It is not exactly a turning point in global economic thinking but when the International Monetary Fund (IMF), the global champion of neoliberal economics – which few dispute has taken inequality to new global highs in the past four decades and counting – asks the UK to reconsider its income tax cut proposals for fear of raising inequality, it is certainly time to sit up and take note.
More so because this is as much relevant to India, or more.
What got the IMF’s goat?
IMF openly criticised the UK’s tax cut plans in the early hours on Wednesday, warning that it would raise inequality and add inflationary pressure, thereby worsening the cost-of-living crisis the country is going through. Last Friday, the new UK government under Liz Truss announced income tax cuts worth £45 billion – billed as the country's biggest tax package in 50 years – ostensibly to boost growth amidst four-decade high inflation, rising interest rates and looming recession. Seen as “unusually outspoken statement”, the IMF said the tax proposals were “at cross purpose” with the monetary policy and advised to consider ways “to provide support that is more targeted and re-evaluate the tax measures, especially those that benefit high income earners”.
Last week, the Bank of England raised interest rate to 2.25% – the highest in 14 years– to contain inflation.
The UK’s tax proposals (called a “mini budget”) include a cut in basic income tax by 1%, from 20% to 19%, which is expected to benefit more than 31 million people (to come into effect from next April), but there are several others which are aimed at benefiting the rich more. These include (a) scrapping 45% additional tax rate on earnings above £150,000 (b) axing the cap on bankers’ bonuses (c) scrapping the planned rise in corporation tax to 25% (d) doubling the stamp duty “holiday” on property purchases to £250,000 (e) allowing the overseas wealthy to shop duty free anywhere in the UK – not just at airports (f) reversing the 1.25 percentage point rise in national insurance contributions and (g) tightening the benefits rules to make it harder for part time workers.
Resolution Foundation, a think tank, estimates the net result of these tax cuts: (i) almost 45% of the tax cut (£45 billion) would “go to the richest 5% alone”, who will benefit by £8,560 (on average) while (ii) “only 12%” of the gains will go to the poorest half of households, who will benefit by £230 (on average). The skewed structure forced some to call the tax proposals “a budget for the top 1%”.
The impact of the announcement has been devastating for the Pound, the UK’s currency. It fell to a record low of $1.03 on Monday, from $1.35 in January this year. Depreciation of currency aid to inflation – which is four-decade high already. To get an idea of how currency depreciation leads to inflation, here is what the RBI’s monetary policy of April 2022 said about the Rupee devaluation: “Should the INR (Indian national rupee) depreciate by 5 per cent from the baseline, inflation could edge up by around 20 bps…” Inflation remains elevated in many countries, including the US, Eurozone and India – all of which are raising interest rates to check inflation and which, in turn, would hit global growth further.
The tax cut has also sparked fears that government borrowing would surge in the UK – another area of concern the IMF flagged. But then, the IMF has continued its advocacy of fiscal austerity (tight limits on debt-to-GDP ratio and fiscal deficit) right from the days of Washington Consensus of 1980s.
Although it must be added that in more recent times, it is more circumspect. For example, it devoted an entire issue of its inhouse journal ‘Finance & Development’ (March 2022) advocating a rethink on the long-held paradigm of restricting debt-to-GDP ratio to 60% and fiscal deficit to 3% in view of the pandemic-inducted changes in ground realities, which Fortune India’s article “Beware! IMF’s rethink on debt-to-GDP, fiscal deficit limits has consequences” talked about .
IMF and its inequality concerns
IMF’s approach has seemingly changed after the global financial crisis of 2007-09, popularly known as ‘Great Recession’. The crisis is seen by many as a failure of its neoliberal economics. The pandemic crisis hastened its concerns about inequality and other adverse outcomes of its flawed economics.
