Tuesday, March 08, 2005

India and the Laffer Curve
Al Jazeera of all publications has a piece on how India is gunning for position as fastest-growing-greatest-potential-developing country.

When the Swedish economist Gunnar Myrdal began his Inquiry Into the Poverty of Nations in 1957, India was at the top of his list. A decade later he produced Asian Drama, a three- volume study of 2284 pages.
He was awarded the Nobel Prize in 1974 in recognition of this contribution. The only problem was that Myrdal came to exactly the wrong conclusion, arguing that India had failed to sufficiently tax its people.......
In the year Myrdal accepted the Nobel Prize, the highest marginal tax rate in India, encountered at an income threshold the equivalent of $25,000, was 97.5%. The rates were similarly confiscatory in Pakistan, Sri Lanka and Bangladesh. The old colonial masters smiled.
The first break from this pernicious advice came in India in 1975, when poverty became severe as the rupee followed the inflation that struck the world economy when the United States left the gold standard in 1971.
India's work force was pushed into the confiscatory tax brackets and the distress was so great that civil disorder ensued. In March 1975, prime minister Indira Gandhi suspended democratic rule and civil liberties, reflecting Myrdal's call for "hard" government...[she used the opportunity -] Not only was the 12.5% surtax removed, but the top rates were cut to 77% from 85% The wealth tax, which had been 8% annually on assets of about $2 million, was slashed to 2.5%, and an urban-property wealth tax, which ranged from 5% to 7% annually, was abolished entirely.
I tell the rest of the story of how revenues boomed so much that Subramaniam came back for a second "whack" at the tax code, cutting the top rate to 66% and slashing income thresholds all the way down the line. Gandhi became popular as the economy expanded and inflation subsided - with the expansion increasing the demand for rupees.
She called elections, thinking she would win easily. But instead of campaigning on the tax reforms, she asked the people of India to approve her suspension of civil liberties.


Unfortunately for India, while Indira Gandhi never got the chance to make substantial reforms. However, recently things have been different:
It has taken India 30 years to get back on that track. In his first term as finance minister, Chidambaram experimented with the Laffer Curve and for every 10% reduction in direct income levies, revenues rose 14%, rising seven-fold between 1991 and 2001.

Let's hope India stays on track and continues developing its economy.

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