Increase Import Taxes to Create Demand
November 30, 2020
In view of the contraction of GDP, Govt. has encouraged banks to give loan to consumers and businesspersons without any inhibition. — Dr. Bharat Jhunjhunwala
Many institutions had assessed in June that our economy will suffer a contraction of five percent. Now the same institutions are saying that the economy will suffer a contraction of ten percent. This contraction is likely to get worse in the coming months because the Corona Pandemic is showing no signs of abating. We may face a second wave in the winter months if the experience of resurgence of the Pandemic in Europe is any guide. In this gloomy scenario, the Government is mighty pleased that a huge 75 percent increase in sales of tractors, about 18 percent increase in the sales of cars and 12 percent increase in the sales of motorcycles has taken place in September 2020 as compared to the same month in the previous year. Question is this: how come the purchase of tractors and cars is increasing when the GDP is contracting? My assessment is that farmers are making “distress” purchases of tractors due to the shortage of labour which has been caused by the failure of the Government to encourage migrant workers to their host states. Similarly, the unavailability of public transport like bus, metro and local trains have pushes commuters to make distress purchases of cars and motorcycles. These purchases should not be misconstrued as indicators of revival of the economy.
The Government, however, is aware of the contraction of GDP. It has encouraged banks to give loans to consumers and businesspersons aggressively to generate demand in the market. There is a basic difference in the loans taken by businesspersons and consumers. Loans taken by investors are used for setting up factories, establishing shops or buying trucks. The businessperson and the nation generate additional income from these investments; and she could pay the interest and repay the principal amount from that additional income. Say, a businessperson took a loan of Rs 10 lakh, earned an additional income of Rs 3 lakhs and used this to repay the interest of Rs 1 lakh, principal of Rs 1 lakh and she may still have left Rs 1 lakh for making new investment in the next year. Her total expenditure will increase from 10 lakh this year to 11 lakhs in the next year. The situation of a consumer stands on an entirely different footing because she is not likely to obtain any additional income from buying, say, a fridge. Say, she took a loan of Rs 10 lakh. She would have to pay interest of Rs 1 lakh, and principal of Rs 1 lakh and will have left lesser Rs 2 lakh for making new purchases in the next year. Her expenditure will decrease from 10 lakh this year to Rs 8 lakhs next year. The income of the common person is already under stress. They should not invite further decrease in the same by take a consumption loan. The economy may show some immediate benefits from disbursals of such loans just as steroids help increase the milk yield in cows immediately but this will only lead to greater problems later.
The second method of increasing demand in the market is for the Government to borrow and transfer some amount directly in the bank accounts of the people who can use this windfall to buy goods from the market. However, the Government will have to repay the loan and for this purpose it will have to impose additional taxes or print notes. The imposition of these additional taxes will lead to reduction in income in hands of the people and to lower demand in the next year. Printing of notes will lead to an increase in the prices and again lead to reduced demand in the next year. These are, therefore, band-aid type of temporary fixes that will only push the economy deeper into the pit.
The third method of raising money for making the direct transfers is for the Government to increase import duties. The share of import taxes in the revenues of the Government has declined from 18 percent about six years ago to 12 percent today. The Government has actively promoted imports by reducing import duties. Note that we have committed in the World Trade Organization (WTO) that we will not increase the average import duties beyond 48 percent. The actual rate today is less than 20 percent. Therefore, we face no roadblock from the WTO in doubling the import duties. The Government can increase the import duties, say, from present average 20 to 40 percent. The Government was obtaining revenue of 170 lakh crores from import duties in a year till recently. Doubling of the import duties would lead to a reduction in the imports hence the revenue raised will be less than double. I reckon the additional revenue generated will be about 150 lakh crores. This money can be used to transfer Rs 1100 per year in the bank accounts of the 135 crore citizens or Rs 5,500 families per year. People can buy goods in the market from this money. Such a payment will not lead to additional burden of interest in the ensuing years. It will also not lead to increase supply of printed notes and inflation. Indeed, there will be price rise in the imported goods. But even this may be short lived until domestic production picks up to supply cheaper-than-imported goods. The great benefit of this approach will be that imported goods will become expensive, domestic goods will become cheaper in comparison, domestic industries will revive and employment will be generated. The income earned by workers will establish a fortuitous cycle of demand generation and income.
A caveat is necessary here. We had high rates of import duties before the economic reforms were unleashed in 1991. That had not led to increase in domestic production before 1991. One may ask how, then, will the imposition of high import duties lead to increase in domestic production now? The difference today is that our businesspersons have since been exposed to the international market and have acquired the capacity to produce goods of international standards.
The Corona Pandemic is here to stay for some time. Short term fixes like disbursals of loans will not help in this situation. But the Government’s hands are tied. The only solution is to make a huge increase in import taxes and simultaneously implement policies that encourage businesspersons to adopt advanced technologies and make good quality goods at low cost. qq
Formerly Professor of Economics at IIM Bengaluru