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Tax and spend (Please)

Excessive taxation can dull incentives and hinder growth. But too little taxation can do the same. Governments with meager tax revenues can't provide basic public goods. Worse yet, low tax revenues in poor countries often result from defects in tax collection systems (rather than low tax rates) that also promote unproductive enterprise.

India illustrates the importance of a well-designed tax system. In Bangalore, high-tech companies have built world-class campuses replete with manicured lawns and high-speed data communication networks. Outside these campuses, however, lie open sewers, uncollected garbage, and roads in acute disrepair. Whereas technology companies instantaneously transmit terabytes of data to remote continents, local transport proceeds at an almost medieval pace.

As a result, businesses in Bangalore run their own bus services, contract with private suppliers for drinking water, and install generators to protect themselves from interruptions in electricity supply. The state can't fix the shambles because it is broke. India's government debt exceeds 70% of GDP, so more than half its tax receipts go to paying interest.

But the debt isn't because of excessive spending in the past. India's government expenditures amount to about 15% of GDP, compared to an average of around 40% of GDP in the OECD. Rather, India's financial difficulties stem from a badly designed and administered tax system. Rates and rules for personal and corporate income taxes appear reasonable by international standards. Nonetheless, India's government collects income taxes amounting to only about 3.7% of GDP, about half that in South Korea and the other Asian tigers.