Matrix 11.2: Anticipated Reactions (King, Advisers)
Advice of Trustworthy Advisers Accepted
Advice of
Untrustworthy
Advisers Not Accepted
Success
(Pleases, Pleases)
Failure
(Enrages, Fearful)
(Enrages, Fearful) (Pleases, Pleases) According to Kautilya, a king should be aware of the various possibilities so that he can anticipate the possible reactions of the advisers and take the necessary steps. Particularly, he should be able to differentiate between the possibility (advice of Trustworthy Advisers accepted, Failure) and the possibility (advice of Untrustworthy Advisers not accepted, Success). Despite a failure in a campaign, a king should not be angry with the trustworthy advisers. Since not only might he suffer a significant loss of men and material due to the failure, but also might lose his trustworthy advisers, who might be afraid of the king. On the other hand, despite success he should be concerned about the Untrustworthy Advisers and win them back or remove them. Incidentally, the possibility (advice of Untrustworthy Advisers not accepted, Failure) is interesting since in this case the king cannot blame the advisers for the failure since he ignored their advice. Therefore, he has no reason to be angry with them.
21. This is identical to the statement ‘instead, rely on reports from dissatisfied customers’ by Mookherjee and Png.
22. These conclusions are very similar to those reached by Robert Gibbons (1998). He concludes, ‘We have seen, for example, how it may be useful to impose job restrictions to reduce an agent’s distractions, and that reducing the agent’s outside interests (such as through changing asset ownership) can play a similar role. Once such distractions are reduced, the optimal incentive contract may well have a low bonus rate. In this sense, job restrictions, asset ownership, and low-powered incentives may be complementary.’
23. On the other hand, Stiglitz (1974), after undertaking an in-depth analysis of sharecropping, concludes, ‘Thus, it would appear that the main contribution of the model of risk sharing and incentives in agriculture may be more in extending our understanding of the operations of the closely held firm and the differences between it and the modern widely held corporation, than in its direct implications for the latter.’
24. Rajesh K Aggarwal and Andrew A Samwick (1999) find such evidence.
25. The classic work of Stiglitz (1974) evaluates the efficiency of sharecropping system in depth: as many as sixteen propositions are established. He concludes, ‘Since there is a natural non-convexity associated with supervision, it was the larger farms which used the wage system.’ He adds, ‘The landlord wants the best techniques to be used. Either he must provide a strong incentive to the worker to acquire these techniques or he must supervise the workers closely.’
Akerl of (1976) also analyzes wage and sharecropping systems and sums up his findings as follows: ‘Where supervision is needed for reasons other than determination of effort, the model predicts that wages rather than shares will be paid. In India, for example, as an excellent rule of thumb, capital-intensive plantation crops are grown on a wage-payment system. And these crops need supervision to insure proper cultivation.’ The works of both Stiglitz and Akerlof provide theoretical justification to Kautilya’s insights.
CHAPTER -12 1. Auerbach (1987, p 604) remarks, ‘In the historical evolution of government finance, the income tax is relatively novel. It is difficult to find any evidence of a serious national income tax being used until the end of the 18th century, when William Pitt achieved the passage in Great Britain of the Act of 1799 which imposed a comprehensive income tax, complete with exemptions and abatements for dependents, on all residents of Great Britain. The tax was introduced to maintain the solvency of the British government in the face of the expense of the Napoleonic Wars.’ This assertion by Auerbach may be true of the Western world, but does not hold for the rest of the world.
2 . Current State of the Theory of Income Tax: Current discussion of income tax concentrates on: how to accomplish an intended redistributional goal with a minimum loss in economic efficiency, which results from the distortionary changes in behavior related to work-effort, savings and risk-taking. The question asked is: what should be the rate of progression or how to balance equity and efficiency [although Atkinson and Stiglitz (1980, p 360) call it an artificial distinction] for a specified amount of tax revenue? Nobel Laureate Mirrlees (1971), in his pioneering work, finds (i) ‘the income-tax is a much less effective tool for reducing inequalities than has often thought’, and (ii) ‘the optimal tax structure is approximately linear ie. a constant marginal tax rate.’
Recently, Diamond (1998) provides several insights into the optimal income taxation for developed countries. However, he concludes, ‘There is not a simple route between the Mirrlees model and policy implications for annual income taxes levied repeatedly on families and covering both capital and labor incomes. The assumption of a zero income elasticity of labor supply and the limited information on both the shape of the skill distribution and the pattern of elasticities of labor supply by skill level would limit inferences even if there were a simple route.’
Similarly, Stern (1987, p 83), while exploring the relative efficiencies of various designs of tax systems for developing countries, writes, ‘We shall suggest that, although the theories provide valuable and important lessons for practical tax policy, they do not in general provide direct results on tax rates.’
Dahan and Strawczynski (2000, fn. 2) note, ‘In Mirrlees’ pioneering simulations, optimal marginal taxes decline with income. Since the shape was close to linearity, this point was stressed neither by Mirrlees nor by other authors citing his work.’
It is obvious that despite the mathematical sophistication and progress in economic knowledge, we are not any closer to answering the basic question: what should be the rate of progression in the income tax? Additionally, this is the situation despite the fact that the expenditure side of the budget is totally ignored in these explorations.
