Stephanie Kelton is one of the most influential advocates of Modern Monetary Theory, or MMT. The MMT challenge to mainstream thinking on how to manage an economy has grown in popularity in recent years.
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It especially challenges the view that government spending to support an economy is constrained by tax collections.
Kelton has written a lucid introduction to MMT, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. Much of it deals with the situation in the USA. Is MMT relevant to India?
This is worth asking for two reasons. First, the recent fiscal expansion to bolster the ongoing economic recovery will ensure that public debt as a proportion of the Indian economy is at its highest in several decades. The 15th Finance Commission, in its recent report, has estimated that public debt will be at 85.7% of gross domestic product (GDP) in 2025-26, even after the government begins to chip away at its fiscal deficit.
Second, Kelton makes an important argument in her book. The ability of a government to spend its way out of an economic downturn is contingent on its institutional details, especially the idea of monetary sovereignty. Any country that issues its own fiat current, and only borrows in that currency, is in effect released from the usual concerns about how to fund a budget deficit.
Kelton illustrates this through two extreme examples. The US prints the global reserve currency. Greece has signed away its monetary sovereignty to the European Central Bank. Interestingly, Kelton writes that even the US did not have complete monetary sovereignty under the Bretton Woods system, when its dollar was linked to gold.
Most countries are somewhere between the two extremes. Kelton rightly says that monetary sovereignty is a continuum rather than a binary classification. Countries have different levels of monetary sovereignty. Where would India fit in?
The Indian government mostly borrows in rupees. Yet, the country as a whole borrows from the rest of the world. One of the central claims of MMT is that governments do not face any financial constraints. They only face real constraints. However, countries such as India do face a financial constraint. It is called the balance of payments. India needs foreigners to buy domestic assets to get the dollars it needs to fund its current account deficit. It is a financing constraint, and one that is not unrelated to government budgetary policy.
The MMT camp is not unconcerned about inflation. It climbs when the economy runs faster than its productive capacity. Kelton also argues that inflation can take hold if people hold too much money that they may spend, thus pushing up prices, though the focus is on nominal spending rather than the printing of money by the central bank.
Some MMT arguments involve straw men. Few mainstream economists believe that the government budget faces the same constraints as a household budget. Kelton almost exclusively cites politicians rather than economists in this context. However, mainstream economists believe that budget deficits are sustainable so long as the borrowing costs of the government are lower than nominal economic growth.
Kelton does not completely dismiss this concern, but points out that a government with monetary sovereignty has total control over the domestic rate of interest. The central bank can provide the monetary support to make any level of government borrowing sustainable, at least till inflation begins to accelerate.
India does not have this freedom. It is a price taker rather than a price maker in the global financial system. Indian interest rates are influenced by global rates through flows of international capital into local financial markets.
MMT economists argue that governments create money so that citizens have the means to pay taxes. People use the currency as a medium of exchange later. This has clear roots in the early 20th century school of thought known as chartalism. Changes in tax rates are a means to either keep or take away more money from citizens, thus allowing the government to regulate economic activity. It is not clear how frequent changes in taxes to manage aggregate demand will affect long-term investment decisions of households and firms.
One final point. The MMT view is that inflation takes off only when resources are fully employed. This is also what Abba P. Lerner argued many decades ago in his articles on functional finance. The job of fiscal policy is to ensure full employment, rather than maintain “sound finances”. Most of these arguments are in the context of developed economies that face weak demand as well as excess production capacity.
The situation in India is far more complex. The labour market is informal. Employment is often seasonal. There is a persistent problem of disguised unemployment. Labour force participation is low, especially for women. The structural challenge is to create jobs outside agriculture. It is doubtful that these issues can be dealt with through the management of aggregate demand alone.
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Petrol in India is cheaper than in countries like Hong Kong, Germany and the UK but costlier than in China, Brazil, Japan, the US, Russia, Pakistan and Sri Lanka, a Bank of Baroda Economics Research report showed.
Rising fuel prices in India have led to considerable debate on which government, state or central, should be lowering their taxes to keep prices under control.
The rise in fuel prices is mainly due to the global price of crude oil (raw material for making petrol and diesel) going up. Further, a stronger dollar has added to the cost of crude oil.
Amongst comparable countries (per capita wise), prices in India are higher than those in Vietnam, Kenya, Ukraine, Bangladesh, Nepal, Pakistan, Sri Lanka, and Venezuela. Countries that are major oil producers have much lower prices.
In the report, the Philippines has a comparable petrol price but has a per capita income higher than India by over 50 per cent.
Countries which have a lower per capita income like Kenya, Bangladesh, Nepal, Pakistan, and Venezuela have much lower prices of petrol and hence are impacted less than India.
“Therefore there is still a strong case for the government to consider lowering the taxes on fuel to protect the interest of the people,” the report argued.
India is the world’s third-biggest oil consuming and importing nation. It imports 85 per cent of its oil needs and so prices retail fuel at import parity rates.
With the global surge in energy prices, the cost of producing petrol, diesel and other petroleum products also went up for oil companies in India.
They raised petrol and diesel prices by Rs 10 a litre in just over a fortnight beginning March 22 but hit a pause button soon after as the move faced criticism and the opposition parties asked the government to cut taxes instead.
India imports most of its oil from a group of countries called the ‘OPEC +’ (i.e, Iran, Iraq, Saudi Arabia, Venezuela, Kuwait, United Arab Emirates, Russia, etc), which produces 40% of the world’s crude oil.
As they have the power to dictate fuel supply and prices, their decision of limiting the global supply reduces supply in India, thus raising prices
The government charges about 167% tax (excise) on petrol and 129% on diesel as compared to US (20%), UK (62%), Italy and Germany (65%).
The abominable excise duty is 2/3rd of the cost, and the base price, dealer commission and freight form the rest.
Here is an approximate break-up (in Rs):
a)Base Price | 39 |
b)Freight | 0.34 |
c) Price Charged to Dealers = (a+b) | 39.34 |
d) Excise Duty | 40.17 |
e) Dealer Commission | 4.68 |
f) VAT | 25.35 |
g) Retail Selling Price | 109.54 |
Looked closely, much of the cost of petrol and diesel is due to higher tax rate by govt, specifically excise duty.
So the question is why government is not reducing the prices ?
India, being a developing country, it does require gigantic amount of funding for its infrastructure projects as well as welfare schemes.
However, we as a society is yet to be tax-compliant. Many people evade the direct tax and that’s the reason why govt’s hands are tied. Govt. needs the money to fund various programs and at the same time it is not generating enough revenue from direct taxes.
That’s the reason why, govt is bumping up its revenue through higher indirect taxes such as GST or excise duty as in the case of petrol and diesel.
Direct taxes are progressive as it taxes according to an individuals’ income however indirect tax such as excise duty or GST are regressive in the sense that the poorest of the poor and richest of the rich have to pay the same amount.
Does not matter, if you are an auto-driver or owner of a Mercedes, end of the day both pay the same price for petrol/diesel-that’s why it is regressive in nature.
But unlike direct tax where tax evasion is rampant, indirect tax can not be evaded due to their very nature and as long as huge no of Indians keep evading direct taxes, indirect tax such as excise duty will be difficult for the govt to reduce, because it may reduce the revenue and hamper may programs of the govt.