governance, political economy, institutional development and economic regulation

Posts tagged ‘demonitisation’

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

Budget 2017 – say what you mean

professor

Some pictures may be worth a thousand words. But when the two are put together, as in a video, they evoke deep emotions and convey subliminal messages. Watch the master of the spoken word — Barack Obama, in his January 2016 address on the mundane subject of gun control in the United States and you will see what I mean. It is unfortunate, that despite the best talent in branding and outreach we fail to use words which convey our intent unambiguously.

Poor namkaran begets poor results

Consider the name of the government department, which is supposed to privatise the public sector. It was created in 1999 under the BJP-led NDA regime and helmed by finance minister Arun Jaitley. Even way back then, it was clear it would not take root. Mandated to raise capital through privatisation — it ended up being named, hypocritically, the department of disinvestment. “Divestment” would have been more proximate to the intent. But the fuzzy name, matched the lack of sustained resolve for a big-bang approach to privatising the public sector. It muddled along till, mysteriously, in April 2016, it was cumbersomely renamed as the department of investment and public asset management (DIPAM). It does nothing of the sort. Its core mandate remains to sell the industrial Central public sector. Public sector investment and asset management continue to be the mandate of every line ministry, for the state-owned enterprises (SOE) under them. No wonder then that the Central public sector not only lingers but grows.

In 2015, there were 235 operating SOEs. But an additional 63 were coming online. One-third of the operational SOE made a loss of Rs 27,000 crore in 2015. The data for 2016 is yet to be publicly shared. But there are unlikely to be surprises here. Named badly at birth, the department lingers on much like the loss-making SOEs.

Clever acronyms can mislead

bhim

Consider also the new government-sponsored payments app named Bharat Interface for Money (BHIM) created by the National Payments Corporation. The app was ostensibly named after Babasaheb Bhimrao Ambedkar — the learned dalit leader and constitutionalist. A payments app named after Babasaheb is quaint just as launching a human rights initiative in his name would resonate. The app is more likely to be associated with the brute power of the legendary Bhim from the Mahabharat conveying that the app is safe and impregnable. Yes, security is one important feature of an app. But it must also be nimble, adaptable, scalable, efficient and convenient to use. Bhim of the Mahabharat was none of these. Legend has it he was pretty resource-intensive — gobbling up nearly as much as all his four other siblings and was difficult to discipline, much like an invincible Robocop. “Killer app” is how kids term an outstanding app. But slang shouldn’t be taken literally to name government initiatives.

Words without momentum

modi-troubled

Prime Minister Narendra Modi, in his New Year’s Eve address to the nation, fell into the same rhetorical trap of belting out a preachy sermon but chose the wrong words. He stressed purity, pain and renunciation as key processes for exorcising evil — in this case black money and corruption-fed terrorism, Naxalism and Maoism.

Left unanswered was who should feel the pain more and make sacrifices — the honest many or the dishonest few? Also, conflating Maoism and Naxalism with terrorism, drugs and loss of human rights is okay if you are a right-wing, conservative American. But in India, these misguided socio-economic movements are the consequences of state failure in providing a basic level of welfare to the poorest of the poor. One cannot simultaneously romance the poor for their virtues — fortitude and honesty; finger the rich for their vices — dishonesty in evading tax, wallowing in luxury in big city bungalows — and yet denounce social movements which seek to give voice to the marginalised, however unpalatable their senseless violence may be.

BJP – get your mojo back

The BJP came to power in 2014 as the voice of reform and growth. It has traditionally been private sector-friendly. This resonated with an India fed up with populism and ersatz socialism, unemployment, poverty and a low quality of life. Touting the cause of the poor by pulling down the rich was never meant to be the BJP’s trademark. The Communist parties and the Congress fight from that shrinking corner of the electoral base. The poor versus rich genie will now be difficult to put back into the bottle. This will be particularly so if growth disappoints and economic stability suffers — both of which are near-term probabilities.

A strong government can trample over many citizens’ rights so long as it can stuff the mouth of citizens with money — as in China. But no money, no jobs and no rights are the fertile grounds on which violence, Naxalism and Maoism thrive.

Keep the narrative simple, not simplistic

Multiple objectives in public governance are a recipe for disaster. One hopes that in the waning days of this fiscal the government will shed some of the fluff it has accumulated. Focusing on infrastructure, macro-stability and private sector-led growth is the only option for creating sustainable jobs and reducing poverty. If an all-out fight against corruption is a must, because of electoral promises, let it begin where corruption breeds. This is in the public and not in the private sector.

A trishul for action

trishul

Three initiatives are overdue. First, make the funding of political parties open to public scrutiny. This is a far more important political reform than having simultaneous elections. Second, exorcise the public sector of corruption before terrorising the private sector. The bribe-giver is the victim of an unresponsive governance system. It is the bribe-taker who is delinquent. It is public sector banks, public service departments, the police and the lower judiciary which need to be “purified”, not the voting public. Third, restore the credibility of regulatory institutions by respecting Chinese walls purposefully built between them and the government. The Reserve Bank of India seems to be the latest victim of executive activism in the demonetisation snafu. Let’s ring the curtain down on disruptive, executive muscularity.

Adapted from the author’s article in Asian Age January 11, 2017 http://www.asianage.com/opinion/columnists/110117/to-create-new-india-3-initiatives-overdue.html

Fiscal love for job loss

unemployed

Times are tough. Exports are in free fall. The import bill is increasing as oil prices harden in response to the international oil cartel’s plans to cut production. Domestic demand is moribund despite the largesse of the Seventh Pay Commission for the public sector. The stock market has sagged. Informal sector jobs are under threat. We need a push to get people over this sullen hump.

