Inflation A Tax By Another Name

Updated: Apr 27 2003, 05:30am hrs
Inflation is a bugbear to all consumers and to most governments. There are, however, some who love inflation. Among these are manufacturers and collectors of revenue for governments.

Our perceptions about inflation have changed over the years, and are still changing. When Roger Bootle first published in 1996 his book The Death of Inflation, it had attracted more criticism than praise. It was a provocative book. He asked us to imagine a world without inflation: prices in the shops rising in some years but falling in others; pay rising by 2 or 3 per cent in the good years, but static or falling in the bad ones; house prices as likely to fall as to rise; interest rates in the range 2 to 4 per cent.

According to Bootle, this is not and need not be an imaginary world. It was the way things were in the past and it is a world that we could return to.

Soon after the Great Depression of the 1930s, the foremost concern was employment. To keep the level of unemployment low, countries tolerated high inflation. Germany was the exception. During the 1970s most European economies were converted to the German philosophy. The new orthodoxy was that high inflation must be avoided at all costs. All central bankers now swear by price stability. Even manifestoes of political parties advocate price stability (see, for example, the Congress manifesto for the 1991 general elections).

There is something inexorable about prices. Nobody believes that prices can and do actually fall. Everyone expects prices to rise those inflationary expectations trigger more price increases. In our country, successive governments have condoned inflation. It was only during the mid-1990s that serious attention was paid to price stability. During 1995-96, the 52-week average of the annual inflation rate (based on wholesale price index) was 8 per cent, but the inflation rate at the end of the year was 4.4 per cent. Since then, a determined effort has been made to keep the rate of inflation low. There have been periods when high inflation reared its head, but it was quickly brought under control. For example, during 1999-00, the end-of-year inflation rate was 6.5 per cent, but in the next two years it was only 5.5 per cent and an incredible 1.6 per cent. At the end of 2002-03, inflation has been estimated to be 4.4 per cent and the 52-week average has been estimated to be 2.6 per cent.

Recent trends, however, are worrying. The government and the Reserve Bank have allowed the inflation rate to climb beyond 6 per cent. It has remained at that level now for a few weeks. The concern seems to be about a low interest rate regime. Lower interest rates mean enormous savings to the government on account of interest payments on domestic debt. Lower interest rates also mean lower lending rates which will undoubtedly give a boost to investment and production. But if inflation is on the rise, can the government and the central bank afford to keep interest rates low

John Maynard Keynes had said: Inflation is the form of taxation which the public finds hardest to evade and even the weakest government can enforce when it can enforce nothing else. Very true. In a laymans language, inflation is the worst form of taxation. It taxes the rich and the poor alike. If the rate of inflation is 10 per cent, it robs a rich man of Rs 1 lakh out of his income of Rs 10 lakh, and it robs a poor man of Rs 100 out of his income of Rs 1,000. The rich have a cushion against inflation in the form of higher incomes or past savings, but the poor have none.

I would like to sincerely hope that the government has not decided to relax the discipline of price stability. Manufacturers love price increases, because it will boost their bottomlines. With automation and new processes, it is possible to keep input costs under control while selling prices rise (and before input prices catch up).

Another class which loves inflation is the revenue department. Inflation means higher collection of ad-valorem taxes such as excise duties and sales tax. It is easier to meet the targets set at the beginning of the year, if the actual rate of inflation is higher than the assumed rate. High inflation is particularly tempting when revenue collections are likely to fall short of target.

I sincerely hope that the government will not lend a sympathetic ear to manufacturers and tax collectors. The foremost duty of the government is to the common people, mostly poor, with fixed or uncertain incomes. Among them are the farmers who are enduring the consequences of a bad drought year. It is their interests that should be uppermost in the minds of the finance minister and RBI governor.

In the European Union, the member-countries are bound by the Maastricht Treaty to observe certain fiscal disciplines. Countries which violate the parameters are punished and are required to take stringent measures. New members will not be admitted unless they accept this treaty and show performance towards meeting those standards. Turkeys application was kept in abeyance for many years. In most European countries, people will vote out the government of the day if there is runaway inflation. In modern times, runaway inflation is usually associated with irresponsible governments or reckless dictators.

We are, no doubt, a democracy, but most people are voiceless for the five years after which the next election will take place. Parliamentarians rarely throw out a government on the charge of mismanaging the economy. Party loyalties and the dreaded whip force them to support even the most foolish policies of a government. It is only when there is an election that price rise becomes an explosive issue. In the past, we have had onions determining the result of an election. To my mind, there is little comfort in that. The damage caused during the five-year tenure of a government that condones high inflation will be enormous.

The people of this country, including me, would be happy if we can hear reassuring words from the two men, the finance minister and RBI governor, about their abiding commitment to price stability.

(The author is a former Union finance minister.)