Tax Hikes: They May Just Not Be As Bad As You Think

Posted on March 3, 2011 in Business and Economy


By Srishti Chauhan:

A while ago, when the Bhartiya Janta Party (BJP) launched their 3i campaign against the incumbent government, many people were rather puzzled about this sudden change of strategy by the BJP. From raising slogans in sonorous voices against inflation, corruption and the innumerable problems that they see in the government, the BJP had suddenly turned to a savvy sounding ‘3i’. For all those who are in dark about the campaign by BJP, 3i stands for inflation, internal security and incompetence of the UPA-led central government.

The BJP, in turn, is proposing tax cuts and lowering of inflation by allocation of subsidies in various areas. The question that arises here is “How will the BJP-led government, if it comes to power, cover the expenditure that any government has to incur if it chooses to obstruct the very source of its revenue?”

A very simple economic theory lies behind these gigantic decisions. To spend, the government needs money. To get this money government needs to impose taxes. If, however, a government relies on tax cuts to please the citizens then the budgetary deficit increases- to finance which the government either resorts to monetary expansion, public borrowing or borrowing from foreign international institutions like the International Monetary Fund (IMF) or World Bank.

The policy of monetary expansion might make sense to a lot of people. Print more money and spend it. It couldn’t get simpler! However, the increase in supply of money in the economy, in turn, accelerates inflation. The value of money goes down because of excessive supply. A simple logic: The more number of shoes you have, the less you value each pair.

An excellent and highly amusing example of this phenomenon is when during the post war period many European countries had thought of printing currency to stabilize their budgetary deficit. The ironical implication of this was that the value for money plunged so deep that to buy a loaf of bread people had to carry money in carts. The counting of such money became a complicated and tedious task and hence, money was weighed instead of counted!!

The second option that the government may resort to is public borrowing. This also may seem like a fancy idea since the government pays interest to its borrowers. However, pause and think. The government does not have money and that is the reason why it’s borrowing. How is it going to pay the interest on those taxes? This will eventually lead to the third and final option: Borrowing from IMF or the World Bank.

Many of us might have already formulated our opinion and decided that if foreign institutions are ready to provide a loan then why not make use of the opportunity? We shall repay the loans. With the growth rate high and India being touted as the next super-power, paying back loans won’t prove to be too tough.

The reality is, however, quite contradictory. Since independence, India has repeatedly borrowed from these institutions. The degree of borrowing is about 20% of the GDP of the economy. As time passes, this value is predicted to rise. The adverse effects of international borrowing are many. Ranging from political to economic sub domination, the country can transform into a marionette in the hands of the developed countries. Such a country has its imports, exports as well as policies controlled by the developing nations in their favor.

A simple example to illustrate the point would be: If India borrows massive sums and becomes subjugated to order by developed nations then there may come a time when the production of goods domestically will be deterred and exports will dominate all markets. In such a situation, price control shall be none.

In case the government does not borrow and chooses to make do with the funds it accumulates despite the tax cuts, then a major inconvenience that the masses face will be lack of infrastructure building in the economy. How will the government make new flyovers and bridges and roads if it has no money to spend? How will it expand its railway network if it spends all its revenue on providing petrol and diesel at cheap rates?

With all these and more adverse effects of lack of revenue with the government, the one thought that enters the mind is if taxes really are bad. Of course, excessive taxation in the name of progress which ultimately goes in the bank accounts of corrupt politicians is detrimental to the common man as well as the economy, but excessive tax cuts push the economy into deeper and graver quandaries. So, is the proposal made by BJP really for the “greater good”? Will domestic industries not suffer extensively in the long run by this small step that pleases the populace for a short period? The decision is crucial and the effects might be ruinous.