Which One is Reagan’s Country? Which One is Nehru’s Country?

The question sounds utterly frivolous and dumb. Until Thursday, August 13,  we would have thought so as well. But that evening, we read media articles which made us wonder whether we are living in the Twilight Zone.

Wonder of all wonders! That day, the Indian Finance Minister unveiled a new tax regime that promises to “drastically cut the tax liability of most individuals by considerably raising tax slabs (brackets)”, to quote the Times of India. The Economic Times called it a “paradigm shift”. Some details of this tax plan are:

  • The ceiling for the 10% tax bracket rises from Rs, 300,000 to Rs. 1,000,000.
  • The bracket for the next tax rate of 20% rises from the old Rs. 300,000 – 500,000 income bracket to Rs. 1,000,000 – 2,500,000. In other words, the income ceiling for this bracket has been raised by 500% . Rs. 2,500, 000 is approx. $50,000 and is close to the average American wage. It is a huge amount in India.
  • The final bracket of 30% taxes will apply to incomes exceeding Rs, 2,500,000. 
  • The corporate tax rate has been cut to 25% from 30%.

This is a great gift to the people of India from the Government of India and it was given 2 days prior to August 15, India’s Independence Day. We rejoice in this action and invite all well wishers of India in the world to celebrate with us. 

That we live in the land of Reagan makes this moment so sweet. This action from the Indian Government is pure Reaganesque.

It was Ronald Reagan who cured America’s malaise of 1970s and changed America’s economy by a targeted program of Tax Cuts. At the same time, he allowed Paul Volcker to kill inflation by keeping interest rates high. Reagan put money in the pockets of ordinary Americans to create true secular growth while his Fed Chairman ensured this growth would be bubble-free with a tight monetary policy.

As a result, a Secular Bull Market in Treasury Bonds began in 1981 that continues to this day. As Treasuries rallied, a Secular Bull Market in Stocks began in 1982.  The secular bull market in Treasuries made America the envy of the world and persuaded the world to keep their reserves in US dollars. The secular bull market in Equities made Americans wealthier and allowed American corporations to raise inexpensive capital in the American stock market.

We have been long term bullish of India, its economy and its ability to re-achieve its great place of leadership in the world. We are convinced that this paradigm shift in taxes will bring that day within reach much faster than it would have otherwise.

The Indian Administration has talented people and it works better than most people think. Let us not forget that it was Dr, Raj Reddy, the Governor  of India’s Reserve Bank, that restricted India’s Banks from extending loans for real estate in 2006, yes 2006. How we wish Dr. Alan Greenspan had done so in America! Dr. Reddy’s act of great foresight and political courage ensured that India’s banks and India’s financial system were spared the credit bubble that engulfed banks all over the world.

Indian economy today is virtually unique in the Emerging Markets space. It is a primarily domestic consumption economy. It does not live on exports like Germany, Japan and China or the Asean. Further, it has real demand. Not stimulus generated artificial demand but real demand from consumers with real disposable income. The demand may be small per capita but , in aggregate,  it is pretty serious.

With this tax cut, the real consumer demand will grow and with such growth in demand will come investment by Corporations, both domestic as well as foreign multinationals. After all, today’s corporate world is hungry to find areas where it can meet real, unmet, growing demand.  

Good for India but what about the America, the country that produced Ronald Reagan. Unfortunately, when we look inwards into America, our good feelings evaporate. It seems as if America is embarked on the policies that Nehru and his socialism-enamored central policy makers forced on entrepreneurial India in the 1950s and 1960s.  

Today, our elected Government in America is proposing to increase taxes across the board. Federal taxes are going to be raised in addition to state and local taxes that have already been raised. In free market capitalistic America, the tax burden could exceed 45% while in socialist populist India it is going to down to 30%. America is talking about raising corporate taxes while India is planning to cut corporate taxes to a level 10% below America’s.

America is engaged in a fiscal binge that contains more pork than programs that produce demand and jobs. This  fiscal policy has been so unhelpful to the real economy that the Bernanke Fed has no choice but to keep its monetary policy very easy.

But this combination will NOT create inflation. We will not be so lucky. The proposed Health Care Reform has absolutely petrified the majority of Americans. We confess that we personally are so scared of what lies ahead that we have stopped spending. Between cap & trade, health care reform and taxes going up on all income, why would  we want to spend on anything until the dust clears? 

This makes deeply concerned about a vicious cycle of increased taxes leading to decreased incomes & decreased buying power resulting in weaker growth creating greater fiscal deficits which in turn will force further increase in taxes – this is not inflation but a prosperity-killing deflation.

When we wrote our July 18 article comparing Obama to Nehru, we thought we were making a long-term, semi-futuristic argument. Little did we realize that this comparison will face us in less than a month. And never would we have imagined Nehru’s country becoming Reagan’s country and vice versa!

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