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Searching Roots of Modern Economics from Kautilya’s Arthashastra

Updated: Sep 7, 2022

The western history of economic thought seems to be doing injustice to Kautilya - a great Indian philosopher and statesman by denying him the place of the originator of economics. Western economic thought recognized the role of Mercantilists (15th century to 18th century) and Physiocrats (17th century to 18th century) in economics and accepted Adam Smith as the father of modern economics. The Kautilya’s Arthastra, supposed to be written in the 4th century BC, explains many concepts of economics and talks about many economic policies which are used not only in India but in many western worlds at present time.

Kautilya emphasized fiscal prudence for addressing economic, political and administrative problems and maintenance of the social order and for the state-run welfare-oriented schemes by giving importance to the two broad objectives: how to maximize the revenue of the state and how to utilize optimally the state revenue.

Kautilya’s main principles of taxation can be briefly summarized as follows:

Firstly, he suggested tax rate-1/6th is based on the combination of the ability to pay and benefit principle. Kautilya argued that the tax rate should be neither less than nor more than 1/6th as it reduces state tax revenue. Kautilya’s this principle is a predecessor of the Dupuit- Lafer curve(this inverted U curve shows that tax revenue is less in both situations of less than 1/6th or more than this). Interestingly, many European countries are following this tax rate suggested by Kautilya, 2400 years ago. This marginal tax rate is also an anticipation of the present-day Linear Income tax System. Kautilya suggested the collection of tax when it is due, i.e., after the harvest of crops. The hallmark of Kautilya's tax structure reflects the present day principle of certainty-of time, of rate and mode of payment. He advised higher tax rate (upto 50%) on bad goods, like, present higher tax rate on cigarettes, liquor, etc.   Kautilya suggested such a tax structure that maximizes net tax revenue. The tax was collected from agriculture, singers, dancers, prostitutes, fortified towns, mines, irrigation works, forest and trade routes. There is no income tax on the salaries of state employees. There is the stability of the tax structure and fiscal federalism envisaged in the Arthashastra. The state maintained the database that enabled the king to assess the taxable capacity of the subjects. Kautilyabelieved in compliance as an integral component of the tax system. He was aware of the difficulty in collecting taxes. However, there is a full enforcement system to check tax evasion in the Arthashastra.

Second, there are very comprehensive explanations of factors of production and fixation of their rewards.

(i) Kautilya was aware of monopoly elements and hence he suggested the entrepreneurial rewards should be the profit limits of 5 to 10 percent. Kautilyasuggested twice (10%) profits on imports as compared to domestic goods (5%).  Kautilya was aware of the comparative advantages from international trade like classical and modern economists of international trade.

(ii) Kautilya suggested charging interests on loans. He argued that the rate of interest should be determined by two forces the risk involved in the project for which capital borrowed and the productivity of the capital. Interestingly, Kuautilya exempted following classes, students and those who are unable to pay, from charging interest.  

(iii)Kautilya suggested that 3/4th of tax revenue must be available as capital formation and should be used for productive activities. Only, 1/4th of the state revenue should be used as a salary bill. The Punjab government should learn a lesson from Kautilya. For the welfare of the state, the treasury should spare three fourth of the tax revenue as a capital formation and use this capital formation for the improvement of education, health and other important social and economic infrastructure projects.            

To sum up, it can be seen from the above analysis that Kautilya was no Machiavelli; he’s the most eminent economist.

By- Dr. Anupam Sabharwal

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