How 'luxury' taxes keep living standards low in India

February, 2005

Imagine you are passionate about something. Forget imagining - without a doubt, you definitely have a passion for something. Let's say you're obsessed with this passion, and you want to turn it to reality. Let's say you want to build a product - a product that's absolutely the best in every way, a product that's world class. Now let's say you take a great leap of faith, and do what needs to be done - you commit to your dream, you work hard, you work under tremendous emotional and financial pressure, you work through setbacks, you work through other people's negativity, and you always, always, always, hold on to your dream. And you finally achieve it. What happens next?

Take an example. Say there are only poor or mediocre quality hotels in India. Someone, passionate about hotels, is unhappy with this state of affairs. He decides he wants to build a truly magnificent hotel, comparable to the best in the world. He turns into an entrepreneur. He does a lot of hard work, goes around finding goods and services of the finest quality, and puts it all together. He then works day and night on the numbers to come up with an appropriately reasonable price. While his hotel may still not be affordable to everyone, the charges are reasonable enough for a significant number of Indians.

What's the hotelier also done in the process? He has raised the standard so people now have a choice of a better hotel, a choice that didn't exist earlier. What happens next?

The Indian government does something incredibly stupid: it slaps a big luxury tax on the hotel. The hotel is now out of reach for the people who could have patronized it minus the luxury tax. In effect what's the government telling these people? It's saying, "This hotel is too good for you. You shouldn't be staying there. Stay in a mediocre hotel." And what's the government telling the hotelier? That if you produce something of great quality, we'll ensure that only a select few will benefit.

It's not just hotels that suffer a luxury tax. The government will slap a luxury tax on anything it considers expensive or a luxury, although luxury taxes are also imposed in the guise of other labels like surcharges or cesses. Take air travel. The government decides it's a luxury, so it imposes all kinds of surcharges on air travel. The problem is, by taxing air travel, the government turns air travel into a luxury. People who could have otherwise travelled by air can't do so now. In contrast, the government decides rail travel is a necessity. So it subsidises rail travel by keeping fares artificially low. Now, I'm not saying rail travel shouldn't be subsidised. But why penalise air travel? By penalising air travellers, the government turns away potential air travellers by forcing them to travel by train.

The government is now planning to impose a tax on 'expensive' schools. What is the government actually saying? That these schools are luxuries. What have these schools done? They've raised the standard (well not in all cases, but we can safely say that they do indeed provide better facilities and teaching than government schools). In fact, the products of our private schools have been the backbone of India's success in the knowledge-intensive IT and biotech industries, and in virtually all other fields. Paradoxically and fortunately, the government had earlier decided that higher education isn't a luxury, and hence subsidised universities. India is reaping the fruits of this policy - we now have a huge, educated workforce that will drive our competitiveness in this century.

But think what will happen if the government imposes a 'luxury' tax on schools. Not all kids who go to 'expensive' schools are children of rich parents. In many cases, parents are not rich but work extremely hard, scrimp and save to put their kids in the best schools. It's a long struggle, but the parents feel it's worth the effort. After the tax, what's going to happen? Kids who could have gone to good schools will be forced to attend mediocre schools or even government ones. Good education will become the preserve of an elite few.

Unfortunately, this is how the government thinks. Anything that's of excellent quality or makes life easier is treated as a luxury. And taxed to death. What would have been affordable to many people becomes unaffordable to all but a tiny minority. What does this mean? Lower living standards for the majority.

In India, the government has conditioned us to believe that we're poor and hence have to suffer scarcity and poor quality. This has a terrible long-term result - the vast majority of the populace start believing they aren't worthy of a higher standard of living, and hence are perpetually forced to feel 'poor'. It creates a defeatist attitude. What if I said the government should encourage people to stay in five-star hotels, and not three-star or two-star ones? Most people would feel uncomfortable with this thought. Why? Because five-star hotels are only for the rich. But what if lower taxes made it suddenly affordable for you to stay there too? What if the government said that three-star hotels are of poorer quality than five-star hotels, so three-star hotels should be penalised and taxed MORE? That way, more people could stay in five star hotels, and fewer people would stay in three-star ones. Ergo, the standard of living would go up.

Similarly, what if the government said that people should fly rather than take the train, because train travel is time-consuming and unproductive? What if the government penalised long-distance rail travellers with a luxury tax, because wasting time is a luxury? What if the government actually subsidised air travel? What if the government paid good schools to lower their fees?

You're probably having a tough time dealing with this. This is because the government has done an absolutely astonishing job, brainwashing us into believing that we're not worth a higher standard of living. High living standards are only for people who live in 'rich' countries. Life in India is tough and that's how it is.

In all of this, the people we should feel most sorry for are those who fight against all odds to create products and services that are world class. All their efforts go in vain. Even worse, this sends out wrong signals to potential entrepreneurs - don't even aim for excellence. Aim for mediocrity.

I'm not saying there should be no taxes on anything that's of high quality. What I'm saying is that 'luxury' goods should not have to suffer additional taxes by virtue of being 'luxury' items. The government should stay away from the business of classifying things as luxury goods or necessities. It should tax everything equally. This way, what the government loses in lower taxes on 'luxuries', it will more than make up for in the higher numbers of people who are now able to afford these luxuries. And this will mean better living standards for the people as a whole.

The only things that should attract higher and punitive taxes are goods that are proven to be bad for health or cause problems for the community, such as cigarettes, tobacco and alcohol. (If you're wondering about air travel and pollution, yes, air travel is polluting. But the government's stance was that air travel is a luxury. Pollution linked to air travel is a different argument and requires another discussion in itself).

Until we get our policies right, we will continue to shackle our own development.

- Chetan Dhruve in Bangalore

The views of this column are the author's own, and do not necessarily represent the views of NRI Online.

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