Prime Minister Narendra Modi deserves thumping congratulations for demonetizing notes of Rs 500 and Rs 1000 denominations. This will hit hard at the fake note rackets being run by terrorists, and the large amount of monies stashed away by politicians, government officials and hawala operators. This move will provide much relief to honest taxpayers. Businesses in the country make large transactions in cash. They do not pay taxes on these transactions. This leads to large loss of revenue to the Government. The loss of revenue by these unscrupulous businessmen is made up by imposing greater burden on honest taxpayers.
Demonetization will certainly lead to an increase in government revenues. Businesses will find it difficult to evade taxes by making cash transactions. I have to often get thousands of photocopies done for the court cases relating to environment. My photocopier does not provide me bills for the photocopies. Instead, on being pressed, he provides bills for paper, packing tape, pen and other office supplies. He does not want to pay taxes on the paper purchased for photocopying, and the income earned by him from photocopying. He has two streams of businesses running parallel. One stream runs in cash. He buys paper in cash and collects payment in cash. The other stream is of “tax paid” goods like paper, packing tape, and pen. He buys these after paying tax and pays tax on the sale of these items. Now, consider what happens when I start paying to him for photocopying by my debit card. The money will be reflected in his account and he will have to pay sales tax and income tax on these sales. This will lead to an increase in revenue collection by the government.
The increased collection of taxes will make more funds available for government expenditures on infrastructure, and can usher in a virtuous cycle of tax collection, investment and growth. Thus India’s premier rating agency CRISIL has said, small and medium industries will face problems immediately but overall there will be improvement because more monies will be available for investment in infrastructure. Needless to say, this fortuitous result depends upon the increased tax collections being used for increased investments in infrastructure.
This is easier said than done. Fact is that the Government is spending more on consumption and less on investment. This is made possible by a classification of government expenditures in “capital” and “revenue”; and “plan” and “non-plan” categories. Generally “capital” and “plan” expenditures are considered to be productive while “revenue” and “non-plan” expenditures are considered wasteful. But that is not always the case. For example, capital infusion in a loss-making Public Sector Banks is classified as “plan” expenditure though it supports the corrupt ways of bank officials and is unproductive. On the other hand expenditures on law and order are classified as “non-plan” though they are the lubricants of the economy and hugely productive.
The Government has also created a huge army of government servants in welfare sectors in the last sixty years. These are classified as “plan” expenditures. This was started with the Community Development Programme in the fifties. It caught speed during Indira Gandhi’s Garibi Hatao in the eighties. The real objective of welfare expenditures is to lock the poor into poverty. The best youth are employed in these jobs. That leads to a huge increase in the number of supporters of government programmes. Simultaneously, the capacity of the people to resist tyranny of government servants is reduced because the best youth are co-opted in the government machinery and become agents of impoverishing the rest.
Government teachers draw ten times salary of private teachers but produce one-half results. People feel their children are getting free education while actually they are being locked into poverty by imparting of poor quality education. Patients are regularly asked by Government Hospitals to buy medicines from outside while the government supplies are sold in the black market. Village Pradhans have to pay 20 to 30 percent commission to government servants for obtaining sanctions and payments under MNREGA. Instead of empowering people to engage in self-earning vocations, they are being made dependent on government doles through this scheme. These expenditures are considered to be good by mainstream economists even though they are hugely harmful.
Need is for the Government to remove the distinction between “plan” and “non-plan” and replace it with a classification in ‘empowering’ and ‘disempowering’ categories. The previous NDA Government had set up a Committee under chairmanship of Mr Vijay Kelkar to draw a roadmap for the implementation of the Fiscal Responsibility Act. Kelkar had suggested that the “plan” and “non-plan” categorization should be replaced with ‘“public goods”’ and “private goods” categories. “Public goods” are those services which a citizen cannot obtain even when willing to pay. These can only be provided by the Government. These include defense, currency, rail, canals, roads, law and order, justice, anti-malaria spraying, making curriculum and conducting exams. These functions can only be done by the Government. Kelkar wanted the Government to increase these expenditures and, implicitly, reduce those on education, health and employment guarantee. The idea was that people will be employed and be able to buy good quality health and education from the market if roads and law and order were suitably provided.
The positive impact of expenditures on “public goods” is well established. Noted health economist K N Reddy concluded that expenditures on ‘“public goods”’—mass education, research, Public Health Laboratories, and prevention & control of diseases–were more significant in bringing about a reduction in the Infant Mortality Rate than “private goods” such as hospital care. Yet, only 18 percent of the Indian government’s health expenditures went to the provision of these goods. In contrast, the provision of “private goods” like curative care in government hospitals consumed most of government expenditures but contributed very little to people’s health.
The Government must make the classification of government expenditures in “public goods” and “private goods” as suggested by Kelkar. The primary responsibility of the Government is to provide those facilities which people cannot obtain on their own—employment-oriented economic policies, roads, law and order and canals. But this policy is not beneficial for government servants. There will be less malaria if village ponds are sprayed with anti-malaria insecticides and the need for appointing large number of government doctors will vanish. Hence the strategy is to cut expenditures on “public goods”, worsen the health and welfare of the people; then co-opt the bright boys into keeping rest of the people impoverished.
The final impact of demonetization will depend upon the use of the increased revenues. Demonetization will be a boon if the Government increases expenditures on public goods. It will become a curse if the Government increases expenditures on private goods.