REFORMING INDIA--ROLE OF GOVERNMENT

Dear Mr. Modi:

In the first three parts of my letter to you, I argued that the principal cause for many of India’s problems was a big government that tries to do too many things as a result of which it ignores the things it should be doing. Eventually, the government does nothing well. This, unfortunately, has been the history of government in India.

A small government that does a few things but does them well is far superior to a big government that is involved in everything but does nothing well.

It is important, therefore, to understand the appropriate role of the government. Dr. Milton Friedman, Nobel Prize winning Economist and probably the most influential economist of the 20th century, put it best when he said:

“ The government has three primary functions. It should provide for the military defense of the nation. It should enforce contracts between individuals. It should protect citizens from crimes against themselves and their property. When government– in pursuit of good intentions tries to rearrange the economy, legislate morality, or help special interests, the cost comes in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player,”

Mr. Modi, in the new, transformed India, a small and smart government should focus its resources on a limited set of activities which include:

(1) Protecting its citizens from external aggression

Protecting citizens from foreign aggression is the primary function of every government. This requires a trained and well-equipped armed force. India currently spends Rs. 2.75 lakh crores annually on its defense. Of this amount, 71% goes for salaries and pension, which leaves less than Rs. 80,000 crores for modernizing the armed forces and purchasing weapons.

Modern warfare is more about weaponry and less about warriors. Future wars, god forbid one is required, will be short and technology driven. It is imperative that India’s future defense resources be channeled towards high-tech weaponry. The aim should be to cut down the size of the army to half by 2025 and build a smaller, more lethal and agile force, trained in the quick deployment of sophisticated weaponry and intelligent systems like drones, satellites and robots and other autonomous weaponry. Robotic weapons don’t require salaries, or pensions, or health benefits. Nor do they need to be fed. Large numbers of small, inexpensive, autonomous drones working together can accomplish many of the same missions as expensive aircraft and human pilots.

India should invest heavily in the development and deployment of non-human autonomous weapons.  The funds released from the sale of Air India should be used to set up a world-class strategic capability group with a focus on the research and development of autonomous weapons. This institute must be run by the best technical minds and not bureaucrats. Also, India must invest heavily in missile-defense technology capable of destroying incoming ballistic missiles to provide a measure of protection against ballistic nuclear weapons.

In a severe indictment of India’s military preparedness and the lack of a strategic culture to arms purchasing and deployment of power, The Economist in an article titled “ Can India Become a Great Power,” wrote that India’s government is clueless about how to use armed clout. India does not have a central command to coordinate strategic thinking and weapons procurement between the different armed services. As of this writing, India does not have a dedicated Defense Minister–it is shocking that the Finance Minister also doubles up as the Defense Minister. Talk about the government abrogating its primary responsibility of protecting its citizens.

Modernizing the armed forces will require an increase in the annual Defense budget from the current Rs. 2.75 lakh crores to Rs. 4 lakh crores for 2018 and then to Rs. 5 lakh crores by 2020. These additional funds must be dedicated to the development and purchase of modern weapons, not for hiring more people. This will send a clear signal to countries like China and Pakistan that India is serious about defending its territories and its citizens.

Recall that in the 1980’s it was Ronald Reagan’s doubling of the US defense budget and the unrelenting pressure it put on the Soviet Union that accelerated the breakup of the Soviet empire, brought down the Berlin Wall and put an end to forty years of cold war. It was Reagan’s unshakable view that a strong defense is an investment in peace that brought about those seminal events. And while he was soundly criticized for the extra expenditure on Defense, that investment paid off in the form of lower Defense allocations in later years as the Soviet threat dissipated.

Mr. Modi, you must do the same–build strength to buy peace because weakness only invites aggression. India must have an integrated and modern armed force to assure peace for its citizens. It is the best investment the country can make.

(2)Protection from internal crime

Mr. Modi, I urge you to make citizen safety the primary function of your government. The government’s job is not to interfere in the economy but to create a stable and safe environment that encourages investment, risk taking, entrepreneurship and business growth. Protected people focus better on expanding business and creating wealth.

The Indian economy will never grow in an environment of fear and insecurity irrespective of which group is the target of the violence.

Your government must protect all citizens from internal threats of crime, rape, embezzlement, fraud, harassment, and violation of fundamental rights. With about 129 police personnel for every 100,000 people, India has the second lowest number of policemen among the 50 countries in the United Nations survey on Drugs and Crime (2010). Moreover, they are ill trained and poorly paid and open to being bribed. This reduces their effectiveness and ability to be fair and unbiased. They lack modern weapons, communication equipment, forensic labs, crowd control paraphernalia, video monitoring, advanced IoT and computer vision and predictive analysis, and cyber crime training, etc., without which a modern police force cannot be effective.

