Why a Swachch Bharat cess is a bad idea

A tax break will work better

Prime Minister Narendra Modi’s initiative to clean up the country showed that he was prepared to tackle the most difficult problems India faces—cleanliness, hygiene and sanitation are Mahatma Grade Problems, caused by a simultaneous combination of individual, social, market and government failures. The Swachch Bharat initiative has come about because he used both his popularity and power to try and change mindsets and attitudes. To succeed, it needs the government, business and social leaders to change peoples’ minds and moral incentives. If it becomes yet another government programme, it is bound to fail.

So the Modi government’s proposal to impose a cess on telecom services to finance the Swachch Bharat campaign should cause us disappointment and alarm. It is the wrong approach to the problem, using the wrong method. Here’s why.

Levying a cess dilutes the moral incentive that a borderline conscientious citizen faces. Instead of a gnawing feeling when she sees garbage in public places, the marginal citizen is likely to feel the same-old, “I’ve done my part but the government is not doing its job properly”. There is evidence that compliances rates (for tax payments and other rules) goes up when citizens see the government delivering honestly and effectively. Similarly, the perception that government is inefficient and corrupt reduces compliance. In other words, levying a cess on citizens is not only likely to cause them to outsource their guilt and responsibility, but also try and avoid having to pay the cess. Swachch Bharat should be about emphasising that hygiene and sanitation are about personal honour and dignity, not about pay-tax-and-forget.

That’s not all. A cess is a bad way to raise revenues. A cess on an unrelated activity is a terrible way to implement a bad way to raise revenues. As this blog commented on the previous government’s use of a cess on restaurant bills to finance education, there is no better way to signal that a government has confused public finance priorities than a cess. If a programme is important, it should be financed through the core budgetary revenues. Clearly, one of the prime minister’s most important priorities ought to be enough of a priority to be funded through the conventional budget.

If at all a cess has to levied, it should be on non-essential spending. Furthermore, a specific tax on an unrelated economic activity merely to raise revenues is a very bad idea. Telecommunication services are already subject to heavy price regulation, leading to very bad quality of services across the board. An additional tax on these services will burden consumers, impact telecom service provider revenues (and hence the license fees they pay the government) while doing nothing to improve service quality. Telecommunications services appear to have been chosen for the cess mainly because it is easy to collect from them, and people will have to make calls and access the internet anyway.

Why could the tax not have been levied on entities and industries that dirty public spaces? At least that would have attempted to recover the cost of the negative externalities.

But here’s an even better idea to implement Swachch Bharat: give a Swachch Bharat tax break to all income tax payers. When filing their taxes, let taxpayers tick a box saying “I have done my best to make India clean”. Of course, a lot of people will claim the tax exemption without changing their behaviour, but a some will. It is better to trust the citizens more to do the right thing, than to tax them more on the premise that they will do the wrong thing. That’s the only way Swachch Bharat can work–when the relationship between the citizen and the country changes into one of mutual trust and mutual concern. The campaign is about capturing hearts and minds, not more rupees.

The Modi government would do well to resist the temptation to use age-old sarkari methods to solve a nagging social problem.

Redistribution as theft

Alleviating poverty requires economic growth alone.

It is not often that Indian public discourse seriously discusses big ideas. So it was nice to see, a few days ago, a debate in large sections of the mainstream and social media on economic growth vs redistribution. This debate received wider public attention because it was conflated with a personality clash between Jagdish Bhagwati and Amartya Sen, because it became entangled with the hottest political topic of our times and because it came at a time when the issue itself is important.

When faced with two sharply different points of view, it is common—not least in India—to insist that the truth lies somewhere in the middle. This is celebrated as being reasonable, as representing the compromise that is the hallmark of democratic practice and as being the mystic middle path. So when some economists insist that growth is the best way out of poverty while other champion redistribution of wealth, it is to be expected that there will be reasonable people who will say “we need both more growth and more redistribution”. This is a good way to end the debate amicably and drink to reasonability and democratic compromise.

Unfortunately, there’s a difference between appearing reasonable and being right. “We need more growth and more redistribution” is not a reasonable middle position. It is essentially an argument for redistribution but stated in a different form.

