In my previous article, I pointed out that inflation has remained high even though the Reserve Bank of Indi ahas raised interest rates a dozen times over the past year. I had suggested that, instead of raising interest rates, the bank should reduce it to a low 2 per cent or so for long-term projects like roads, railways, electricity, water, sanitation, housing and the like. Several critics have pointed out that while the idea could work in the long run, in the short run it will worsen inflation.
Their reason: when interest rates are lowered for long-term projects, investment will increase and so will employment and, hence, incomes and expenditure.. That will naturally raise inflation. Hence, we need something more than low interest rates to check immediate inflation. Is there a remedy?
Three kinds of taxes
In control engineering, the general practice is to use a three-part negative feedback control. The three parts are forces proportional to the factor that is to be controlled, the integral of the factor and its differential. In the case of inflation, we will then need three kinds of taxes: on incomes (preferably expenditures), on wealth and on changes in income (or expenditure). When all three taxes are in position, better control will be obtained on the movement of the economy.
When incomes increase because new projects are taken up, the increase in incomes (or expenditures) should be taxed rather heavily at, say, 50 per cent. One might even say the entire increase will be free of tax if it is invested in long-term inflation-indexed bonds at a low interest rate of 2-3 per cent. That is a one-time charge; it has to be paid only when there is an increase in incomes (or expenditures). If the income (or expenditure) decreases, the person should actually earn a rebate. That will happen, again, once only — unless there is a continuous decrease in expenditure, which is improbable.
Tax on wealth should be, as mentioned earlier, low — say, 0.1 or 0.2 per cent — and levied on business enterprises, too. Then, a person who owns a house worth a crore of rupees will pay a tax of Rs 10,000-20,000 a year, not a heavy charge. Nicholas Kaldor, the Cambridge economist, suggested a similar tax on wealth and expenditure but as he was not aware of control engineering, he forgot about a tax on changes in income or expenditure. With all three taxes in force, taxpayers will pay a tax on whatever they earn (or consume), on whatever increase they have in their incomes (or expenditures) and whatever wealth they accumulate. Let us see how such a system will operate.
PUTTING IT INTO PRACTICE
First, we should decide whether to tax incomes or expenditures. It is a fact that incomes can be hidden better than expenditures. It is also a fact that, normally, expenditures are less than incomes. Critics do not like a tax on expenditure because tax rates will have to be raised to earn the same revenue — that will be unpopular. However, when there are taxes on wealth and on increase in expenditure, such an increase may not be necessary — particularly since expenditures cannot be hidden as easily as incomes. On the whole, I prefer a tax on expenditures and at the same rate we have currently on incomes. I believe no increase will be necessary.
Secondly, accumulated wealth, whether personal or commercial, should be taxed, as said before, at a very low rate. Our Government did try it but taxed only personal wealth. That created a problem; people hid their wealth and very little amount was collected.
Wealth tax should, therefore, be accompanied by a law that when it is undervalued, anybody can take it over at a small premium over the declared rate. Wealth can be in the form of buildings, land, bonds and in black money stashed abroad or even here. There can be no concealment in the value of bonds.
DEALING WITH BLACK MONEY
Black money is a disease which has to be dealt with separately. That leaves large sums that are owned in real estate — in the form of land and buildings. When people get the legal authority to take over any property at its declared value (plus, say, a 10 per cent premium), real-estate owners cannot and will not undervalue the same.
For instance, I own a flat whose market value is ten times what I paid for it. If I declare it at purchase value (which I now can), the new law should make it possible for anyone to pay the amount (plus a premium) and take it over.
Therefore, I will have no option but to declare it at its current market value. Can I declare property value in ‘white' money but hide its black-money value? That, too, is impossible; anybody can take it over at the declared low ‘white-money' value. Therefore, there will be no incentive to hide the real value of real estate — whether it is in land or buildings. Thus, one of the worst cases of black money will be cured.
However, the tax rate on wealth should be low enough to be affordable. The Government should not get greedy. The issue is — does the Government really want to eliminate black money?
It is the increase in expenditures that truly creates inflation. When that increase is taxed, inflation, too, will come down. That is why I suggest that expenditures, wealth and increase in expenditure should all be taxed; further, even rebates should be given when expenditures decrease.
However, the new German experiment in currency known as chiemgauer offers a new alternative.
(This is the 313th in the Vision 2020 series. The last article appeared on September 24.)
(The author is a former Director, IIT, Madras. blfeedback@thehindu.co.in and indiresan@gmail.com )
(To be continued)