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Bad ideas driving good ideas out- that is what is happening with Baba Ramdev’s tax proposals. Tax harmonization in general is good idea. So there is a good argument for abolishing interstate custom duties creating a unified market for commodities. There is also a good argument for streamlining the income tax code to reduce distortion of consumption choices and making tax calculation easy. But to scrap all the taxes and replace it by one single bank transaction tax- bad bad idea!

One for starters, as far as you cannot observe and tax people’s ability, economic theory suggests there is an optimal mix of direct and indirect taxes. Secondly, by taxing bank transactions, we change the relative price of cash versus transactions routed through banks. It only means that transactions would be done more with cash than through banks. It also might be regressive in the sense that people who do not have access to off the book cash will benefit at the cost of people who have to route their transactions through banks.

It looks like Baba Ramdev has been infected by Arthakranti‘s misguided ideas based on very poor understanding of economics. For those who are interested can find my critique of Arthakranti Proposals here. But let me demonstrate the absurdity of these ideas in a few lines.

For example, Ramdev wants de-monetisation of currency notes of Rs 500 and Rs 1,000 to help ease inflation, improve employment generation and also lower corruption. True that inflation in the long run is a purely monetary phenomenon but that does not mean if some denominations of currency notes become unavailable inflation is going to be eased. In order to reduce inflation, in this case, would need a sustained decrease in overall money supply.

Now this would work if in fact inflation is just a monetary phenomenon for India. There is plenty of literature debating on what actually causes inflation in India and the consensus seems to be that supply side bottlenecks and rising demand for protein foods is causing it. I am not sure how making some denominations of notes unavailable is going to change that. Moreover we actually want people to eat more protein based foods rather than less and as incomes improve we should expect this demand to increase further. Eventually, production will respond and the rise in protein prices will be arrested. What actually might help stem inflation right now is not to institute the next few pay commissions and may be use that money to fund more roads, electricity and schools!

Simplistic ideas are many times just that- they are simplistic but might end up causing more damage than good. We should all be wary of those and remember that there is no shortcut to better economic performance but to invest in infrastructure, education and health.