Without growth, redistribution is at best a transfer and at worst, theft. If a community earns the same amount of money (or produces goods of the same value) every year, then redistribution takes from Preetam to pay Palani. If Preetam consents to the arrangement, it is a transfer. If he doesn’t, it is theft. Over a period of time, it will make the community more equal, but it doesn’t necessarily make the community less poor, for even after achieving income equality, the average income can be below what is required to subsist.

Growth is the only way to increase the overall income of a community. It can raise the respective incomes of both Preetam and Palani, although Preetam’s income might rise faster than Palani’s. Inequality will rise in such a community—perhaps because Preetam was born into a better endowed family, perhaps because Preetam works harder or perhaps because Palani faces greater social hurdles—but because both Preetam’s and Palani’s incomes rise, the whole community can climb out of poverty. There is vast empirical evidence for this, and growth is the best antidote to poverty. It’s the most effective anti-poverty scheme known to humankind.

Here’s the best thing: in such a society, there is no inherent need to take from Preetam to pay Palani on the grounds of poverty alleviation. There might be other issues—for instance, progressive taxation to finance public goods based on the ability to pay, but not to help a poor Palani out of poverty.

Hey, wait a minute! Isn’t inequality rising? Isn’t that a bad thing? Aren’t Palani’s prospects not handicapped by historical social hurdles? Aren’t Preetam’s disproportionate gains coming from exploiting Palani? The reasonable people who argue that “we need both more growth and more distribution” usually raise these questions to argue for more redistribution. (There are unreasonable people who raise these questions for other reasons, but let’s stick with responding to the reasonable).

Yes, inequality will rise, especially during periods of high growth. But inequality is a social problem only if it is permanent and ossified. However, growth is the best way to ensure that it is not—with growth comes mobility, and the expectation that one can improve one’s life allows societies to thrive despite the inequalities. Ask migrants to New York or Mumbai. Many also see a moral problem with inequality, but why expect the state to solve moral problems? Let the moral conscience of society address its moral problems.

Shouldn’t we account for historical social hurdles that hobble some citizens? Yes, but these are addressed by creating equality of opportunity, not by insisting on equality of outcomes (where Preetam and Palani end up earning the same income). You can achieve equality of opportunity without redistribution—affirmative action and reservations (without subsidies) are ways to address this challenge.

Isn’t Preetam exploiting Palani? This blog post will not attempt a comprehensive critique of Marxist thought. However, the ideas of economic freedom, property rights, voluntary exchange and comparative advantage together prove that Preetam’s gain is not at Palani’s cost. Although the sort of people who argue that Preetam exploits Palani will seldom acknowledge that redistribution, by definition, means that Palani’s gains come at Preetam’s cost. Unlike redistribution, growth creates non-zero-sum or win-win situations. Only growth creates such situations.

From this alone, we should conclude that “we need growth, not redistribution”. But reasonable people will go to great extents to be reasonable. It’s about sequencing, they’ll say, and contend that some redistribution is necessary for growth. It’s unclear why this is called a reasonable argument—if we accept that both Preetam and Palani will be better off with growth, then the decision to take some from one and give it to the other is unnecessary, whimsical and entirely arbitrary. Instead, why not spend extra effort to ensure that there are no constraints to growth in areas that benefit Palani?

Ergo, what appears reasonable is not quite reasonable: we need growth, not redistribution. The state can ensure growth by getting out of the way of private enterprise, ensuring public goods are provided, acting as an impartial referee, ensuring equality of opportunity and a level playing field. Governments are not good at redistribution: it involves taking money from people who don’t want to give it up and passing it through a system where everyone wants to grab as much as they can get. That is why redistribution is attractive to politicians who are keen to listen to intellectuals who say it is necessary.

Why levy a Cess for education?

A question of priorities and an excuse for extravagance

Taxpayers and restaurant-goers in India will find a cess (2%) and a higher education cess (1%) added to their taxes and bills. The cesses are earmarked taxes collected to ostensibly finance education and higher education.

Like with most of the budget, few ask why this must be so.

