governance, political economy, institutional development and economic regulation

Archive for the ‘Tax’ Category

Fix the “market” for political power

Indian army

Citizens expect governments to intervene when the markets fail. The market for Diplomacy failed last month at Doklam. If the Chinese Army is to be stopped well north of the tri-junction between India, Bhutan and Tibet/China, then only the Indian forces, funded by taxes, can do the job. This is a satisfactory arrangement for all Indian and Bhutanese citizens, who otherwise may be hard-pressed to secure their territory.

When State failure fails to fix the underlying market failure

But not all government actions have an obvious rationale. Demonetisation was unleashed in November 2016 to end black money. Few believe that this objective has been achieved. Black money is not an outcome of market failure. It is an outcome of governmental failure to tax income effectively; control corruption or control crime. Poor governance only encourages the generation of black money, which then requires another intervention to root out black money. Economist Shanta Devarajan of the World Bank, in New Delhi last week for the NCAER annual India Policy Forum <http://www.ncaer.org/event_details.php?EID=184>  believes such iterative interventions are ineffective in improving the quality of governance, and can reduce the legitimacy of governments. Far better instead to rethink how to deal with the underlying market failure – in this case the “market” for political power.

Poor tax administration

So why do governments tax ineffectively? Most commonly, multiple objectives in the tax policy are to blame. The sale of loose groundnuts — the ordinary person’s food — may be tax-free but packed groundnuts, even if unprocessed, are taxed. This creates a five per cent tax differential for arbitrage between the two categories, which are difficult to administer separately. A single rate of tax levied on a non-evadable tax base is the most effective. But consider that this would be akin to the colonial “poll or head tax” — levied on each person uniformly. Effective, but terribly inequitable.

The killer “app” for instant equity – Universal Basic Income- how effective?

Admittedly, mechanisms like transfer of a basic income to the poor can neutralise such an inequity. But transfer of a similar amount of cash, to each poor person, itself creates huge inequities, even among the 40 per cent population vulnerable to poverty. Transferring differential amounts, depending on need, attracts the same inefficiencies as trying to administer progressive tax rates fairly.

The big 2Cs – Corruption and Crime

Why is corruption or crime so hard to control in India? If citizens feel that political power can be acquired by subverting the “popular” vote, it reduces their faith in the power of their vote. It also delegitimises the government and undermines its ability to rule, in the eyes of those who voted against the government. Bihar faced this conundrum for two decades.

It does not help that, in India, governments can be formed even with a minority of the total votes cast in elections, so long as each elected member of the ruling party gets more votes than the next candidate. This first-past-the-post system fractionalises politics. It encourages parties to form coalition governments, which are unable to discipline errant behaviour by their constituents. This “coalition dharma” fosters crime and corruption.

Are laws aligned with context?

An alternative explanation for pervasive crime or corruption is that laws are out of sync with local customs. And not enough has been done to change social behaviour beyond legislating transformative rights and duties. Ending open defecation — a prime driver to reduce the vulnerability of women to crime — is one such example. The benefits from ending open defecation are dependent on collective action. One reason why we did not do more earlier could be that the political incentives are perverse. They favour exaggerating, rather than bridging, the social cleavages of caste and religion, which inhibit collective, progressive decision making.

Feudal governance patterns breed poor accountability

Low public accountability and lackadaisical collective action can also be traced to the continuation of feudal traditions of governance and poorly distributed income growth. Richer citizens are more resilient to State encroachment of their rights and less dependent on State largesse. Luckily, over the past three decades, we have become less poor, better educated and more aware of our rights versus the State.

But the extent of inequality remains significant as does the infrastructure deficit across rich and poor areas. The privileged crust is thinner than a hand-tossed Neapolitan pizza — possibly just 10 per cent of the population. The rest seethe in forlorn frustration. Can we get away from this low-level equilibrium? Yes, we can by fixing the market for political power.

End the perverse incentives in our political architecture 

Our political architecture is riddled with perverse incentives which  constrain the will to reform. Here are four changes which are overdue – deepening decentralisation; enhancing state government autonomy; enhancing the representativeness of the legislatures and regulating political parties better.

First, bridge the trust deficit and distance between citizens and the State. Empower state governments versus the Union government and local government versus state governments. Hopefully, the 15th Finance Commission will carry forward the trend of forcing the Centre to devolve functions and Central taxes to states and directly to local governments based on performance criteria.

Second, cut the colonial fat; abolish the titular but unedifying position of state governors. These are unelected nominees of the Union government exercising oversight over elected state governments. Transfer this role to the President, who is elected. This will level the playing field between states and the Centre versus the presidency.

Third, make Parliament and state Assemblies more representative. Sharply reduce the size of constituencies. Only directly-elected members should be eligible to become Prime Minister or chief minister. A candidate should be able to contest an election for only one seat at a time. The winner must secure a simple majority of the available votes and two-thirds of the votes cast. Municipalities must be headed by elected mayors.

Fourth, the functioning and finances of recognised political parties must be made transparent. Inner-party elections must conform to common but effective guidelines. The Election Commission must be empowered to determine constituency boundaries and diversified beyond the administration, to include citizen representatives and the judiciary with the chief election commissioner chosen specifically.

Use the GST process of risk-free consensual decision making

GST became a reality as a process of cooperative federalism was followed led by the finance minister. Reforming the market for political power could benefit from a similar approach.

Adapted from the author’s article in The Asian Age, July 19, 2017 http://www.asianage.com/opinion/columnists/190717/power-structure-needs-reform.html

Can GST make Hasmukh Adhia smile?

