[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
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REIMAGINING INDIA<br />
Taxes, Corruption And Structural<br />
Defect<br />
Tax system is a powerful weapon in the<br />
hands of economic policymakers. Tax system<br />
is a major source of funding where<br />
political parties and government planners<br />
collect money and slice a fraction of the<br />
GDP for government spending and consumption.<br />
Currently India levies moderate<br />
tax rates on corporate and individual<br />
income. By <strong>2007</strong>, top personal and corporate<br />
income tax rates were 33 percent plus<br />
10 percent surcharge. Other taxes includto<br />
the realization of promises which is oftenly<br />
negatively related to growth prospects<br />
and economic performance. Political<br />
preference for expansionary welfare<br />
state demand greater involvement of government<br />
into the economic structure and<br />
thus political pressures reduce the scope<br />
of growth potentials. Every economic<br />
theory agrees that the long-term engine<br />
of growth is capital creation which means<br />
savings and investment. <strong>The</strong> share of government<br />
in the economy is equally important.<br />
<strong>The</strong> following picture known as the<br />
Rahn Curve shows the empirical relationship<br />
between economic growth and government<br />
spending.<br />
Output<br />
performance<br />
RAHN CURVE<br />
Goverment apending<br />
as a share of the GDP<br />
Source: Brimelow (1993), Mitchell (2005)<br />
Picture-1: Rahn Curve<br />
An Empirical Perspective On <strong>The</strong><br />
Trade-Off Between Government<br />
Size And Economic Growth<br />
Extensive public sector involves several<br />
macroeconomically important costs. Every<br />
single per unit increase in government<br />
<strong>size</strong> reduces potential unit of output added<br />
to the gross domestic product. <strong>The</strong><br />
costs associated with government spending<br />
are huge. First, government spending<br />
requires the collection of funds of spending.<br />
Costly choices mean an inevitable<br />
adverse consequence such as reducing the<br />
<strong>size</strong> of investment which is an important<br />
component of the GDP. Second, the effi-<br />
ciency of investment is determined by the<br />
efficiency of allocation of resources. In<br />
this respect, expanded public sector hinders<br />
private sector activities subject to the<br />
fact that resources are scarce; the foremost<br />
basic corner-stone of economics.<br />
Third, government spending supports<br />
backward regulation and intervention,<br />
displacing the competitiveness of product<br />
markets and interfering growth performance.<br />
Phillips and Shen (2003) showed<br />
that the overall impact of a 10 percent decrease<br />
of state-owned enterprises in China<br />
boosted the regional growth of GDP<br />
by 1.14 percent. 5 <strong>The</strong> case of China shows<br />
that costs involved in government spending<br />
include economically undesirable<br />
choices and decisions. In addition, high<br />
level of government intervention through<br />
regulatory agencies protecting existing<br />
monopoly or oligopoly structures stimulates<br />
market distortions by discouraging<br />
productive behavior. <strong>The</strong> reason why government<br />
spending is wasteful and burdensome<br />
at some point, as demonstrated by<br />
the Rahn Curve, is that additional spending<br />
empowers the <strong>size</strong> of government and<br />
also because spending outlays boost the<br />
misallocation of resources due to asymmetric<br />
information.<br />
A valuable lesson for Indian policymakers<br />
is to learn the lessons associated with<br />
government spending from other countries<br />
where decades of output growth and<br />
rising productivity returned a comparatively<br />
high GDP per capita and sound<br />
economic performance and also an experience<br />
with economic setbacks and downturns<br />
caused by the mistakes in economic<br />
policy. Bassanini and Scarpetta (2001)<br />
showed that an increase in one percentage<br />
point in tax pressure – two thirds of what<br />
was observed over the past decade in the<br />
OECD sample – could be associated with<br />
a direct reduction of about 0.3 percent in<br />
output per capita. If the investment effect<br />
is taken into account, the overall reduction<br />
would be 0,6-0.7 percent. 6 Tanzi and<br />
Schuknecht (1996) compared the <strong>size</strong> of<br />
government and growth performance in<br />
selected industrial countries, concluding<br />
that average 5-year growth was higher in<br />
countries with small governments. <strong>The</strong><br />
investigation showed that countries with<br />
small governments observed lower actual<br />
unemployment rate, lower rate of shadow<br />
economy and also exhibited more regulatory<br />
efficiency, higher innovation levels<br />
and a well functioning non-distortionary<br />
labor markets. 7 Another argument in favor<br />
of lower government <strong>size</strong> and spending<br />
as a core economic reform is the wellobserved<br />
fact that the reduction in public<br />
spending as a share of the GDP is positively<br />
related to the growth of total factor<br />
productivity. <strong>Dec</strong>ades of mismanaged<br />
economic policy led to an obscure increase<br />
in the <strong>size</strong> of state-owned enterprises<br />
carrying out some major deficiencies<br />
and the failure in the allocation of<br />
resources which caused a decline in the<br />
overall competitiveness of the economy.<br />
148 THE <strong>IIPM</strong> THINK TANK