The fundamental purpose of government revenue—the reason it collects all sorts of taxes on income, sales, excise—is to fund development expenditure. What could be more important for our country than spending on basic education, public health and basic infrastructure? Whatever the government spends on these heads must be fully financed from its primary revenues. In other words, these subjects should have the first claim on the government’s resources. Whatever might be our politics or ideology, no one can deny that these should be our priorities, and after we have adequately provided for these, we should spend on other things.

Why then does the government charge a cess for education and another cess on higher education? This seems to suggest that the fundamental priorities of the government are not concerned with improving the lot of the poor, the needy and the citizenry as a whole, but something else. The message is “Ladies and gentlemen, since we’ve allowed other things to have the first claim on the government’s revenues, we don’t really have money for the most important priority, so we’re raising earmarked funds for education.” Beyond the technicalities of the economic effect of the cess, and without regard to ideological positions on how education ought to be delivered, the fundamental signal here is that the government’s priorities are wrong. The government is like an irresponsible husband wasting the family income on useless things and then seeking help to support his children’s school fees.

The cess is what is known as an earmarked tax. In terms of its economic effects, it has been found that “earmarking can be beneficial, but the conditions for this are quite strong and are rarely met in practice. The earmarked tax (which may be a separate tax or a fixed proportion of a broad tax) needs to be kept separate from other revenue, be applied exclusively to the expenditure programme for which it is identified, and fully fund (but not over-fund) that programme rather than being mixed with general revenue.”

Money is fungible. If you give 100 rupees to a college student to buy his books, and he uses 100 rupees of his own pocket money to buy cigarettes, it’s tantamount to your money being used for cigarettes. This is the gimmick involved in the education & higher education cess. People who might object if the government had charged a “Moon Mission cess”, a “Nuclear Arsenal cess” or a “Petrol Subsidy for the Middle Class cess” are less likely to do so if the cess were collected for a “good cause”. That does not change the fact that every rupee collected in the name of an education cess is a rupee being spent on the most wasteful, most extravagant and most unnecessary items.

The finance minister needs to explain why a cess is necessary when tax revenues have been growing steadily over the last two decades. If the government has the money to subsidise unwarranted tablet computers for college students, why does it burden with cesses?

For some serious policing

Planned spending, informed planning

Sushant K Singh and Ramavtar Yadav make a case for police reforms in today’s Mint.

Social and economic security needs to be immediately adopted as one of the Plan sectors by the commission. This sector should set national objectives and provide assured resources—funds, manpower, equipment and training—for policing and encompass crimes, crimogens, criminal justice system (CJS), police organization, correctional services and judicial service.

There have been incessant calls to discard the archaic system of centralized planning and the distinction between Plan and non-Plan accounting, which has many drawbacks. In the present scheme of things, however, a Plan scheme acquires priority and urgency by virtue of being a Plan item of expenditure. A very elaborate process governs the fixing of Plan expenditure by the government and the commission. Non-Plan expenditure suffers from a lack of cost consciousness, no medium-term perspective for continuing activities and allocations, lack of macropolicy knowledge at the level where budget estimates are made and lack of feedback on performance and results. The underlying logic of identifying and channelling resources into core sectors through planned expenditures will provide policing with the necessary legitimacy, urgency and impetus in the present government set-up. [Mint]

They also call for a national crime survey that can form the basis for planning. If that sounds like common sense to you, isn’t it shocking that the current approach lacks it?

My op-ed in Mint: The civil-military balance

India needs comprehensive military reforms, not mere salary increases for officers

In today’s op-ed in Mint, Sushant & I argue that rather than merely addressing military pay and procurement in isolation, India needs to urgently conduct a fundamental overhaul of its armed forces. Continue reading “My op-ed in Mint: The civil-military balance”

Dear Yusuf Raza Gilani

Regarding freezing defence expenditure

Your decision to freeze Pakistan’s defence expenditure as “a show of its desire for peace with neighbours” is welcome. We even hope that you will someday be able to control that budgetary head.

You also hoped “to see a reciprocal gesture from our neighbour for the sake of peace and prosperity of the region”, which we are told is an “obvious reference to India.” While your sentiments remain worthy of praise you should have also asked your neighbours to the North and to the West to reciprocate too. It’s a pity you didn’t.