The advocacy for a rethink on fiscal austerity mentioned earlier is one. Another is focus on inequality. It recognises that inequality is a threat to “macroeconomic stability and inclusive growth” and its focus on it has become “more systematic” after 2015 – the year the UN launched its Sustainable Development Goals (SDGs) for the next 15 years with heightened focus on achieving (a) No Poverty (Goal 1) (b) Zero Hunger (Goal 2) and (c) Reduced Inequalities (Goal 10). Since then, the IMF is increasingly engaged in addressing inequalities at country, region and global levels “with analysis and advice on how to address inequality concerns”.
The IMF has published several policy and research papers on inequality. At least two of these stand out as “defining” work. In 2015, it published a study which analysed economic data from over 150 countries for the period 1990-2012, spanning advanced, emerging and developing categories and concluded: (a) rise in the income of the bottom 20% (the poor) drives GDP growth and (b) rise in the income of the top 20% (the rich) reduces GDP growth.This is a clear reversal of the “trickle down” theory of growth it favoured until then and went against the flawed “a rising tide lifts all boats” argument.
In 2020, it published another study which flagged the pitfalls of excess financialisation on inequality. After studying 200 countries between 1993 and 2017, it concluded that while initially, financial deepening helps in reducing inequality but after a point, financialisation raises inequality and causes financial crisis of the 2007-09 kind. Its other important findings were: (i) inequality increases before a financial crisis (ii) inequality falls during the crisis and begins to rise afterwards as lower-income households disproportionately experience income loss (which some studies have shown to have happened during the pandemic) and (iii) higher growth in debt is associated with a greater probability of banking crisis.
Why India is silent on inequality?
Why should all these matter to India? Why India should care about the UK’s tax proposals?
These should worry Indians for the simple reason that India’s tax regime too is skewed and regressive in nature which worsens inequality, more so after a new tax regime came into place after September 2019. This tax regime put new tax rates for companies and individuals not availing tax rebates and exemptions. First, the peak base rate of corporate tax for domestic companies was cut from 30% to 22% for existing manufacturing companies and from 18% to 15% for new manufacturing units. But when it was extended to individual taxpayers in 2020, the peak base rate for individuals continued to remain 30% for income above Rs 15 lakh.
If the UK’s tax cut disproportionately benefitting the high earners would lead to inequality, that would have already been the case for India for the past three years when the new and skewed tax regime was put in place. Yet, there is no hue and cry over it – in India or abroad.
It is by now well known that rising inequality is a global phenomenon, not restricted to India. But India stands out because the rise in inequality here is far more than anywhere else in the world. A World Inequality Lab report of 2019 said the rise in India’s inequality “has no precedent in recent history”. Multiple studies since then – from Global Hunger Index of 2021 to World Inequality Report of 2022, UN’s HDI report of 2022 and Credit Suisse’s Global Wealth Report of 2022 – have repeatedly flagged how not just income and wealth inequality but health and education inequality too have grown by leaps and bounds – worse than even Bangladesh, Bhutan, Sri Lanka and of course, China, in most aspects.
The Economic Survey of 2020-21 said India’s priority remains growth to alleviate poverty. It said: “…economic growth has a far greater impact on poverty alleviation than inequality. Therefore, given India’s stage of development, India must continue to focus on economic growth to lift the poor out of poverty by expanding the overall pie.”
This is more of a throwback to the “socialist” era of planned development in India. Sukhamoy Chakravarty, one of the key architects of five-year plans along with PC Mahalanobis, had explained the policy priority of that era in his 1987 book Development Planning: The Indian Experience. He wrote: “…there was a tolerance towards income inequality, provided it was not excessive and could be seen to result in a higher rate of growth than would be possible otherwise”.
Truth be told, little attention has been paid to either poverty or inequality. Centre stook silent when the HDI and Credit Suisse reports flagged growing inequality in income, wealth, health and education. India is one of the poorest in the world. In fact, the global average per capita income of $12,263 (2021), is 5.4 times more that of average Indian at $2,277. The UK’s per capita income at $47,334 is 21 times more (richer than average Indian).
