Time to fix up income tax system, end most of the exemptions: Arvind Panagariya

Dr. Arvind Panagariya is one of the world's most distinguished economists. He’s the former Vice-Chairman of Niti Aayog and Professor of economics at Columbia University. Dr. Panagariya has done extensive research on the Gujarat model, and is one of the first people to have done in-depth studies on what distinguishes Gujarat from other states. In a wide-ranging conversation with Moneycontrol, he spoke on economics, politics, and the politics of economics.

Shweta Punj: Dr. Panagariya, a very warm welcome to moneycontrol.com. Let me begin by asking you, were you expecting this landslide victory for the BJP in Gujarat? What is it that defines the Gujarat model? What is it that distinguishes Gujarat from other states?

Arvind Panagariya: Thank you Shweta, really great to be with you. The BJP’s victory in Gujarat shows that the Prime Minister's personal popularity reigns supreme. This was one rather exceptional case where all the exit polls turned out to be right. So this was a victory foretold and it did play out as predicted.

Multiple factors are responsible for any election outcome, even though in this case the Prime Minister's popularity was key. For instance, Gujarat’s prosperity is there for everybody to see. When something is going well, you don't want to change it.

Gujarat has grown phenomenally over the last 10 years. Indeed, it is the fastest growing state after Mizoram I think, or one of the smaller north-eastern states. But Gujarat is a large state, and it grew at about 9.4 annually. Haryana, the only state that comes close to it, is a full percentage point below it, at 8.4 percent. The Kerala model which we talked about so much during the 2014 elections has done very poorly, with a growth rate of 5.7 percent.

Shweta Punj: With respect to Gujarat, what are the reforms that have helped drive prosperity? I was in Gujarat last week. The work that's happening in GIFT city seems very forward-looking. People also said that water was one of the problems the Prime Minister had tackled head on. So what are the defining schemes or policies that have been instrumental in driving this growth?

Arvind Panagariya: I've not looked closely at policies. Besides, many of the policies that really matter come from the central government. It is the implementation that varies across states, and Gujarat is very effective in that. I think the bureaucratic tradition in Gujarat is very different from, say, my own state, Rajasthan.

Gujarat’s bureaucracy works. During my time at NITI Aayog, I saw that the bureaucracy was really on top of what was going on. They had their own databases going all the way down to the village level. It's very data-driven policymaking and policy execution in the state. That plays an important role.

A lot of good policies that are adopted pay dividends with a bit of a lag. A lot of the policies Modi adopted as Gujarat Chief Minister played out over the subsequent years.

Shweta Punj: The state attracted the highest FDI of 1.62 lakh crore in the 2020-21 fiscal. What is it that the investor community finds attractive in Gujarat as an investment destination?

Arvind Panagariya: It's the business environment and the government. Investors choose the country because of its policies. But which state to set up shop in — the state government and the bureaucracy has a key role in helping facilitate that.

Every investor has to deal with things like land acquisition, power and water connections, vendors / ancillary industries, etc. For all of that the ecosystem in Gujarat happens to be quite good. In this, Gujarat stands out. Also, Gujaratis being a business community, the state has traditionally had a very good business environment.

The special economic zones (SEZ) of Gujarat account for about a third of the exports from these zones, pan-India. I think that that says a lot.

Shweta Punj: Unlike people in other states, Gujaratis don’t seem to be queueing up for government jobs. Instead, they say that they want the government to be a facilitator. Like the PM says, minimum government, maximum governance. He's managed to implement this slogan successfully in Gujarat. Can you throw some light on how he did that?

Arvind Panagariya: Gujarat’s bureaucracy does not suffer from a sense of entitlement, they’re there to serve, and ensure things work. The view from the inside may be a little different, but that’s what I feel as an outsider. When I visited Gujarat as the Vice-Chairman of the Niti Aayog, I was very impressed with the work they were doing on transportation. Even in 2016 they had a centralised control room from where they could monitor everything.

In terms of public projects, I visited the Sabarmati waterfront and the Kankaria Lake, among others. Things were very well managed. Where fees should be charged, they were charging fees, but small fees, because you don't want high fees in public places. That allows you to maintain the place well.

Shweta Punj: Roti, kapda, aur makaan (food, clothing, and shelter) are no longer a priority in Gujarat, or even jobs for that matter. But these are burning issues in many parts of the country.

Arvind Panagariya: People not wanting government jobs is indicative of Gujarat’s prosperity, where incomes are growing at 8-9 percent a year. That is where you want to be.

Roti, kapda, makaan is history for Gujaratis. if you look at per capita income levels, they are now among the highest. Among the larger states they are just a little below Haryana. Considering price differences between Haryana and Gujarat, in real terms Gujarat’s per capita income may be higher than Haryana’s.

Gujarat was below Karnataka, below Tamil Nadu, it was below even Uttarakhand about 10 years back, but that's all history.

Shweta Punj: The state government has taken some financially unpopular decisions. For instance, they’ve scrapped the old pension scheme, angering government employees. Both the Aam Aadmi Party (AAP) and the Congress had promised to reinstate it. But despite that the BJP managed to seize the electoral narrative. Your thoughts.

Also, with the budget round the corner, might the central government be tempted to reintroduce the old pension scheme?

Arvind Panagariya: The old pension scheme was scrapped  by consensus across the entire country. It was recognised that the old scheme was eating up the budget. Every year, the share of pensions in the government budget was rising. Increasing life expectancy was compounding the problem. Also, the pension would rise along with your age. When my father passed away, in real terms his pension was higher than his salary at the time of retirement. The fiscal burden of pensions would have turned us into Brazil, which spends about 12-13 percent of its GDP on pensions.

No country can bear that. The bureaucracy is maybe 2 percent of the population, 2 percent of the workforce. You cannot tax the people and transfer that kind of money.

This is also intergenerational transfer, because the young who are employed today are paying for the pensions of those who have already retired.

All this is avoided with the new pension scheme. You can see why the state governments want to do it. Because it lowers their budget deficit.

The old scheme will shift the burden of the pension to future generations. They will pay for the pensions of those who are employed today. This is a very risky and irresponsible thing to do.

It's unconscionable for any government or political party to make such offers to win an election. They are not helping the people in any way. In fact, they're really hurting them because ultimately the taxes they pay will be spent on pensions instead of public projects. This is basically like taking money from one person's pocket and putting it in somebody else's. That is not the right thing to do unless there is a compelling reason like poverty alleviation. I would be very, very surprised, devastated even, if one day the central government is tempted to try this.

But I don’t think they will, as they did not in Gujarat. It's a very responsible government. Responsible Congress leaders have also not spoken in favour of going back to the old pension plan.

I recently saw an interview of Mr. Chidambaram’s on this. He said that he will not speak on this as he's bound by his party's discipline. Which basically means that he doesn't support reverting to the old pension scheme, but as a responsible party leader he would not say anything against the party line

Shweta Punj: We’re barely two months away from the budget. It is the last budget before the Modi government goes in for the general elections. There’s been a lot of talk about whether the government needs to spur consumption by putting money into the hands of people. Should there be a scheme like an urban MGNREGA that will spur consumption? Or do you think that India is in a very safe position and the government does not need to resort to such measures?

Arvind Panagariya: Quite the contrary. We need to get back to fiscal consolidation. Which means restraining government expenditure. As far as I can see the data is showing that consumption demand is returning. Investment demand is also robust. We have seen investment as a proportion of GDP rise. This trend should last several quarters.

Programmes like MGNREGA are rolled out when there’s a drought, etc. But we have made it a permanent feature and that’s not a good use of resources that get taken out of the economy. If we want to give money to alleviate poverty we should have done simple cash transfers, so that people can use their labour on productive activities rather than unproductive public projects.

Speaking of the budget, it’s time we fixed the personal income tax system, and considerably simplified that. And much like what we have done with taxes on corporate profits, we need to end all exemptions, or most of them.

If revenue is an issue, we can have four or five tax rates. Today computers calculate the taxes. So the reasons for having only two or three rates are no longer applicable. We also need to reform our higher education system, which has been pending for two to three years.

We need to privatise public sector enterprises, including banks, for which there is a policy now, which separates strategic sectors from the non-strategic ones.

We should also continue with our free trade agreement (FTA) negotiations and conclude them within two years, with some sort of agreement with the European Union (EU) as well.

If we pursue this agenda, I have no doubt that we will continue to grow at 7 percent-plus.

Shweta Punj: Is inflation a concern? Considering how it is impacting small business owners, is that something the budget needs to address aggressively?

Arvind Panagariya: Inflation is not a budget issue it is a central bank issue. The only way the budget can help is through fiscal restraint. We cannot say we want feel-good consumption on the one hand, and on the other, we complain about inflation. These are contradictory forces.

If inflation is a concern, then the fiscal policy ought to have fiscal consolidation in place and it should begin with the new year.

We were impacted by external factors which are abating now. In the United States we are seeing incipient signs of a recession. Though total employment remains robust we’re also seeing a lot of job losses.

Since the external factors are abating, I'm not worried about India’s inflation. In fact, the RBI should seriously think whether it wants to continue on its current path, because when you raise interest rates they get transmitted to borrowers rather easily. But when you reduce them the transmission takes longer. We ought to bear that in mind.

Shweta Punj: How would the looming recession in the US and UK impact India? What's your view on the India story at this point?

Arvind Panagariya: I read it very differently. I don't think that recession in the US economy is round the corner. Even though tech firms are laying off workers in thousands, total employment is robust, and it is still increasing.

But should there be some mild recession, that is not necessarily bad news for India. In fact, it is good news. Because that will restrain interest rates. Thus, the capital flowing out of India  and putting pressure on the Rupee would be stanched, and that is a good thing. From the point of view of inflation, external factors will become less important, or would at least stop contributing to domestic inflation.

Shweta Punj: Any specific FTAs that India should pursue aggressively so that exporters can benefit?

Arvind Panagariya: We have to conclude the one with the UK. Exports used to be a pittance in 1991. From $50 billion in 2002 - exports have expanded as rapidly as our exports during that period. So, liberalisation is good for us. If we go in with that attitude we seek market access vigorously.

The big FTA that we need to conclude is with the EU. That is a large market and we need access to that to grow. This is the most opportune moment for that, because when multinationals explore a China-plus-one strategy what are they going to look for? We have everything: market size, skilled labour, etc. An FTA with a large market such as the EU would be a big plus.

Shweta Punj: You mentioned asset monetisation and privatisation of the public sector. That's been an ongoing theme of the Modi government but hasn’t seen much success. Not being a very popular move, and with elections round the corner, there may be pushback from the unions and the government might go slow on this. Any inputs on how the government can push this through?

Arvind Panagariya: There are many companies where the unions are not a threat. During my time at Niti Aayog I found that it was the ministries and the management who pushed back harder than the unions. Even with Air India, the union that came to see me was not so opposed to privatisation. They wanted their health insurance and medical benefits to continue.

The unions understand that the enterprise will do better in private hands, hence their workers will do better too. They can see for themselves that virtually all the companies that were privatised by the Vajpayee government have flourished over the last 20 years. As for the sick enterprises that are doing nothing, close them down. If the timing of an election is an issue, there are still ways to do things.

We should not worry whether the government will get good value for the companies. The companies do not belong to the government. They belong to the people. The primary issue for the country as a whole is whether or not the enterprise flourishes. That ought to be the sole consideration. Otherwise, we will never be able to privatise anything.

Shweta Punj: One last question. What's your outlook on the Indian economy? I know you're optimistic about the India growth story. I want to understand where your optimism stems from.

Arvind Panagariya: My optimism is supported by the outcomes that we have observed. I had predicted 8 percent growth in the second quarter. It didn't quite pan out that way. While the economy still did decently (it grew 6.3 percent), it was not 8 percent.

That's because none of us thought that manufacturing would clock minus 4 percent growth. I was expecting manufacturing to clock about 4-5 percent growth, in which case my prediction would have come true.

Be that as it may, the reason I'm optimistic is because there’s a very well-functioning government at the centre. It is reforms oriented. I've huge, huge hopes because of the Prime Minister himself. The one thing that one can see, and hardly anybody disputes, is that the Prime Minister really wants to take the country forward as fast as possible.

A leader like that is a cause for optimism and inspiration. It means that reforms will continue.  The issue isn’t whether reforms are going to happen or not, the issue is when. Which he decides, strategically, which is fair enough.

It's better to have a three-time Prime Minister who will do a hell of a lot of reforms rather than a one-term Prime Minister who might stop them. Which is what happened after the Vajpayee government. Between 2004-2014, we lost 10 years as far as reforms were concerned.

Shweta Punj: Any growth estimates that you'd like to share with us?

Arvind Panagariya: If we stay the course, probably about 7-8 percent annually. But that is well below our potential, which is 9-10 percent. However, that requires aggressively embracing the global economy. I think we have slipped a bit on that front.

The recidivism in liberalisation is turning into protectionism. That is a big mistake. It takes away from the positive reforms we have done. But I think I'm sort of a lone voice on that. Industry loves protection from imports. In the US you will see that the exporters are very vocal, they want to open up markets. But in India, exporters never come to the table, never push for liberalisation.

But even in the US exporters have  become a little less vocal in recent years because a lot of them have invested abroad. When you have an automobile factory in India (e.g,), then you don't want the Indian market to be liberalised.

But that's not the case with India, so Indian exporters ought to be more vocal, particularly when it comes to FTAs, etc. They ought to be at the table countering the anti-import lobbies. That is how these negotiations work in places like the US and the EU.

Shweta Punj: The protectionism is hurting small businesses, driving up their cost of raw materials. But their voice is not reaching the powers that be. There's a gap between the policies and the people.

Arvind Panagariya: Remember one thing. The bulk — 80 to 90 percent — of the exports are done by large firms. Yet everybody keeps claiming that micro and small enterprises (MSME) are big exporters. Where is the evidence? Pravin Krishna, my friend at Johns Hopkins, a very eminent trade economist, has looked at export figures at the firm level. He tells me that 80-90 percent of the exports are coming from a very, very small number of firms that are incredibly large. Where are these firms when the FTA negotiations happen? They ought to be present. Why will they not be heard? I don't buy the argument that their voice is not reaching the powers that be.

Shweta Punj: That’s interesting.

Arvind Panagariya: They're simply not lending their voice to this. I don't know what the reasons are. For some inexplicable reason they seem not to articulate their own interests in these negotiations.

Shweta Punj: We do hope that budget ‘23-‘24 sets India's agenda for the next decade. And we hope that your optimism for the country continues to grow. Thank you very much, Dr. Panagariya, always most edifying talking to you. Thank you very much for your time and for joining us all the way from New York.