3. In recent years, the flat income tax has received some attention. For example, according to Browning and Browning (1994, p 378), ‘If AGI were the tax base, a rate of 13.3 per cent would suffice’ to collect the same revenue as the 1989 tax structure (USA) did.
Similarly, Hall and Rabushka (1995, p 52) claim, ‘The astonishingly low 19 per cent tax rate raises the same revenue as does the current tax system.’
4. Allan (1971, p 178) notes, ‘It is possible, therefore, to come to the same sort of policy conclusions by either the ‘benefit’ or the ‘ability’ argument. The rich paying more than the poor is clearly indicated by both approaches.’
5. Alm (1988) analyzes the impact of uncertain tax policies on individual work effort and savings. He distinguishes between two kinds of uncertainty: the tax base uncertainty and the tax rate uncertainty. With the income effect and the substitution effect working in opposite directions (in general therefore), it is not possible to assign a sign to the direction of change. He concludes, ‘Still, the results indicate that uncertain tax policies often have a negative effect on expected revenues; tax rate risk in particular always has this effect. At present, in these cases complaints about unpredictable government actions seem well founded. Not only are individuals made worse off by the randomness, but the government itself loses revenues.’
6. Parmar (1987, p 36) remarks, ‘The state in ancient India, at least in the Mauryan India, was, to use the language of modern political science, not unitary but federal and consisted of numerous principalities. However, it is difficult to ascertain the exact relationship that obtained between the imperial power and the provinces that comprised the empire. If federalism is taken to be a system in which the central authority exercises only a limited power over the authorities beneath it, Mauryan state was a federal one; for it did not exercise unlimited jurisdiction over states under it and was in fact a loose confederation of a conglomeration of different states.’
7. In a re
cent work, Oates (1999) remarks on fiscal federalism, ‘However, the choice of a system of governance involves other values as well: the extent of political participation, the protection of individual rights, and the development of various civic virtues.’
8. Since it assumes simultaneous moves by the merchant and the government. In fact, this could be set up as a sequential game in which government announces the policy first and the traders react to it. The tax authorities may choose the probability of detection, φ such that the trader decides not to cheat or the tax authorities may choose to audit a random sample (see Rasmusen 1994, Chapter 3 for a lucid exposition). Recently, Andreoni, Erard and Feinstein (1998) survey the models related to the ‘interaction between taxpayers and the tax authorities.’ They classify these models into two groups: (a) primarily principal-agent types in which tax authorities make commitment to audit and (b) truly game-theoretic ones in which tax authorities do not commit to auditing. Kautilya’s model may be classified as a principalagent type.
9. Dupuit-Laffer Curve: Atkinson (1987, p 392) notes, ‘The possibility that revenue may reach a maximum has been popularized among US Congressmen by Arthur B Laffer but has been well known for many years: for example, Jules Dupuit noted in 1844, “If a tax is gradually increased from zero up to the point where it becomes prohibitive, its yield is at first nil, then increases by small steps until it reaches a maximum, after which it gradually declines until it becomes zero again” (quoted in Arrow and Scitovsky, 1969, p 278).’
10. Drekmeier, Charles (1962, p 214) states, ‘Taxation policy in The Arthashastra and in the Manusmriti (as in the great body of theory culminating in the Shukranitisara) reflects the view that while the state has a right to the golden egg, the goose must be protected. Taxation should be gradual, increased only in times of emergency, and then only when rationalized to the people. It should be based on net profits instead of gross earnings, and an article should be taxed only once.’
11. Adam Smith (Book V, Ch II, p 350-351) listed four canons of Taxation: (1) equality, (2) certainty, (3) convenience of payment and (4) economy in collection. He (p 350) explained the canon of equality as: ‘The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. The expense of government to the individuals of a great nation, is like the expense of management to the joint tenants of a great estate, who are all obliged to contribute in proportion to their respective interests in the estate.’ Musgrave (1959, p 67) comments, ‘Smith thus shrewdly inserted an ability element into the weak link of the benefit rule. Thereby, reliance on the protection theory of state was tempered. The two approaches were joined in one, foreshadowing a similar solution in the modern version of the benefit doctrine.’ He (p 68) remarks, ‘Thus the subsistence theory of wages led Smith to progressive taxation at the lower end of the income scale.’ He (p 92) adds, ‘For Adam Smith, the reason is simply that ability to pay was considered only as an adjunct to the more basic benefit rule.’
CHAPTER -13 1. Table 1, which is based on able 2.4 in Sihag (1978, p 22) supports Kautilya’s intuition that many regions were affected by a drought.
Table 1: Interstate Correlations among output Levels
BR MP PB UP BR 1.00 0.71 0.50 0.68 MP 1.00 0.75 0.80 PB 1.00 0.83 UP 1.00
2. Ravallion concludes, ‘Economic analysis can help understand famines’ and he adds, ‘An effective but affordable (and hence sustainable) stabilization policy in famine-prone economies with poor infrastructure will probably combine buffer stocks and regulated trade.’