Slapping cess

How you should react if the government increases taxes to subsidise petrol

Over at Barbad Katte, Ramesh makes a startling call:

Here is a possible response to the Petroleum Minister’s proposal to levy a cess on income tax payers in lieu of a hike in the price of fuel. Get hold of your neighbourhood Congress man and give him one tight slap. [Barbad Katte]

No, no, it’s not a partisan thing. Go read his post to understand why.

Now, this blog deplores the use violence to make political points (and this has to be said, because there are always some irony-deficient, metaphor-deaf people). Instead, it recommends that taxpayers to line up in large numbers and vote against the simians making economic policy.

The knave of bad times

They destroyed the paddle. Schitt creek* is coming up

Growth in industrial production fell to 3%, the lowest in six years, indicating that bad times might be ahead. There’s worse. As Niranjan Rajadhyaksha demonstrates, the UPA government has frittered away the opportunity to put the economy on the footing to handle the coming problems. In the “misery index” he constructs, among emerging market economies, only Pakistan and Egypt fare worse than India.

But there is little doubt that the economic fundamentals are deteriorating. The hole in the government’s finances is getting bigger. It could now be close to 1991 levels, if measured correctly. The current account deficit, too, is growing and could conceivably touch 1991 levels by the end of this year. The foreign exchange market has already picked up these worrying signs. The rupee has been slipping against most major currencies over the past few weeks. Somewhere in some tax haven, a few hedge funds must be seeing these trends and sharpening their claws.

It is unfortunate and inexcusable that India is now at a point when it seems far more vulnerable than most other emerging market economies. The government should have used the splendid five-year economic boom and soaring tax collections to slash its deficit and prepare the economy for an economic downturn. It did not.

History will not judge the United Progressive Alliance government too kindly on this score. It is distressing that some of the same people who helped pull India out of trouble in 1991 have done so little to prepare for the next round of economic turmoil. One expected more from a team led by Manmohan Singh.[Mint]

Mr Rajadhyaksha is being charitable to Dr Singh and the UPA government. Not only did this crew fail to prepare for the coming storm, but actually damaged the boat. It’s a sin of commission. [Also see Swaminathan Aiyar’s piece on fiscal deficit]

* Thanks to Chidanand Rajghatta for revealing the decorous use of that euphonious euphemism

Podcast Trial

Listen to the voice of the revolution

Pragati will be available in a specially produced podcast edition, from April 7th onwards. It will provide a broad overview of the articles in the month’s issue of Pragati. Mohit Satyanand, your host, will read out key segments from the articles. You’ll be able to listen to the podcast online or download the podcast in MP3 format.

Here’s a sample track Mohit recorded last month. The purpose was to make sure that the technology works as intended. Unlike the the podcast edition of Pragati here he just reads one article from last month’s issue.

[audio:http://media.libsyn.com/media/pragati/trial1.mp3]

To listen to it you’ll need Flash enabled on your browser and a broadband connection for optimum listening experience. You can also download the file onto your computer.

Tell us what you think.

Pragati April 2008: Give them their freedom

Issue 13 - Apr 2008

Issue Contents

PERSPECTIVE

The unkindest cut Salil Tripathi
The loan waiver keeps poor farmers where they are

Waiver of mass debt Vijay Mahajan
How that money could have been used to really change lives

Concerning senior citizens Mukul G Asher &? Deepa Vasudevan
Budget 2008-09 and the implications for a greying population

Waiting for modernisation Sushant K Singh & Nitin Pai
The dismal state of long term defence procurement planning

Letters
On the arms race in outer space

FILTER

Foreign aid to Afghanistan; Water and climate change

IN DEPTH

Dealing with China’s power projection Harsh V Pant
A rising China will not tolerate a rising India as a peer competitor

ROUNDUP

It matters what generals say K S Madhu Shankar
The army chief’s worrying remarks on the India-China border

Options in Sri Lanka T S Gopi Rethinaraj
And the risk of Sri Lanka falling sway to outside powers

New language formulas Sujay Rao Mandavilli
From an unsatisfactory compromise to a liberal decentralisation

BOOKS

Tagore in China Stephen S Hay
Edited excerpts from Asian Ideas of East and West

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