The Big Myth behind India’s Tax -To-GDP Ratio

PM Vidyut ji,

 

As your manager of the treasury of our realm, it is my bounden duty to acquaint you with how much treasure you have, and – more importantly – do not have, at your disposal to run your Government.

 

Central Bankers are usually bearers of bad news for new Governments eager to change the world.  Which no doubt accounts for their inordinately high mortality or short half-lives.  I am no exception.  Please bear with me.

 

First of all, I would like to talk to you about India’s tax-to-GDP ratio, which is a measure of what the Govt. takes away from the total produce of its citizens in an year.  We may call this annual tax yield or Govt. “income.”

 

World over, the tax-to-GDP ratio for most normal economies is between 15% to 20%.  In the US it is something like 16%.  In India, as per last count, it was a shade over 18%.  For my exposition, I shall assume a round number of 20%.

 

Now, if our economy were entirely composed of households, one half of which fried pakoras for a living, and the other half brewed chai, which they exchanged with each other, we could say a 20% tax-to-GDP ratio would give Govt about one-fifth of all the chai-pani & pakoras produced annually.

 

That, even by our lax standards, would be too high a proportion of GDP to take as chai-pani-pakoras from the poor knaves. But it can be justified by noting that, historically, excluding the periodic pillage & loot by raiders from Afghanistan, a despot’s take was usually of that order.

 

Beyond 20%, the law of diminishing returns sets in. As history notes, the earliest Aryans very nearly took over almost 100% of our hearths & homes.  In fact they claim to be the original owners today. The later arrivals took progressively less & less.

 

You may think that almost sinks all your plans to give your voters the bright future that you promised them.  That is correct.  But I have even more grim news for you.  Your predecessor Govts. have been borrowing from the wealth of future generations – wealth that doesn’t exit.

 

You may have heard of fiscal deficits.  It is a polite way of spending money you don’t have; usually allowed only to Govts.  This fiscal deficit is about 4% of our GDP.  Over and above this, about 2% has been borrowed by Govt. through some very creative accounting.

 

Furthermore, the States have their own deficits.  The combined deficit of all States is rumored to be about 5 to 6% of out GDP.  If you tot up all of the deficits, official + hidden + States, the number adds up to something between 10 to 12% of GDP.

 

Now here is the crucial maths for us to understand which no economist or babu in our civil service will explain to you. But it is something you must never forget.  The Govt. takes in about 20% of GDP by way of taxes but spends – actually spends – 30%+ of GDP. Let that sink in.

 

Of everything thing that India produces in an year – every chai, every pakora – the Govt. takes away 20% or one-fifth. That is bad enough because in a growing economy, the number should be less – say 10% – leaving more money with people to spend & invest.

 

But, Govt. takes in 20% and SPENDS 30%.  A full one-third of everything we produce in the economy in an year is actually gobbled up by Govt. We may call this 30% spend by Govt. as “extraction” which is made up of 2 parts – taxes 20% + forced borrowings 10%.

 

For perspective, please note that barring pillage & plunder by Afghan raiders, the total “extraction” in India under despots of all sorts from Mad Tuglaq, through Moghuls to the British, never reached 30% of GDP, even when land revenue was one-third of farm produce.

 

I realize you may have some questions about the 10% forced borrowings that I have added to taxes to arrive at the total extraction.  Clever babus will tell you there is no forced borrowings but only legitimate loans taken from citizens.  This is baloney.

 

Banks, public and private, have to hold Govt. debt as a statutory requirement. This ratio over time has been around 30% of all bank liabilities.  Citizens put savings in bank, Govt. forces banks to lend to Govt., and babus pretend there is no forced borrowing.

 

There are 2 things to note here 4 you. Firstly, Govt. total extraction, by of taxes & forced borrowings, is way too high to permit people to actually save & and invest anything on their own.  And second, Govt. has no way of repaying what it borrows.  Sorry, if you fell of the chair.

 

That is right.  Govt. has no way of repaying what it borrows.  We pretend it does but what it repays on bonds comes from more borrowings. The only income that a Govt. has is taxes.  Since taxes cannot exceed 20% of GDP, the extra 10% of GDP that the Govt. borrows will never be repaid.

 

But that is an issue which is intractable and so must be put aside for the moment because we have an even more urgent problem to contend with.  The money that Govt. borrows to spend annually, the extra 10% of GDP, has to come from financial savings of households & others.

 

A bulk of the savings in the economy come from households. We put that number at about 15% of GDP.  Corporate business add another 10% of GDP to the kitty.  So total saving – financial and non-financial – add up to about 25% of GDP.

 

Corporates need to invest. In a growing economy they would invest far more than they save.  So Govt. shouldn’t count on them to finance its spending.  That leaves households who typically save about 60% of their savings in financial assets and 40% in fixed assets such as Gold or land & housing.

 

So households can typically give the Govt. the maximum – if they did nothing else but buy Govt. bonds – of 9 to 10% of GDP as the pool of savings that Govt. can borrow from, one way or the other – through banks or debt mutual funds.

 

So here is the equation PM Vidyut ji which your Babus & tycoons & politicians with grubby hands will never ever tell you in plain words.  The Govt. needs to borrow 10 to 12 % of GDP annually, while the total available pool of financial savings is only 9 to 10% of GDP.

 

Daboo ledu.  There is no more money to borrow. The Govt. has for all practical purposes borrowed every penny that is available as savings in the economy – and a bit more by starving corporates, especially PSUs.  That’s why it finds virtue in borrowing abroad now.

 

But as I said earlier, the Govt’s income is only 20% of GDP.  No more extortion in taxes has ever proved feasible.  Its extra 10% of GDP borrowing can never be repaid.  But thereby hangs an important difference that you must grasp.

 

Everybody in the domestic economy “knows” Govt. borrowings will never be repaid.  But nobody can demand repayment as long as Govt. owns all the tanks.  And if they did, Govt. has the nuclear option of printing as much currency as required to repay.

 

But Govt. tanks, backed by printing presses, are of no use when it comes to borrowing abroad – say via sovereign bonds as some babus have been shoving at you.  Foreigners can & do demand repayment, and that too usually when the economy is in trouble.

 

Since your income is limited to 20% of GDP, and on top of that you are already borrowing another unsustainable 10% of GDP, and on top of that you wanna borrow another 2% of GDP as sovereign bonds, how can you repay foreign borrowings if ever asked 2 do so?

 

The “as a going concern argument” doesn’t apply to foreign borrowings.  The world is littered with debris of economies who were sold that argument by clever investment bankers who offered to sell sovereign bonds for no fees with a green shoe option.  Be very wary.

 

I will sum up this note here by simply saying you are the first unfortunate PM who has no money to spend, either by extorting or borrowing, though there is no difference between the two.  Daboo ledu.  Let that be your abiding mantra.

 

All is not lost however.  There are plenty of ways to save from current expenses to have money to spend on things that really benefit people & build for the future. I shall revert to you with them shortly. Meanwhile please meet every request to spend more with “Daboo ledu.”

 

 

It is the abiding truth.

 

Humbly but sincerely.

 

#AltSarkar