An ineffective police force compels self-appointed vigilantes to take the law in their own hands–a dangerous outcome in a populous country like India. It is, therefore, vital for the country to invest heavily in (a) a well trained and modern police force and (b) an independent, efficient, and just legal system.

Currently, the government spends about Rs. 65,000 crores on the police and around Rs. 940 crores for the administration of justice. This is not enough. You must allocate an additional Rs. 50,000 crores to attract the best, brightest, and strongest of India’s youth to build a trained and sophisticated police force and for the acquisition of the latest in criminal, crowd control, antiterrorism, and cyber-defense technology.

Also, Rs. 30,000 crores should be budgeted to build a vast network of District, Circuit, Consumer, and High courts, and for the training and hiring of competent judges. It is imperative that India create a legal system that treats everyone equally and hands out fair and speedy justice. The US has a very efficient system of federal prosecutors who are assigned to the states. Their job is to prosecute state crimes, and since they report only to the central government, they are immune from political coercion at the state level. India should consider adopting a similar model to curb massive corruption at the state level.

Also, if constitutionally permissible, time limits should be imposed on the disposition of all civil and criminal cases. Currently, 28 million cases are pending in India courts, and many undertrials have been languishing in jail for years waiting for their trial–in many cases for longer than their sentence would have been had they been found guilty. This a travesty and must stop immediately. The right to a fair and expeditious trial is the right of every Indian and ensuring that is the government’s responsibility.

It is a sad indictment of India’s poor governance and its multitude of crazy, and often contradicting regulations, that the government is a litigant in almost 60% of all pending cases. About 13 million of the pending cases could be resolved almost overnight if the government were to eliminate tens of thousands of useless and redundant regulations.

As pointed in Part 3 of my letter, there are only three situations which require government regulation:

(1) Protecting citizens from fraud and unsafe products

(2) Ensuring equal rights and opportunity for all

(3) Eliminating negative externalities where a private transaction negatively affect an unrelated third party–for example, when a leather tanning factory creates pollution that affects people downstream.

Mr. Modi, I urge you to use your executive powers to order the elimination of all regulations that do not meet these criteria. Overregulation is choking India and it is impossible to transform India without killing unnecessary regulations.

( 3) Education and skill development

The government also has a major role to play in basic education because it alone can ensure (by coercion or incentives) that every Indian gets at a minimum a high school education. Research has shown that the primary cause of economic inequality is differential educational levels. Countries that have greater equality in education levels–Denmark, Sweden, Finland, for example–also have significantly higher economic and social equality.

Sabka sath sabka vikas will come from expanding education for all citizens and not by increasing subsidy and welfare programs.

It is extremely disappointing that your 2017-18 budget allocates a mere Rs. 36,000 ( 3.3% of GDP) for education and skill development. Seventy-five percent of the countries spend a higher percentage of their GDP on education than India. Eighty percent of the countries have better technological readiness than the citizens in India and seventy-three per cent score higher on the youth development index.

For a country where about fifty percent of the population is under the age of 26, the demographic dividend could easily become a demographic nightmare if the government does not act soon to come up with a strategic plan to arm its young population with the skills required in today’s technology-driven workplace. Much of the actual ‘skilling’ should be implemented by the private sector, with the government’s role being that of an information provider and an unbiased rater of provider quality.

Mr. Modi, to boost education and skill development, I urge you to :

1) Have a separate Ministry of Education run by a respected educationist, not a politician.

2) Increase the expenditure on education to Rs. 1 lakh crores or about 5% of GDP.

3) Require every university ( public and private) to spend at least 5% of their budgetary resources on programs for enhancing skill development for low-income people.

4) Incentivize low-income people to upgrade skills by creating a MNREGA type pay-for-skill program which pays people an amount equivalent to a non-skilled labor’s daily wage for enrolling in skill development programs. This would allow low-income people to engage in skill improvement without loss of regular income.

5) Develop a public-private partnership to explore new ideas for enhancing on the job training and skill development. Tax incentives can be used to encourage companies to offer job training programs.

(4) Infrastructure spending

Private sector involvement should be the cornerstone of most infrastructure projects including all municipal projects for the provision of public services. There is nothing like competition in a free market to reduce costs, improve delivery and increase efficiency.

There are two exceptions where government involvement is necessary because it alone can marshal the required resources: projects that require land acquisition (highways), and large-scale projects that require massive investments ( inland waterways for example). The World Bank estimates that India needs $2 trillion to build the infrastructure it needs to support future growth. Funds of such magnitude can only be raised in the global financial markets using instruments that are backed by the government.

This is an excellent opportunity for the country to build its infrastructure. Global yields are very attractive–in the 2% to 3% range– and foreign debt is cheap relative to domestic debt. I urge you to authorize a committee of global financial experts to explore the issuance and marketing of government-backed infrastructure and municipal bonds in the global markets to raise capital for large infrastructure projects. To make these instruments attractive, the government should encourage SEBI to develop active and liquid trading markets for these instruments and their derivative products.

(5) Taxation–A New Tax policy

The greatest myth ever perpetrated in economics is that increased tax collection creates economic growth. In fact, just the opposite is true. Lowering tax rates stimulates economic activity because the private sector gets to keep more of its money which stimulates consumption and investment. Every rupee that the government collects in taxes comes from the private sector. This deprives wage earners the opportunity to increase consumption, and businesses from investing in new plant and equipment, building more widgets and growing the economy.

There is one inexorable truth in economics: No country has ever taxed itself into prosperity. Focusing all the government’s attention on increasing taxes and unearthing black money at the expense of promoting growth is counterproductive and will destroy India’s economy.

While taxes do impede economic progress, they are necessary to pay for public goods like defense, police, justice, education, and large-scale infrastructure. It is, therefore, important that the government implement a sensible tax policy which is simple to understand, easy to comply with, and fair in its regulations. In fact, the main reason for India’s black money problem is an arbitrary and complicated tax code which makes compliance difficult.

India needs a new policy that meets the following objectives:

(a) Maximizes revenue collection with the least disruption to the economy

(b) Broadens the tax base to avoid the free-rider problem

(c) Makes compliance and administration simple and predictable

(d) Is proportional, so the rich pay more

(e) Does not unfairly advantage one sector or group over another

The current tax code with over 53 different taxes is a hodgepodge of conflicting rules and regulations and does not meet any of the requirements of a good tax system. It is not broad based –less than 3% percent of Indians pay income tax. It is not proportional–the tax burden is borne disproportionately by the middle class. It is not simple–the tax code has thousands of complex and often conflicting regulations. It is not easy to monitor since black money is rampant in the country. Tax collection is not equitable among sectors–agriculture, for example, does not pay any taxes, and hundreds of other distortionary subsidies and exemptions create tax advantages for various industry groups. And it is not easy to implement –the average business spends almost 250 hours a year on filing tax returns, and another 400 hours a year on compliance and audits.

India ranks at the very bottom –172 among 190 countries in the World Bank’s ranking on ‘ease of paying taxes.’ And, coincidentally, among the major economies, India has the lowest percentage of voters that pay tax–less than 7%. This suggests that the more complicated the tax code the lower the level of compliance.

Here are some facts about the Indian economy that are unlikely to change anytime soon. A large percentage, about 83%, of the economy is in the informal sector, and much of it runs on cash. This is to be expected in an economy where the formal sector is not big enough to provide all the jobs. In the informal cash-driven sector, the payment of taxes remains a voluntary activity.

The generation of black money is, therefore, largely an unavoidable consequence of a complicated tax code juxtaposed on an informal economic structure. All attempts to coercively collect taxes will thus be counterproductive. What is required, instead, is a new tax system that mitigates tax evasion and black money structurally, rather than administratively.

Mr. Modi, let me propose a transformational tax policy that will reduce the generation of black money and, more importantly, create powerful incentives that will unleash unprecedented economic productivity and growth.

You should eliminate all existing taxes–income tax, corporate tax, capital gains tax, wealth tax, excise tax–every single existing tax should be scrapped and replaced by a flat 10% GST on all goods and services sold in the country. One single tax rate for ALL goods and services sold in the country and not the multi-tax boondoggle currently proposed by your government. There should be no exempt group, and low-income people can be reimbursed for their GST tax through a direct deposit of Rs. 1000 in their accounts. This would compensate anyone making Rs. 10,000 per month or less for their GST tax on essentials like food.

The 10% flat rate will be revenue-neutral for the first year, but would substantially increase tax revenue in the out years as the economy grows rapidly from the elimination of income taxes, corporate taxes, capital gains taxes, and all the other taxes that stifle growth without increased tax revenue. Gross value added from all goods and services in 2016-17 was almost Rs. 170 lakh crores. Ten percent of that would be about Rs.17 lakh crores which is approximately the tax revenue for 2016-17. India has already become accustomed to the idea of a GST, so the implementation of this new tax policy should be easy.

Conclusion:

Mr. Modi, the future of India is its people and their enterprise, not big government. The only way to transform India is to reduce the size of the government and its reach into economic and social activity. The government should engage only in areas where it alone can marshal resources, leaving everything else for private citizens to manage on their own. This limited role includes citizen safety through a robust national defense system, a modern, capable, and honest police force, a fair and expeditious system of justice that treats everyone equally, educational and skill development institutions to support the needs of the private industry, and a new tax policy that replaces all existing direct and indirect taxes with a flat 10% GST on all goods and services.

 

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2018-07-27T12:49:59+00:00 August 15th, 2017|

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