3. Toshihiro Ihori and Martin McGuire (2008, fn. 13) remark, ‘For individual protection and insurance, a hierarchal separation between protection and insurance decisions sounds implausible. The smoker anticipates lower life insurance rates when he quits smoking. He may think of buying more insurance at the lower rates as well. But to impute this sort of foresight to a government, however, is not at all obvious. Thus our “complete information” case might be regarded as ideal, even utopian.” Apparently they ignore the most important role of foresightedness by confining their analysis to a single period. Since no one can build buffer stocks during a drought and similarly it takes time to build irrigation facilities.
4. Ravallion (1997) remarks, ‘Famines do not lend themselves to easy prediction.’
CHAPTER -14 1. Adam Smith and Laissez Faire: Historically, Adam Smith has been hailed as a harbinger of unfettered free trade. However, in recent years, that view has been challenged. The change in tone may be captured by the following comments by a few writers during the last four decades. Letiche (1960, p 70) asserts, ‘Smith was not a doctrinaire advocate of laissez faire. He recommended at least four major programs of reform: the removal of impediments to free choice of occupation; to free trade in land; to internal free trade; and to free trade in foreign commerce. Moreover, he recognized the need for government activity in such fields as public education and hygiene, public works, regulation of currency and coinage, progressive (in effect, proportional) taxation, patents, copyrights, and even moderate export and import taxes for the purpose of revenue and development.’
Tribe (1999, fn., 49) remarks, ‘For example, Smith did not employ terms “free trade” or “laissez-faire”, although he would have known of their use by others.’
Grampp observes that ‘In the extended debate from 1815 to 1846, over the British Corn Laws, the protectionists cited Smith’s statement that there should be a duty on an imported good that competed with a domestically produced good subject to a tax.’ He adds, ‘He expressly said domestic “industry necessary for the defense of the country” should be “encouraged”. Domestic trade is superior to foreign because domestic trade gives twice the encouragement to industry that trade gives and also receives its returns more quickly (p 463, 377-78, 426, 368)’ He points out that ‘In the Wealth of Nations and in the Lectures on Jurisprudence there are (depending on how finely one makes distinctions) some 35 or 40 measures of government intervention of which Smith approved or which he advocated. They are of five kinds. The fourth restricts foreign trade, and the most important measures are those that contribute to defense.’
The comments from Grampp clearly cast doubt on Adam Smith’s historical image. Since he did favour domestic industry over imports. Perhaps, Adam Smith went too far in attacking the Mercantilists on their obsession with trade surplus and wanted to change the focus towards domestic production.
2. Cooper (1977, Vol 26, p 910-916) describes the nature of international trade in ancient times. He observes, ‘Early trade was attended by large risks—both natural risks such as storms and human risks such as piracy and brigandage—and was hampered by poor transport. Because of risks, trade was limited to easily transportable, high-value products. Trade was based largely on goods derived from natural advantages—the presence of desirable natural resources such as tin, gold, amber, or ebony—but occasionally also on the products of special technology and unique skills, as in the case of Egyptian glass beads and cloth dyed with the famous Tyrean purple.’
3. Kautilya suggested a mix of riskless and risky products: He emphasized the principle of diversification by requiring a combination of risky high value products and riskless low value goods. He classified products into two groups: the low value ones, which were safe to transport (also might have been because of their bulkiness and heaviness) and the high value ones, which were potential targets of bandits and therefore risky to transport (probably these were very light and not bulky). Therefore, Kautilya proposed a mixing of low value products and high value products. The figure (14.1) may be used to express Kautilya’s ideas.
Figure 14.1: LH is the efficiency frontier. Point L indicates a point of no risk and low return for low value products and point H represents the return and risk combination for high value products. It should be noted that these are the only points and not a Markowitz-Sharp
e kind of smooth efficiency frontier as such. Kautilya suggested the selection of a point E, which indicated the portfolio-mix consisting of 75 percent of low value products and 25 percent of high value products. Kautilya did separate the decision regarding the choice of the portfolio-mix from the determination of the total size of the caravan. However, it is not claimed that he was aware of the separation theorem.
4. Caves, Frankel and Jones (2002) believe if the trade is based on ‘natural advantages’ then there is not much to be explained and definitely the services of an economist are not needed. They (p 13) assert, ‘Some trade patterns need little explanation. If you live in the United States and like coffee, you have your coffee imported from Brazil or some other coffee-growing country because it is not produced at home.’ They add, ‘There would be little need for the economist either to expound on the virtues of trade or to explain trade patterns. These would be almost self-evident.’
5. Kautilya explicitly considered two countries and two commodities. Let P
F
x and PF be the respective prices of products X and Y in a foreign y
country and P
H H x and Py are their respective prices in the home country. The home country should export say product X only if after paying transport cost and security expenses for passage, C, and tariffs and gratuity to the king, T, can get more of product Y in exchange in the foreign country than could have gotten at home. Also, the phrase ‘the price likely to be realized’ indicates his concern for price uncertainty. Let Z captures the risk element in the price. According to him, a country should engage in trade if it is beneficial to do so, that is, a country should export product X and import product Y only if
Kautilya- the True Founder of Economics Page 40
