# 26 Taxes, the OPM of the Masses, What Cost Formality

Taxes - the OPM of the Masses

“Auto drivers pay 600 rupees a month to send their kids to my school, rather than to the free government school across the road”, the edupreneur Vikas Jhunjhunwala told me last week. As a tax-payer, I find it galling that the Delhi government spends 10 times more than what his schools charge -  78,000 rupees per year, per child, to be precise.

For several years now, Delhi’s ruling party, AAP, has tom-tommed the improved quality of Delhi government schools, complete with visuals of swimming pools, and colourful plastic furniture. The increased expenditure is not in doubt, but with two years of disruption in schooling, we will have to wait for evidence that the quality of learning has improved. Spending money is easy. 

If you have followed educational policy and outcomes in India for the last couple of decades, three conclusions are inescapable:

1. There is a secular shift to private schools. By 2019 (pre-COVID), almost 50% of all Indian children were attending private schools. The disruptions of COVID have disrupted that trend, but I suspect it will be temporary.

2. It costs government bodies - state, city, or municipality - way more to school a child each year than budget private schools. The Delhi spend is unusually high, but budget schools typically charge one-third  of what government schools spend on salaries and other direct costs. Land and buildings are not included in government school budgets, so a full and fair accounting would raise the ratio of government to private expenditure to 4:1.

3. With a few exceptions, learning outcomes in private schools are significantly better than in government schools. In 2018, the ASER (Annual Status of Education Report) reported on

a. Reading skills: only half of all Class 5 students could read a Class 2 text. The percentage for government schools was 44; for private, 65.

b. Math: only 22.5% of Class 5 kids in government schools could do a simple division. In private schools, almost twice as many, 39.8%, of kids in private schools could.

On most counts, and in most states, private schools educate their students way better than government schools, at a fraction of the cost.

If you believe that school education is the responsibility of governments, this still raises the question of the best way to provide school education. Given the data, government schools are not the best solution. This raises the obvious question of why they continue to exist. I can think of many answers - teachers’ unions are a substantial political force; every head of government expenditure is a bureaucrat’s fiefdom, and a politician’s chiefdom; providing good schools for ‘your’ children is a viable political narrative. But above all, I think they are just one more illusion of ‘free’ services.

So much political capital is built from the narrative that the government - aka the benevolent leader - is providing something from the largesse of his heart. Free vaccines, free gas, free houses, free medical care. The success of socialist policies comes from nurturing the illusion that government services come free of any cost to the beneficiary. If the poor think at all about the funding of such programs, politicians lead them to believe the rich, the other, is paying for them. Little matter that the government raises almost as much from taxes on bidis, chappals and cycles as it does from the incomes of the super rich. Indirect taxes, on goods and services, account for almost as much government revenue as ‘direct’ taxes on personal and company income. 

If we all got over this illusion of Other People’s Money (the OPM of the masses), we should be asking how efficiently the government spends our money. In the case of school education, the answer is clear - very poorly. In their book, In Service of the Republic, Vijay Kelkar and Ajay Shah assert that “the cost incurred by society for each rupee of public expenditure - is about Rs. 3 in India. “

This means that a more efficient Indian economy requires us to replace government spending with private spending wherever possible. If we were able to wish away the incentives for politicians to raise taxes and loans for large projects - I know this is a big ‘If’, and not likely to happen - we have to ask,

Are there some government services that cannot be replaced by private services? 

The classic liberal answer to this is - law and order, justice, and defence. Everything else, from schools to roads, can be built and run, far more efficiently, by business. 

This does not mean that non-governmental services become exclusionary - if there is societal consensus, for example, that all homes should have piped gas, government need only function as a channel for redistribution of funds to the gas company. 

Every rupee of government expenditure thus saved can either produce three rupees worth of goods in more efficient hands, or reduce government borrowing, leaving more room for investment and growth. Right now, though, the narrative is that the government needs to collect more taxes to fund our growth. In the face of evidence, this is economic lunacy. 

‘Until the lion learns to write, every story will glorify the hunter’. We don’t have enough people writing the story of limited government. The narrative is dominated by hunters, smiling fake smiles of benevolence from hoardings, election posters and full page newspaper ads. But if you care about the economy and your own bank balance, remember that the OPM of the masses is your money.

What Cost Formality?

It began as an ex-post justification for demonetisation, but ever since 2016, we have been hearing about the formalisation of the economy, a trend which GST further cemented.

What does this mean for economic growth? Our statistical system has become less robust over the last decade, and 2 years of COVID have made data collection more difficult, hence there are no reliable numbers for the performance of the informal sector. I therefore decided to run a thought experiment around formalisation.

In 2016, the economy was roughly 50:50 between formal and informal (the exact number depends on definitions around registration and accounting methods). Since 50-50 is an easy ratio to work with, I assumed that Indian GDP in 2016 was 200 (the unit of measurement doesn’t matter) -100 each for formal and informal.

Next, I recognised that current Indian GDP growth numbers measure the growth of the formal sector. Using the annual growth numbers in the table below, the GDP of the formal sector would have grown from 100 in 2016 to 127 in 2022. This represents an annual growth of 4% per annum, because the lockdowns in 2020 led to a 9% drop in GDP that year.

Formal sector in India

Year Growth GDP

2022 6.5% 127.3

2021 11% 119.5

2020 -9% 107.6

2019 4% 118.3

2018 6.5% 113.7

2017 6.8% 106.8

2016 100

For the informal sector, I assumed that while many units were shut down, others grew; the net impact was zero. Press reports and anecdotes suggest that the sector was grievously hurt, and growth was definitely negative, but I stayed with the softer trajectory. By this reckoning, the GDP of the non-formal sector remained at 100.

National GDP, then, went from 200 to 227 over these 6 years. This translates to an annual GDP growth rate of just over 2%. This also means that the ratio between the formal and informal has shifted from 50:50 to 56:44. This does not seem too drastic, and many economy observers I talked to suggested that 60:40 would be a better estimate of the damage to the non-formal sector. 

Since this is only a thought experiment, the actual numbers don’t matter. What matters was succinctly stated by a friend, Vikram Bajaj, responding to an early draft of this note -  if you believe that the government’s actions formalised the economy, then you have to believe the formal-informal ratio shifted, and applying the old ratio overestimates Indian GDP growth.