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Rooting out perverse incentives in GST

Hasmukh Adhia Masterclass

Muscular tactics are paying-off in the Income Tax system. The number of assesses went up by an astounding 25 percent from 37 million in March 2016 to 46 million, by March 2017 and to 63 million by mid-July 2017. The linking of Aadhar-PAN card to bank accounts; the campaign against cash and now the GST, together create desirable institutional incentives for individuals and business to bank their transactions. This provides the “push” factor for enlarging the income tax base of potential assesses.

Transformative GST  

The GST is even better designed to provide desirable incentives for enlarging the indirect tax base. Unlike, Income Tax where “push” factors compel assesses to pay tax on the income revealed via bank transactions, the GST uniquely also has “pull” factors for better tax compliance. The biggest being the facility to set-off GST paid on purchases against GST payable on sale, which reduces the net tax payable. This induces both buyers and sellers to bank their transactions – which is also good for income tax collections.

Transformative, as the GST is, glitches have inadvertently crept in, which go against the grain of positive incentives to prefer banked to cash transactions; increase value addition and boost tax revenues.

But design glitches remain

One such, relates to small service providers with annual revenues of up to Rs 2 million. Those providing services within the state are exempt from both registration and payment of GST up to this limit. But the moment they provide a service across the state borders or to a client abroad, they are compelled to get a GST registration; submit the mandatory three returns per month and much worse, pay GST on their entire revenue stream.

Killing the small cross-border service provider

Individual IT professionals writing code or designing websites routinely get contracted over the internet to provide services to overseas clients or to clients across state borders. Each contract may be as low as Rs 20,000. But all these professionals will need to get registered and incur the transaction cost on submitting monthly GST returns. For these small service providers, the price points are highly competitive. It is unlikely that clients will be willing to part with the 18 percent GST for out of state providers. They will be pushed to get registered and pay the GST themselves or absorb the tax in the price they charge with the GST paid on the purchase by the client.

The net result will be that out- of-state small service providers will become uncompetitive and may stop seeking work outside their states, reducing competition. GST which was meant to create a Pan Indian national market will instead, end up creating intra-state silos for small service providers.

The negative impact is fiscally marginal but it rankles

This design flaw will also impact income tax revenue. Service providers whose annual billing reaches Rs 1.6 million within a state, will refuse out-of-state work of less than Rs 0.5 million because, by increasing their out-of-state billing by up to Rs 0.4 million they end up paying the entire incremental amount as GST.

If 2 million small service providers, ranging from civil contractors, designers to business consultants, refuse additional work due to this reason, the government loses Rs 18 billion as income tax. This calculation assumes a tax rate of 20 percent and the underlying taxable income lost at one half of the amount of work refused.

Protection for local service providers breeds inefficiency

The “infant industry” proposition can be used to justify discouraging cross border services and thereby encouraging small local service providers to ramp up their capacity and fill the gap. This may well be true. But it rankles against the pan-Indian tax framework objective of promoting efficiency and competition. It is also, against the logic of digital India which is meant to enable seamless work across state and international borders.

Whence the pan-Indian market and digital India?

Admittedly lost income tax revenue of Rs 18 billion is small change, in an income tax kitty of around Rs 4 trillion. But it is personally frustrating for small service providers who can see the cross-border opportunity to expand their business but are blocked by the “deadweight” amount of Rs 0.4 million of billing, which equals the GST they would pay by increasing their billing to Rs 2 million, if some part of it coming from cross border contracts.

Have a common GST exemption limit irrespective of location of the client

Is there a way of getting away from this flawed design? Yes, there is. The first option is to extend a common GST exemption limit to all service provision, irrespective of whether it is within state, across state borders or overseas. This immediately removes the “deadweight” of GST becoming payable, the moment a cross border transaction, no matter how small, is made.

Tax only the incremental revenue above the GST exemption limit

However, this still leaves the problem of expanding billing above Rs 2 million and thereby losing the exemption from GST on the initial Rs 2 million. Adopting the principle of taxing only the incremental amount, as used in the Income Tax, can effectively avoid the perverse incentive for opting for cash based transactions to avoid losing the tax exemption above a billing of Rs 2 million, till billing expands substantially beyond Rs 2.4 million, at which point it would neutralize the additional GST paid and yield a net income increase for the supplier.

Harmonise tax exemptions under IT and GST to reduce reduce the compliance cost 

The best option is to harmonize the exemption limits under GST and income tax. The current income tax regime presumes taxable income at 50 percent of billing, unless shown otherwise. A billing of Rs 0.5 million corresponds to a net taxable income of Rs 0.25 million which is also the maximum limit for income exempt from income tax. Hence the exemption limit for GST could be reduced to Rs 0.5 million from the existing limit of Rs 2 million. But rolling back exemptions is tough. Alternatively, the exemption limit in Income Tax could be increased to Rs 1 million. Enhancing the income tax exemption limit is the preferred option.

The number of income tax assesses increased by 25 percent in 2016-17 over the previous year. In comparison the revenue from Income Tax increased by 18.4 percent. Tax yields are lagging increase in assesses. Efficient tax collection practices would point towards focusing on high value targets rather than cluttering up the system with marginal yield assesses until tax filing systems are vastly more simplified and easy to follow for the average citizen.

This article is also available at http://blogs.timesofindia.indiatimes.com/opinion-india/end-perverse-incentives-for-small-service-providers-in-gst/

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Digital connectedness, Economy, India, Tax

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Book Review

 

parag-khanna

Connectography: Mapping the Global Network Revolution, Parag Khanna, Weidenfeld and Nicolson, 2016

In the 1980s, Disney World, Florida offered a gripping, virtual journey as viewed by a blood corpuscle as it rushes through the arteries, veins, into and out of organs in the human body. Parag Khanna’s fourth and latest book –Connectography: Mapping the Global Network Revolution – does much the same for the world of physical and digital infrastructure -roads, railway tracks, power lines, communication cables, oceans, rivers, canals and electrons joining suppliers to customers, uniting families physically and virtually, whilst creating ever widening value enhancing networks around mega cities.

In this world, national borders are little more than irritants; national sovereignty a barrier to be overcome; national passports a poor substitute for global identity options and the ownership of land valueless, unless it is part of global supply chains.

Global citizen

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Parag is a self-confessed global citizen. He was born in India, grew up in the United Arab Emirates, studied in the US, works in Singapore but feels at home anywhere – chatting with Chinese workers in Tibet, Turkish Gastarbeiters in Germany or breakfasting with the President of Mongolia in Ulan Bator. There are around 300 million others like him. This book describes the way the world could be from the view point of global citizens. A world without borders or intrusive governments; self-regulating businesses kept customer friendly by competition; open markets allowing capital and goods to move freely, perpetually in search of optimizing costs and maximizing value.

Open economy

The virtues of the “open economy, networked” universe are generally accepted today, even if most peoples’ view on markets is similar to their opinion of democracy – not the best option but better than anything else available.

Parag hammers away at re-establishing these generic concepts with relentlessly energy via a high octane delivery, interspersed with a wealth of granular information to buttress his argument. It helps that the book is extensively researched. Its bibliography lists nearly 500 references and almost each page has a quotable quote. An added attraction is the 38 color plates which illustrate what connectography could look like. Maps or traditional cartography which represent geographical or political features, actually tell us very little about the world. These are of little use beyond being partial navigational aids. Consider that Singapore is a mere dot on the world map with just 0.1 percent of the world’s population. But if countries were mapped to scale on the size of their GDP, it would be twice the size of Bangladesh. Does Singapore’s land size or population determine its function in the world today or its economic heft?

Connectivity is key

The book is divided into five parts. Part one dwells on the truism that connectivity and not territory or resource endowments, are the arbiter of how nations grow. In a riposte to the reasons listed by Paul Collier of why nations fail, Parag argues, that countries can overcome the disadvantage of poor geophysical endowments. There is hope even for land locked nations, like Rwanda. Despite being resource poor, it is one of the fastest growing economies, in Africa, because it actively searches out opportunities for becoming part of global supply chains.

The withering Nation State

Part two posits controversially, that the nation state is an artificial construct whose longevity is explained by inertia rather than any irreplaceable value addition ascribable to it. This is especially true in nation states which spend much time and effort to reconcile mutually antagonistic and parochial domestic stakeholder identities. Far better then, to devolve power away to homogenous, smaller sub entities – tribes, communities, companies and cities which, in any case, are the basic framework for solidarity and common interest.

The recent splintered vote in Britain, with London, Scotland and Northern Ireland voting to remain in the European Union whilst the rest of the country voted to exit, seems to illustrate the inherent fragility of nation states in the face of sharp internal divisions based on self-interest. The nation state is similarly powerless against the loss of sovereignty to larger regional aggregations- earlier the United Nations, cold war alignments and now regional trading blocks. Better connectedness and communications fosters this trend towards aggregation, driven by Metcalfe’s law that the value of a network increases proportionately to the square of the number of interconnected users. Scale is everything.

Sub- national entities are stable

Part three asserts that a future world of connected sub-national entities aggregated into large regional entities, is a more stable and competitive arrangement than the present geopolitical architecture. Sovereign nations seem besieged by split mandates and dissidence at home whilst simultaneously assaulted by external threats. Competitive connectivity trumps national sovereignty. There is no incentive for destabilizing any actor because all are connected for mutual gain. In comparison, Orwellian instability is built into the DNA of competing nation states.

Snap shot of a connected future

Part four fleshes out the future as a landscape of connected megacities. Multinational businesses will be replicas of the Dutch 19th century colonial empire – a web of small enclaves – business hubs for a global supply chain. The nodes of growth would be the four thousand Special Export or Economic Zones, which dot the world today and are also the foundation of China’s extraordinary economic growth.

….and everything else

Part five is mixed fare – an overview of current issues in the digital economy; the genetic transformation resulting from human cross breeding inherent in the physical movement of more people across the globe than ever before- provocatively titled “a mongrel civilization”- and how to best deal with the competing needs of conserving nature and welfare enhancing growth.

For resilient readers only

This is not a book for the faint hearted. The style varies from the explanatory; the exhortatory to being chattily conversational. Some parts are too dense for a lazy afternoon’s read. Others, particularly where the author links his own experiences to more generic issues are lucid and revealing. Editing is unfortunately, lackluster. Rwanda is not a country which is natural resource rich as claimed on page 94; the lead paragraph on page 337 under the attractive title “The digital identity buffet” is an incomprehensible, single sentence of seventy-one words! Deng Xiaoping’s reforms kicked in during the 1980’s in China, not the 1970s as page 380 claims.

Read this book if you are interested in knowing more about the intersections between globalization, geopolitics, business, technology, urbanization and culture. If you are looking for deep knowledge in any one of these areas, you are likely to be disappointed. If you are looking for a new theory of development or growth, it isn’t here. What you do have is masses of information brought together anecdotally in a narrative format.

This is a tour de force of contemporary world trends with attractive, self-explanatory titles to each of the seventy-eight sub chapters. Each of these is self-contained so you don’t have to read the book sequentially. And don’t miss the quotable quotes. My favorite is “a smart rabbit keeps three holes to hide in” to explain why large numbers of Chinese citizens invest in the US or Canada as a safe haven option.

If you are looking for advice on very long term business investments, check out the heat map on plate 31. Be warned, India, China, Africa, Southern Europe, the US and South America may all be deserts by 2100 dried out by the ravages of climate change – unlivable but good for generating solar power. Think instead of investing in Canada, Greenland, Northern Europe, Russia and Western Antarctica, where the climate is expected to be salubrious and the resources plentiful for the depleted population which manages to emigrate there.

This book review by the author first appeared in Swarajyamag, August 2016 http://swarajyamag.com/

 

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Book Review, Digital connectedness, Economy, India, Infrastructure, Space

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