Good tax system is elusive, give Finance Minister time to test her theory

Ever since Finance Minister Nirmala Sitharaman burst into the financial policy landscape, investors are miffed and markets moody. 

Published: 21st July 2019 07:33 AM  |   Last Updated: 21st July 2019 08:51 AM   |  A+A-

Finance Minister Nirmala Sitharaman

Finance Minister Nirmala Sitharaman (Photo | PTI)

Express News Service

HYDERABAD: Ever since Finance Minister Nirmala Sitharaman burst into the financial policy landscape, investors are miffed and markets moody. Yet, she is unyielding. Her new economic doctrine, tax-the-super-rich, is markedly different from advanced nations championing the neo-liberal theory that cutting top income tax rates attracts the economic growth fairy.

Supposedly, reduced taxes incentivise citizens to work, earn and invest more, otherwise called the supply-side, trickle-down economics. The theory’s inventor Aurthur Laffer often claims, “When you tax something, you get less of it, and when you tax something less, you get more of it.” 

But Sitharaman’s belief in this theory doesn’t run deep. Instead, the logic of her and her party is somewhat opposite. It takes money to make money. And higher taxation at the top makes up for the waivers given to those at the bottom. Hence, the NDA government raised surcharge on income above Rs 2 crore, but extended exemption limit for income up to `5 lakh per annum. Such an arrangement may fly with mass voters, but is crushing the bull market, which simply loves Laffer’s reasoning: A good tax system should try to make poor people rich, not rich people poor.

However, there’s no conclusive evidence that trickle-down economics works the way it should. Take the US for instance. President Ronald Reagan gave the trickle-down theory a shot, reducing taxes from 70 to 28 per cent, only to be partially rolled back by his successor George H W Bush, who gave Reagan’s policy a slanderous moniker — voodoo economics. UK’s Margaret Thatcher, the most prominent Conservative politician post World War-II, progressively sliced rates from 83 to 40 per cent, but were partly folded up later.

US President Donald Trump is the latest votary, promising to please the rich despite conflicting evidence from within the country. In 2012, the US State Kansas resorted to drastic tax cuts but abandoned it after five years, having lost $700 million in tax revenue every year. Clearly, the supply-side theory failed to stimulate the economy. 

A recent joint paper by Piketty, Saez and Stantcheva argues that defanging top taxes may have undesirable consequences. Why? The CEOs will put in efforts to increase their salary rather than improving their firms. Maybe, just maybe, they could be right. 

This acknowledgement came from none other than America’s super-rich, who sent a missive urging 2020 US presidential candidates to tax them more if they wish to improve inequality and climate change. The 18 signatories include the who’s who of US Inc, including billionaire investors George Soros and Molly Munger. “America has a moral, ethical and economic responsibility to tax our wealth more,” they concluded. 

Meanwhile, EU nations have a mix of both. While countries like France and Germany have steep tax slabs with the highest being in excess of 56 per cent, half-a-dozen economies follow a flat income tax rate. Ironically, five of those nations continue to be poor.  

The bottom line is this. Despite attempts stretching across centuries, no country has been able to formulate an ideal tax policy with surgical precision. Unhelpfully, what works for one country may prove disastrous for another. Clearly, for any nation, tax revenue is its meat, drinks and dessert and Sitharaman should be allowed time to test her theory.

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