This article is the first of a new series: Jadu Economics. A close relative of the previous "Calling the Bluff" series, as well as of the voodoo economics (sometimes) practiced in the West. What makes it particularly different is its Indian character - we are like this only. Jadu may mean magic, but like many Indian words, the nuances hint more. This series will help identify the magical nuances in our economic thinking.(Business Standard, January 22,2005).

Blurb: As Deng Xiaoping might have said: tax policy should concern itself with catching mice, and not with the equity of the cat.

"Go and tell the world that we are changing. We Marxists are not fools to cling to obsolete ideas. In West Bengal, the Left is right and this is the right place to invest." Budhadev Bhattacharya, Chief Minister, West Bengal (Economic Times; Jan 15, 2005)

Then who are the fools? It is just a hunch, but new alliances are forming. In the left corner, we have the traditional CPM left , together with the radical chic from within the Congress party. In the right corner, are the non-left liberals, from both the CPM and the Congress party!

Tom Wolfe coined "radical chic" in the early seventies, and as befits a developing country, we are confronted with it some 35 years later. His sarcasm and ire was reserved for the do-gooders in America, the socialites, rich artists and intellectuals (the left) who wanted to help the downtrodden e.g. the "Negroes" belonging to the Black Panther movement. While Wolfe was ridiculing the charlatans, a real live version of radical chic was campaigning in India, using a slogan that could have been invented by Wolfe himself: "Garibi hatao". What is co-incidental, and noteworthy, is that as she breathed radical chic, Mrs. Indira Gandhi did everything possible to not make possible the removal of poverty. Not only that, she removed individual liberties with the imposition of Emergency a few years later (civil liberties do not affect the poor, do they?) Now that is the true definition of chicness - just talk the good motherhood talk, because it is so easy to fool the foolish people - that's you and me.

Fast forward to the mid-eighties and note that the young Rajiv Gandhi bravely contradicted most of his heritage. He lost because of Bofors - and many of us (regrettably, including myself) fell for the radical chic of V P Singh. His Mandalization matched Mrs. G in its injudicious mixture of bad economics and divisive politics. Mercifully, he did not last very long, and the Narasimha Rao led Congress, with the present dream economic team in command, renewed India's pact with its own destiny.

Since then, and somewhat uninterrupted, India has been in economic reform mode. The tasks unfinished by the dream team continued in different avatars - first with Deve Gowda and then with Vajpayee. And now back to the founder of sensible economic policies - Manmohan Singh. Given the coalition nature of this government, there are many arguing that the Rajiv Gandhi legacy is in danger of being derailed by the Left partners of the ruling UPA coalition. As the above quote by the numero uno Supreme Leftist easily demonstrates, the Left leadership ain't no(more) radical chic. They are genuinely concerned about development, about the poor, about their tryst with destiny. They are even admitting to past mistakes about labour policy (read the power of unions) and investment policy (read the madness of swadeshi economics). In effect, the Left leadership in West Bengal wants to disassociate itself from the voodoo, jadu (fascist) economics of Mrs. Indira Gandhi, V P Singh, L K Advani , the RSS - and radical chic.

My last article (Business Standard, Earn Poor, Spendrich, Jan. 22nd ) examined the popular misconception that Indian taxes, as a percent of its GDP, was too "little". This conventional wisdom was shown to be manifestly wrong. India's consolidated fiscal deficit, center plus states, problem (upwards of 8 percent of GDP for the last twenty five years!) was shown to be more a result of extravagant spending than deficient taxation. Not to be stopped by mere facts, the radical chic Left has reissued its "demand" for an increase in the tax/GDP ratio, preferably through an increase in tax rates for the rich.

Unfortunately, an increase in tax revenue is not achieved through jadu; worse, for the ideology of the Left, the problem of nonpayment of taxes is not with the super rich, or even the rich. As the table shows, the super rich (individual earnings greater than Rs. 10 lac) have the highest compliance ratio - 54 percent, followed by the poorest tax paying class (Rs. 1 - 2 lac), 42 percent , and then the very rich (Rs. 5 - 10 lac), 34 percent. The problem lies with the missing middle - taxpayers with earnings in the range of Rs. 2 to 5 lacs. These individuals have a compliance level of only 10 percent or so. It bears emphasis - only 11 percent of the 13 million taxpayers with incomes in the Rs. 2 to Rs. 5 lacs actually file tax returns. Who are these guys - and gals? Since most salaried people no longer have the privilege of avoiding taxes, this group comprises shopkeepers, lawyers, doctors, architects etc. (By definition, the rich farmers, who "should" not be taxed because they are serving the nation, have been excluded from the calculation). These middle individuals are today paying an average tax rate of about 25 percent (after exemptions and Section 88 deductions). If their compliance was to increase to only 41 percent (the average compliance rate of the rest of the population), tax revenue would increase by about Rs. 30,000 crores, or more than 1 percent of GDP and more than two-thirds of total tax collection during 2003-04. Contrast this with a tax policy which made every super rich person comply (by inducing them to pay a higher tax rate!) and the increased tax revenue would be only Rs. 7000 crores.

The challenge is to devise a tax system that will get non-salaried individuals to file tax returns. The Kelkar tax report made a significant advance on existing thinking by suggesting a two tier tax structure - a 20 percent marginal tax rate for those earning between Rs. 1 to Rs. 4 lacs, and a 30 percent rate for those beyond. This reform is in the right direction, and certainly better than a policy which only eliminates Section 88 deductions and keeps tax rates at the same high levels. Or keeps the same tax system and prays that a higher tax rate for the rich will get them to comply more!

Tax reform is about inducing taxpayers to comply. It is okay to believe, as radical chic and misguided liberals do, that individuals are moral and will pay whatever tax rate demanded of them. It is especially naïve to believe this will happen given the sorry ( and corrupt) state of the delivery of social services in India. Many people rightfully believe (in my opinion) that there is little merit in complying when the taxes result in state spending and such spending results in lining the pockets of political parties, bureaucrats etc. Recall the Rajiv Gandhi conclusion that only 15 percent of state spending meant for the poor (and Mr. Gandhi was an optimist) actually reaches the poor. But don't tell that to the radical chic - they are busy expanding an employment guarantee program that today reaches only 10 percent of the poor for whom the program is intended.

The goal of taxation should be to maximize revenue; it really should not matter how the mice are caught as long as they pay taxes. How best to catch the savvy Indian non tax- payer? Via a flat tax of only 15 percent for all incomes above Rs. 1 lac. Such a reform is revenue neutral at only 40 percent compliance for all income groups, and should result in significantly higher revenues (around 0.5 percent of GDP) at compliance levels above 55 percent. But the radical chic argues - what about equity in tax collection? Such equity should come about through expenditure patterns, not tax collection. Let's face it - our golden goose is the middle class, not the rich and beyond.