The budget deal that was cleared by the US Senate by an overwhelming majority on Tuesday proposes to increase tax rates on the richest Americans for the first time in 20 years. The proposal of the French government led by Francois Hollande to push up tax rates on the richest Frenchmen has been rejected by the constitutional council in Paris, but the regime has indicated that it will not give up so soon.
The proposed tax hikes on the rich are not the opening salvoes of a new class war. They are the result of broken budgets. “We have no intention to make France inhospitable (to investors), but we are in a period of crisis. It is logical that the wealthiest make a contribution,” French finance minister Pierre Moscovici told the Financial Times.
The political calculation behind the moves is simple: it will be easier to cut spending on social programmes aimed at the common citizen if the rich are also shown to be bear part of the burden for fiscal correction. Most Western nations had very high marginal tax rates on the rich after World War II, when governments were trying to reduce the debt mountain that rose to fund the war against Hitler.
These are early days yet, but if other countries follow the examples of the US and France, then the world could be seeing the end of a 30-year-old cycle of lower taxes that began with the Thatcherite and Reaganite revolutions.
There was a pragmatic as well as ideological reason for lower taxes. The pragmatic reason was popularly captured by the Laffer Curve, which tried to show that lower taxes could lead to higher revenue. Also, Ronald Reagan began cutting taxes as part of an ideological attempt to reduce the role of the government in American life. He called it starving the beast. The reasoning went like this: Tax cuts would lead to a sharp increase in the federal budget deficit which could then be tackled by cutting government spending.
India has also seen tax rates fall since the mid-1980s. Lower tax rates have helped economic growth, but there is a massive fiscal deficit here as well. Most of the official thinking on this issue continues to be focused on the expenditure side, especially finding ways to reduce subsidies. On the revenue side of the government budget, the push is for a regime with low and stable taxes that will eventually boost economic growth and overall revenue.
In a column published a year ago, I had asked whether the United Progressive Alliance was following a mirror image of the Reaganite strategy, by going on a spending spree that would make tax hikes inevitable: “I often wonder whether the economists and activists who are part of the National Advisory Council are implicitly trying out a mirror strategy—feeding the beast to create conditions that make tax hikes inevitable. It is hard to believe that economists such as Jean Drèze do not realize that the Indian state cannot provide ever-growing entitlements without wrecking public finances at some point. The growing commitments of the government backed by constitutional guarantees for jobs, food and education will ensure that spending cannot be reduced easily. The only way the Indian government can deal with a fiscal crisis is by raising tax rates.”
The global narrative could be changing, with higher tax rates being a core part of the strategy to cut high budget deficits. Will we see a new narrative in India as well?