The government has increased the salaries of the government servants in keeping with the recommendations of the Seventh Pay Commission.
There is euphoria in the market. Auto sales, for example, are set to pick up. The government servants are expected to buy more numbers of bigger cars with their increased incomes.
This will certainly provide a boost for the automobile sector. But, this is only half truth. The money paid to the government servants will not come at the swing of the magic wand.
This money will be taken from the pockets of someone else. The final impact of the Pay Commission will depend upon the increased demand from government servants and the effect on those who will pay the increased taxes to pay these increased salaries.
About one-half of the taxes come from income tax. These are mostly paid by the rich. The other half of the taxes comes from excise duties, service tax and sales tax. These are known as indirect taxes.
These are paid by the rich and the common man alike. Let us say one-half of the indirect taxes are paid by the rich and one-half by the common man.
Overall, then about three-fourths are paid by the rich in the form of income tax and indirect taxes; and one-fourth of the taxes are paid by the common man in the form of indirect taxes.
Let us say, the government collects an additional Rs.100 of taxes to pay increased salaries to the government servants. Rs.75 of this will come from the rich and Rs.25 from the common man.
The payment of increased salaries of Rs.100 to the government servants would deprive the common man of Rs.25 of his income. The common man would not be able to buy the motorcycle or the refrigerator that he had planned to buy.
The consumption of rich who pay the tax will also reduce. Let us say their consumption is reduced only by Rs.25. On the whole then, the consumption or demand in the market shall be reduced by Rs.50.
The increased salary of Rs.100 will be paid to the government servants.
The minimum emoluments of the lowest government servant inclusive of DA, pension and other benefits would be about Rs.40,000 per month or more than Rs.5 lakh per year.
I reckon they will save one-half of the additional salary and consume the other one-half. Thus, the demand in the market shall be increased by Rs.50 due to the increased consumption by them.
The net impact on the demand in the market will be zero. The demand will increase by Rs.50 from the government servants and the demand will reduce by Rs.50 from the taxpayers.
The taxpayer will buy less numbers of motorcycles while the government servants will buy increased numbers of cars.
Payment of increased salaries to the government servants thus involves a shift of consumption from the common man to the government servants. Thus a section of the economists are rightly saying that implementation of the Pay Commission will revive the fortunes of the automobile sector.
They are ignoring, however, that this will be accompanied with a parallel reduction in demand in motorcycles.
The same collection of additional tax of Rs.100 would have an entirely different impact if the government spent the money in building highways, e-governance portal or space research.
In that case, the demand in the market would increase by the entire Rs.100 spent by the government. The National Highways Authority of India will buy more steel and cement to build the highways.
The reduction of demand, on the other hand, will be only Rs.50. A reduction of demand of Rs.25 will take place because of the increased taxes paid by the common man and another reduction of demand of Rs.25 will take place because of the increased taxes paid by the rich.
In the end, the reduction in demand would be Rs.50, while the increase in demand will be Rs.100.
The correct formula for reviving the economy is to use increased tax collections for investments rather than paying increased salaries to the government servants.
The impact on the economy in the second cycle will be even more dramatic.
Paying increased salaries to the government servants will increase the chasm between the common man and them.
Walk into any village in the country and you will see that the government servants have invariably made pucca houses. Speak to a jeweller or a property dealer and he will tell you that most purchases are being made by government servants.
These same government servants are being paid even more amounts bay taking the money from the common man.
This widening chasm between the common man and the government servants will lead to an increase in social dissension.
Of course, every young man today wants to join the army of government servants so that he can participate in the loot of the country.
However, few will succeed and rest will be left disenchanted. The result in the second cycle would be entirely different if the taxes collected from the common man were spent for making highways.
The farmer would be able to reach the vegetables produced in his field to the market easily.
The loss of incomes borne by him due to paying increased taxes will be made up by the increase in incomes from the construction of new highways. Such an approach will be in keeping with the welfare state mandate of the Constitution.
I had seen a study done by the World Bank few years ago. The Bank had compared the salaries of government servants with per capita GDP in countries of the world. It was found that the salaries of government servants in India were five times the per capita GDP and this difference was highest in the world.
The Seventh Pay Commission will further accentuate this already perverse distribution of the national income.
The practice of paying huge salaries to government servants was instituted by the British masters so that they could suppress the people of the country.
Alas! The same story continues.
Dr. Bharat Jhunjhunwala was formerly Professor of Economics at IIM Bengaluru. Views expressed are personal. .Author’s phone: 85278-29777