutions of the state—a catastrophic consequence, by any standards.

Taxation and taxation systems have many consequences—both intended and unintended. Perhaps the insurrection in the province of Judaea would have not been so strong if the Roman rulers had paid attention to the fact that their tax system and their tax-gatherers were dysfunctional. Perhaps the Thirteen Colonies would not have revolted if George III and Lord North had been blessed with a TPRU. One can argue that Cornwallis was not in a position to predict the long-term consequences of his Permanent Settlement of Land Revenue and the Zamindari System in Bengal. One can also speculate whether Munro was prescient about how the Ryotwari Settlements would end up influencing Indian history. But it must be remembered that even in their pre-macroeconomics Age, they knew that it was not smart for the sovereign to kill the geese that lay golden eggs—a fact that our 97%-finance minister did not know. And it appears that he had no one close to him who could tell him the facts of public finance that go back to antiquity. Today, we are luckier than Cornwallis or Munro. We can make predictions, which by no means completely accurate or correct, are within a reasonable range of statistical likelihood. We can also postulate alternate scenarios depending on how certain event-driven Markovian processes may actually happen on the ground. While the TPRU may not get all predictions right, it is the case that we have a sufficient body of knowledge, to present before lawmakers a reasonable scenario of the way things will turn out.

We have had Pareto Analyses of our tax systems in the past. Raja Chelliah did a brilliant job in analysing the good (very limited) and the bad (predominant) nature of our tax laws and structures. But the key thing is that these were all “after the fact” reviews. Our erstwhile confused Planning Commission should have played the role of an ex-ante forecaster. But it was so busy multiplying and dividing across various Leontief-Harrod-Domar comical equations that it consistently failed to provide meaningful input to our law-makers as they reeled and ricocheted from one Budget Day to another. Make no mistake—the setting up of a competent, intelligent and influential TPRU is likely to be seen by future historians as the beginning of an important exercise in India’s political economy. We must fervently hope and pray that in the next few years this new unit establishes its impact sufficiently strongly, so that it becomes a permanent feature of our state processes. One can only close with the thought that Kautilya, Todar Mal and David Hume would have all been pleased that the government of a republic is not delegating this important research activity to one or many departments buried under different layers, as frequently happens in modern government initiatives. It is being kept separate, small, influential and empowered. And therein lies sufficient reason for optimism.

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