Don't overtax and overspend: How Modi govt can avoid cooking its own goose

The govt must understand that if you spend more than you earn, you will end up bankrupt one day

In 2003, the then finance minister Jaswant Singh phoned one day to ask how he could put more money into peoples’ pockets. “There’s only one say, Sir,” I told him, “you must take away less from them.”

“I know,” he said, “but how will I pay the bills?”

You don’t need a PhD in economics to know that if, over a sustained period, say five years for a family and fifty for a country, you spend more than you earn you will end up bankrupt one day. The thing is while ordinary people know this, governments don’t.

That is why whether it was the Nawab of Arcot who ceded Masulipattanam (later Madras) to the East India Company or Rajiv Gandhi whose fiscal policies bankrupted India in 1989, it is the same story.

But when families stare at the writing on the wall, they reduce their expenditures. Governments, on the other hand, first borrow more and more and then when that is no longer possible, they tax more and more.

This is perhaps on reason why the ‘normal’ rate of taxation in India over the last 500 years has been around 50 percent, plus-minus 10 per cent.
 

Where the Modi government has gone wrong is in going for the plus 10 percent, rather than the minus. It is this approach - as even Aurangzeb discovered - that is causing the current problem for the Modi government.

Whereas the Mughals and, after them the British, spent on armies and wars, the Modi government wants to spend on welfare. Both have one thing in common: they let the sovereign power stay in power and even expand it.

Eventually, however, as both the Mughals and the British discovered, this approach to public finance ends up with game-changing self-goals. A bankrupt government can never retain its hold on power. 

What is to be done

It was the IMF in 1991 that forced Indian politicians to understand that when you are broke, you must spend less. This is exactly what the Modi government has to do before it is forced to do so. 

India has reached a point where it must, absolutely must, cut back on all expenditure by instituting an across-the-board cut of at least 15 per cent every year for the next five years. There’s no other option left. Or, at the very least, it must freeze expenditure at 2014 levels.

Towards that end, it must reduce the pension bill by stopping the payment of pensions to every family that has an alternative source of income that equals or exceeds the pension. Second, all loss-making PSUs must be shut down gradually. Third, every single subsidy must be discontinued. Fourth, all government salaries must be reduced by at least a quarter, if not more. Fifth, it must fix a hard budget constraint which it will not exceed under any circumstance. 

If we don’t do these things now, our goose will be properly cooked in about three years from now. Indeed, it probably already is.

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