Liz Truss, the unlamented former British prime minister, has given the “low taxes, high growth” framework a bad name. Deservedly so, because there is in fact no clear relationship between income-tax rates and economic growth. In general, the advanced economies have higher tax rates than the rising economies of East Asia, where tax rates peak around the 35 per cent level.
Britain’s peak income-tax rate of 45 per cent is not very different from the average for the euro area, somewhat higher than in the US and lower than in Japan. Among the advanced economies (leaving out places like Singapore), only Canada has a markedly lower peak rate (33 per cent). The higher-income countries in East Asia (South Korea and Taiwan) have peak rates closer to the euro average, with very different economic growth rates.
If there is any noticeable trend, it is for the wealthier economies to be more highly taxed because that pays for ambitious welfare programmes. Rising economies without comparable social-safety nets tend therefore to have smaller government expenditure in relation to GDP. This shows up in the successful middle-income economies of East Asia, which tend to have smaller governments (i.e. smaller budgets) and lower levels of deficit than other economies, when seen in relation to GDP.
Even super-successful South Korea has government expenditure that is equal to only a quarter of GDP (for dirigiste France it is over 60 per cent), and a deficit of just 2.8 per cent.
Malaysia, Thailand, the Philippines, and Vietnam reflect broadly the South Korean example. In comparison, India’s governments are much bigger, accounting for about a third of GDP, with much higher deficits (about 10 per cent for the Centre and states combined). It’s no different with public debt: South Korea’s debt is less than half its GDP, whereas for India it is over 85 per cent. Taiwan’s government is even smaller than South Korea’s, in relation to its GDP, with remarkably low debt.
This might suggest that it is the size of government rather than the peak tax rate that is material — which fits neatly with the long-discarded Thatcher-Reagan argument for smaller governments. But would Britain or any other advanced country settle for smaller welfare budgets (say, a shrunken health service) in exchange for lower taxes and a smaller government?
It is certainly telling that both the current and previous US presidents have committed themselves to increased government spending with ambitious new programmes. Rishi Sunak on his part has made expansive promises, but no one knows how he will square the circle. With large deficits and massive public debt (sometimes greater than India’s), expansive approaches may no longer be sustainable in even the wealthy economies. They might even spell political or financial suicide — or both, as Ms Truss found out.
Where does India fit in? Its government sector is large, relative to GDP, when compared to East Asia (excluding Japan and China). Yet, we have poor-quality public services in every direction, and under-spending on defence. That might tempt the thought that India’s government sector is in fact too small.
But how do the East Asians do better with smaller budgets? Bangladesh too manages comparable growth rates, and in some cases better social indicators, with lower tax rates and a budget that is half India’s, at 15 per cent of GDP, and public debt equal to just 34 per cent of GDP.
So are India’s governments simply bloated, given what they deliver? Besides, there must surely be a warning in the fact that some of the most problem-ridden middle-income economies have big governments, big deficits, high levels of debt, and large-scale corruption.
Two prominent examples are Brazil and South Africa. India has to be careful not to go down that path. Perhaps the finance ministry or NITI Aayog could take a detailed look at what governments actually deliver and at what cost; how their services can be improved and expanded where necessary; how much money can be saved through doing things differently; and how many things the government does which it can safely leave to the private sector. Some international benchmarking may be a good way to begin.
By special arrangement with Business Standard