Electoral compulsions

Four states, comprising one-fifth of the nation’s population, are about to elect provincial legislatures in the first quarter of 2017. From a national perspective, the BJP has little to lose but much to gain. Goa, that is ruled by the BJP, elects just two MPs; Punjab, ruled by ally Shiromani Akali Dal, elects 12; while Uttarakhand, ruled by the Congress, elects five MPs — which together account for a mere four per cent of the 542 seats in the Lok Sabha.

It is Uttar Pradesh, ruled by the Samajwadi Party, which is the real prize. It elects 80 MPs (just under 15 per cent of total seats) to the Lok Sabha. Varanasi is the Prime Minister’s adopted constituency. This is the Hindu heartland of India. A wipeout in UP may not directly impact the BJPs prospects irretrievably in the 2019 general election. But a win would surely be a grand start to the campaign.

Finance Minister as fire fighter

Finance minister Arun Jaitley seems eager to salve those burnt by “notebandi”. He may offer some tax relief in the coming Budget, but that helps only a tiny sliver of the population — just two per cent who pay income-tax. Lower indirect taxes are hostage to progress on the Goods and Services Tax (GST). But a GST with multiple rates, and with the highest nominal rate at 28 per cent, is unlikely to reduce the incidence of indirect tax or drive growth in GDP.

The FM had budgeted a nominal GDP of Rs 151 trillion for this fiscal, 11 per cent higher than the nominal GDP last fiscal. This is now unlikely for two reasons. First, growth in real terms will slip by between one to two percentage points. Second, inflation is lower by one percentage point. Taken together the nominal GDP increase will be eight, not 11 per cent, over last year. Tax estimates are based on “nominal” GDP — real growth plus inflation. So, tax collection at 10.8 per cent of GDP will also slip by about Rs 0.4 trillion from the budgeted amount of Rs 16.3 trillion. There is little headroom in this fiscal to play with tax reduction.

Even in the next fiscal, with significant economic headwinds and domestic uncertainties, the prospects for a revival in growth is wishful thinking. Tax reform with lower taxes seems a far cry. A temporary income support mechanism is more appropriate.

The losers 

The population segment most affected by demonetisation is domestic migrant labour and their families in villages. Urban migrants live on and save from what they earn daily. Over a period of six months, the income shock will feed back into their families in villages as income transfers decrease or vanish and migrant labour return home.

The FM must provide a “package” to soften the hard landing at home for returning migrant labour. This is urgent. Migrant labour are highly aspirational, having seen the “good life” available in cities. Their aspirations must not be squashed. Of cours it is not easy to distinguish between those affected by the loss of employment and others who never had any. Targeted income support for migrants can be ruled out.  But a more generic income support for all those with stressed incomes is not as wasteful as it sounds.

Income support for stressed families in villages

Three approaches can be combined to suit the context. First, borrow the concept of “helicopter money” from the much talked about income transfer scheme. Make the support freely available on demand with very selected and easily verifiable eligibility criteria. Second, revive the now defunct notion of “taccavi loans”, which were used in the colonial period as a famine relief measure. Third, use a participative and transparent good governance approach to identify the beneficiaries. Ranking families by the extent of income loss in open village meetings mediated by village-level government officers is a useful way to develop consensus and reduce the mistargeting. Lastly, devise the support mechanism in a manner which eliminates the undeserving.

Give consumption loans at market rates repayable in labour

nrega

The income support should be a loan and not a grant. This will deter those looking for a freebie. The interest rate should be reasonable but not subsidised for the same reason. Around 12 per cent per year, or one per cent per month can avoid misuse for interest arbitrage and yet peg it much lower that the unsecured informal market loans, which are available at an interest rate of 40 to 50 per cent per year, or between three to four per cent per month.

To further deter those looking for freebies and to make the scheme attractive only for those who really need the work, the loan and interest should be repayable only through around manual labour by the family in village works and not in cash. Around 50 days of labour can repay a loan of Rs 5000 along with accrued interest over six months. The advantage of this twist is that it leaves the migrant worker free to continue looking for work in cities,once he has secured a “taccavi” loan for his family to help them survive for six months without compromising the future through crippling debt. As in NREGA, the productivity of village-level work is very contextual and varies. But such inefficiencies are a small price to pay for the positive ripple effect of well targeted, publicly funded, social security schemes.

The fiscal burden is bearable.

Around 60-80 million such unsecured loans of Rs 5,000 each could cover all needy families (broadly 15 per cent households in urban areas and 30 per cent households in rural areas), with a sufficient margin to spare for the inevitable leakages from poor identification. The one-time cost of Rs 0.3-0.4 trillion can be met by either enlarging the allocation for NREGA (Rs 0.35 trillion for 2016-17) or by overshooting the fiscal deficit target by 0.25 percentage points (3.75 per cent instead of the budgeted 3.5 per cent). With weak retail demand, this temporary transgression from the fiscal deficit target is unlikely to be inflationary and in effect sustains rural demand.

Desperate times need innovation, with a human face, to soothe the hurt imposed by systemic shocks. Shielding the weak from the unbearable cost of bad economic decisions is a must, to preserve the consensus for change.

yech

Adapted from the authors article in Asian Age December 20, 2016 http://www.asianage.com/opinion/oped/201216/fiscal-love-for-a-sullen-electorate.html

 

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