Hasmukh

Hasmukh Adhia, India’s revenue secretary, is finance minister Arun Jaitley’s chief aide for rolling out the Goods and Services Tax. Contrary to his first name, he never smiles, at least not in public. But even he can now take a break and smile. The GST juggernaut is careening ahead. In just over a week, India would have leapfrogged into the league of economies which have walked the talk on rationalising indirect taxes.

Noose tightens on black money generation

card pay

Photo credit: Imagesbazar.com

So what will Mr Jaitley and the GST Council have achieved on July 1, 2017? First, this collegial team of finance ministers, across the Central and state governments, would have fired the first, potent salvo against black money. Demonetisation; tax raids; getting back overseas black money caches — all pale in significance, compared to the institutional impact of GST. Consider, that the most vocal protests against GST have come from dry fruit traders, cloth merchants and jewellery makers. These businesses have been traditionally cash heavy. Of course, the intrepid evader will still have tax leak holes left open. Agriculture, food items and the business in booze remain yawning gaps in the tax revenue security architecture. But the message is loud and clear: the rope is shortening. So watch out!

Lower net indirect tax, lower prices to spur demand

shopping

Photo credit: Imagesbazar.com 

Second, the massive discounts being offered on pre-GST clearance of the stock of consumer durables suggests that prices of these goods will reduce. An entity, empowered to investigate and ensure that net tax reduction benefits are passed on by manufacturers and dealers to consumers, is in the offing. The history of such clunky, intrusive executive action is not encouraging. Due to information asymmetry, determining the cost breakdown of products externally, is invariably inefficient. Either the enforcement agents get compromised or they end up harassing manufacturers and suppliers for trifling results.

But in truth, it really doesn’t matter. Inflation levels are at historic lows — below three per cent per annum; the monsoon is progressing well and global demand remains damp. Babus and their counterparts in the public sector — around 18 million households — have all either been given or will soon get pay revisions. They are itching to spend the windfall.

Clunky “inspector raj” to check price rise – a bad idea

Even if the entire tax rationalisation bonanza is retained by manufacturers and dealers, it will still generate surpluses for private investment — in debt servicing, realty and equity markets. Improving the revenue steam of corporate India is vital for getting over the gargantuan NPA problem, which is bad cholesterol for growth. The good news is that most product markets are competitive. Digital marketers have cut retail margins to the bone. Even the market for services is hyper competitive — think telecom. This makes it tough for corporates to retain extra normal profits.

SMEs & Trade pay the price for becoming accountable – high compliance cost

Also, undeniably, tax rationalisation has come at a cost. The actual transaction cost, for business, to comply with digital GST processes is unknown. But GST provides a huge opportunity to India’s IT developers to innovate low-cost compliance and oversight options — particularly for value segments produced by small and medium industries. These could be perfected at home and marketed worldwide as context-specific solutions for developing countries. In 2013, at a conference in Washington, the World Bank president asked Nandan Nilekani why he wasn’t rolling out Aadhaar across the globe? Mr Nilekani responded that he was too busy at home and had no time left for solving the problems of the world. This single statement projected India’s enormous domestic, digital market potential far better than the glossies, which international consultants and governments routinely produce touting themselves. These digital opportunities have multiplied by several degrees with GST.

Multiple rates align with multiple objectives 

Third, the agreed-upon somewhat clunky architecture for GST reflects compromises made to achieve the twin overriding concerns — protecting the poor and ensuring fiscal neutrality for all governments. In the absence of a direct cash transfer framework, continuing tax exemptions on mass consumption goods and services is a reasonable policy option. Given the federal structure and the plurality of our polity, there never was an option to the consensual approach adopted by the GST Council. Meeting the revenue concerns of state governments has inevitably led to six GST rates. The highest rate of 28 per cent is designed to be used for neutralising any revenue loss for state governments.

Multiple rates result in efficiency loss due to tax leakage from misclassification of goods to a lower tax rate. A good example is the amorphous classification of a storage battery as a computer peripheral (lower tax rate) versus use for backup lighting needs (higher tax rate). Multiple rates also increase the accounting load for keeping track of tax credits and debits. But the economic benefits from early implementation of a less than perfect solution far outweigh the opportunity lost from a prolonged wait for the BJP to come to power in all the states, thereby enabling a best practice single rate template to be imposed from above, China style.

Fourth, GST is good for jobs. It gives a boost to “Make in India” by withdrawing the tax advantage for imported manufacturers. Importers pay Central state tax at four per cent as special additional customs duty. But domestic products are taxed at the rates of state sales tax, which are generally higher. This disadvantage for domestic production will vanish with GST. Imports, in addition to customs duty, will pay additional customs duty at the GST rate applicable for domestic products.

Flexible implementation arrangements – to muddle through the knots

Finally, the finance minister has consistently adopted a firm but nuanced, practical stance on the implementation schedule. Recognising that small-scale industry and traders are lagging in preparations, he has agreed to defer the filing of returns by two months. Assurances have also been given that the GST rates could be adjusted if the net tax burden gets distorted or gets unbearable. A government that is open to negotiating beneficial outcomes for all stakeholders and still retains the will to keep the national interest foremost is quite clearly operating at the tax-related good governance frontier. Smile, please.

Adapted from the author’s article in the Asian Age , June 23, 2017 http://www.asianage.com/opinion/columnists/230617/its-time-to-smile-gst-to-usher-in-a-new-era.html

Jaitley black money

Tag Cloud

%d bloggers like this: