Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund. 

Through the Looking Glass – A Book Review

I have never reviewed a book on my website, so this is a first.

Recently, I read Akhilesh Tilotia’s Through the Looking Glass. Tilotia is a management graduate who has worked both in the private sector and in the government. He was an officer on special duty to the minister of state for civil aviation, Jayant Sinha, for a period of three years, in the first term of the Narendra Modi government. (On a separate note, an apology to the Lewis Carrol fans who might have been conned into clicking on this link).

In this book, Tilotia offers a clear perspective on what it is like to work for the government as an outsider, why the government does not achieve what it normally sets out to do and what can be done about it.

There are two things I immensely liked about the book. First that it is written in simple English, something that many people who write on public policy and economics cannot seem to do, and second that Tilotia tackles the very tricky issue of how politics impacts public policy in India or why the government operates the way it does.

Running for an election, even at the corporator level, is very expensive. It needs a lot of money. To fight a Member of Parliament election, the expenditure allowed is up to Rs 70 lakh. And on paper that’s what the candidates spend. Of course, the real spending is much more. The question is where does this money comes from.

As Tilotia writes:

“The sources of funds are rarely disclosed or discussed in detail. Local, regional, national or even global entities may have an interest in a particular candidate or a party winning or losing. Who the candidate may be beholden to for his election is not obvious at the time of, or post the election.”

This works at both the state level and the national level. State level politics in India tends to be funded by builders in many cases. Hence, there is always a quid pro quo.

There is a very limited culture of making political donations in India. Corporates don’t like the idea of their employees being politically active. And those who are politically active, either need to hide their affiliation or face its consequences.

In this scenario, the politician is perpetually worried and unsure about where the money to fight the next elections is going to come from. As Tilotia writes: “The politician is ever on the look-out for funding commitments over the course of his political journey, whether as challenger, candidate or elected representative.”

Clearly, the incentives here are misaligned, and politicians, like other human beings, respond to incentives and don’t do the things they should be doing. If this problem can be solved, then politicians in India will be in a much better place to focus on the future than the political funding, Tilotia believes.

Due to this, what we call the system fails to deliver, leading to people who can opt out of the system, doing so at the first possible opportunity. This exit is visible in people cocooning themselves in gated communities, making sure that there are diesel generators which ensure the availability of electricity even when there is a power cut, sending their kids to private schools, buying vehicles to move around because the public transport is not up to the mark and so on.

Tilotia calls this the private cost of India’s public failure. And it just doesn’t lead to exits. It is detrimental on two other counts. First, as Tilotia writes: “The cost being high forces the spending of a large part of India’s wallet on basic necessities keeping Indians tethered on a low quality of life.” And second “public failure hits the poor and the vulnerable the hardest.”

The private cost of public failure has clearly been visible in the last 15 months as the Covid pandemic has spread. The out of pocket health expenses for many families who have had to spend money on treating the disease have gone through the roof.

This is primarily because the health system in many parts of the country is broken and/or virtually non-existent. Of course, this has led to a slowdown in economic activity, given that many families have run out of money, some others have ended up in debt and others having seen what has happened around them, are saving for future Covid waves. In this way, the private cost of India’s public failure, has turned into a public one.

Tilotia’s book is also an excellent ready reckoner for those looking to work for the government in mid to senior level positions and hoping to get some taste of how it is likely to be.

On the flip side, the book barely has any masala in it, though I found the callout feature of comparing the state of Jharkhand with Infosys, very interesting. And so was the small bit about the uncanny resemblance about the accounts of the state of Himachal Pradesh and Air India.

In that sense, the book is not something like Sanjaya Baru’s The Accidental Prime Minister.  Personally, I understand why the writer stuck to saying what he wanted to say in a straightforward accessible manner, but some masala would just have made a good book even better. For starters, Tilotia could have told us about how good the food in the Parliament’s canteen is. Are we really missing out on something?

India’s International Black Money Can’t Be Brought Back Though It Can Keep Coming Back

Black money has been a hot topic among us Indians over the past few years, especially Indian black money that has been stashed abroad, over the years. Possibilities of getting this money back to India have been raised and extensively discussed and can lead to flaring up of tempers on the University of WhatsApp.

In this scenario, any news item on the Indian black money stashed abroad tends to fly off the charts. The University of WhatsApp has been buzzing over the last few days on the news of Indian black money in Swiss Banks having gone up in 2020. This has led to surprise among the supporters of the present dispensation and happiness among those against it.

As the Press Trust of India reported: “Funds parked by Indian individuals and firms in Swiss banks, including through India-based branches and other financial institutions, jumped to 2.55 billion Swiss francs (over Rs 20,700 crore) in 2020.” This is a jump from 899 million Swiss francs (Rs 6,625 crore) at the end of 2019.

The Press Trust of India rightly doesn’t use the term ‘black money’ in reporting the funds that Indian firms and individuals have parked with Swiss Banks. Some amount of money can be taken out of the country legally every year and be deposited in Swiss banks (or other foreign banks for that matter).

This is not to say that all the funds that Indians have placed with Swiss banks will be kosher. But the fact of the matter is there is no way of specifically knowing that how much of it is black money. Black money is basically money on which taxes have not been paid.

Of course, after the Press Trust of India reported on it, other news media latched on to this story. In their reports, the phrase funds parked in Swiss banks was replaced with the term black money.

And soon headlines which said that Indian black money in Swiss bank jumps, were all over the place. Politicians from other parties also reacted to this piece of news and said that this was because of increased corruption under the Bhartiya Janata Party. This shows us clearly why nuance is neither a strength in politics or on the University of WhatsApp, for that matter.

The government immediately issued a press release, in which it said: “Media reports allude to the fact that the figures reported are official figures reported by banks to Swiss National Bank (SNB) and do not indicate the quantum of much debated alleged black money held by Indians in Switzerland.”

In all this noise, the more important points on Indian black money which goes abroad or doesn’t come back in the first place, were never made.

Let’s look at them here.

1) The money that Indians had parked in Swiss banks in 2020 has been estimated to be at Rs 20,700 crore. One dollar was worth around Rs 74 on an average in 2020. This works out to $2.96 billion. For the ease of discussion, let’s round this to $3 billion.

Even if all this was black money (which it isn’t), no media house bothered to ask a very basic question. How come the Indian black money in Swiss banks was just $3 billion? $3 billion on its own is a large number. But in the context of a nation which has had a history of a huge black money, this isn’t even small change.

2) A lot of black money is generated through trade misinvoicing. As Global Financial Integrity (GFI), an organisation which specialises in this area, defines this as “a method for moving money illicitly across borders which involves the deliberate falsification of the value, volume, and/or type of commodity in an international commercial transaction of goods or services by at least one party to the transaction.”

Imports coming into the country can be over invoiced. In that process, money can go out of the country without the required taxes being paid on it. Further, imports can be under invoiced to not pay customs duty.

In a similar way, exports going out of the country can be under invoiced and money that should have come back to the country, and taxes should have been paid on it, continues to stay outside its borders.

A number is put to this misinvoicing through the value gap analysis. As GFI explains in a report: “For example, if Ecuador reported exporting US$20 million in bananas to the United States in 2016, but the US reported having imported only US$15 million in bananas from Ecuador that year, this would reflect a mismatch, or value gap, of US$5 million in the reported trade of this product between the two partners for that year.”

While data on imports and exports is never perfect, a significant portion of any value gap is a result of misinvoicing, in order to not pay tax on money earned and ensure that it continues to stay abroad, or to simply move money out of a country. This is the largest component of illicit financial flows globally. In India, we call this international black money.

3) As per GFI, the average value gap of India from 2008 to 2017, a period of 10 years, stood at $78 billion per year, which in total amounts to $780 billion. This means that a significant portion of $780 billion would have left India during these years or should have come back to India, but never did. Of course, this is just one period of ten years that we are talking about. All this didn’t just start happening in 2008. Now compare this with the $3 billion lying in Swiss banks. That’s not even small change.

Also, it is worth remembering that we are talking about black money through just the misinvoicing route. As GFI points out: “Many illicit transactions occur in cash to prevent an incriminating paper trail. For these many reasons, our estimates are likely very conservative.”

Of course, this problem is not specific to India. China, Russia and Mexico were ahead of India, on this front, with an yearly average of $482.4 billion, $92.6 billion and $82.5 billion, respectively, during the period.

4) Take the case of 2016. The value gap of the misinvoiced imports and exports stood at $74 billion. As GFI points out: “The analysis shows that the estimated potential loss of revenue to the government is $13.0 billion for 2016. To put this figure in context, this amount represents 5.5 percent of the value of India’s total government revenue collections in 2016.” Given this, the government loses out on a significant amount of taxes because of international black money.

5) The question is, if so much money on which adequate amount of tax has not been paid, is going abroad every year or simply staying there, why doesn’t it reflect in the Swiss bank numbers. This is where things get interesting.

As the government press release referred to earlier points out: “These statistics do not include the money that Indians, NRIs or others might have in Swiss banks in the names of third–country entities.” This could be one possible reason.

6) The common perception in India is that all the black money that leaves India (or simply doesn’t come back) is in Swiss banks. This is totally wrong. There are around 70 tax havens all over the world. An estimate made by The Economist in 2013 suggested that: “Nobody really knows how much money is stashed away: estimates vary from way below to way above $20 trillion.”

And this money is spread all across the world and isn’t just held in banks in Switzerland. As Gabriel Zucman writes in The Hidden Wealth of Nations – The Scourge of Tax Havens, points out:

“In the past, Swiss bankers provided all services: carrying out the investment strategy, keeping securities under custody, hiding the true identity of owners by the way of famous numbered accounts. Today, only securities custody really remains in their purview. The rest has been moved offsite to other tax havens—Luxembourg, the Virgin Islands, or Panama—all of which function in symbiosis. This is the great organisation of international wealth management.”

Given this, India’s international black money could possibly be anywhere in the world. Also, a lot of this money is held “through intermediaries of shell companies headquartered in the British Virgin Islands, or foundations domiciled in Liechtenstein.” This ensures that the money is not easily traceable to those who took it out of the country or decided not to bring it back.

7) It is worth remembering here that all the focus on black money in India should have made people who stash their black money abroad, smarter. Clearly, when everyone and their grandmother knows about Swiss banks, the black money wallahs are bound to be cautious and ensure that they spread their money around across the world.

8) So, the question is how good are India’s chances of getting this money back? The money that has left Indian shores or should have come to India but never did, could be anywhere. Tax havens maintain secrecy to ensure that they remain attractive options for those who are looking to hide their black money. Hence, recovery will continue to remain difficult. If even a small part of this money is to be recovered, a massive amount of international cooperation will be needed.

9) While it might be difficult to recover black money from outside India’s shores, some of it does keep coming back to India through the foreign direct investment route. A lot of this money comes in through countries like Mauritius, Singapore, Netherlands and Cyprus. In 2020-21, 44% of the total foreign direct investment coming into India, came from these countries. This was a low figure in comparison each of the five years before that, when the proportion had stood at more than 60%. Of course, not all this money is India’s international black money, but a significant portion might be.

As the finance ministry white paper on black money published in May 2012 had pointed out:

“It is apparent that the investments are routed through these jurisdictions for [the] avoidance of taxes and/or for concealing the identities from the revenue authorities of the ultimate investors, many of whom could actually be Indian residents, who have invested in their own companies, though a process known as round-tripping.”

India’s international black money is also round-tripped to be invested in stocks. 

To conclude, instead of trying to chase this black money and get it back, it makes more sense for us to create economic conditions where this black money comes back to India and is invested in different projects. We should also try and simplify our tax system to ensure that the incentives to generate black money in the first place, come down. 

But then that hardly makes for great rhetoric and management of narrative, which is what Indian politics seems to be all about these days. As Thomas Sowell writes in Knowledge and Decisions: “Sober analysis seldom has the appeal of a ringing rhetoric.”

And that’s something worth thinking about.

Petrol and Diesel Prices are High Due to Lower Corporate Taxes, Not Because of Oil Bonds

Life is what happens between WhatsApp forwards.

Yesterday evening, a friend from school WhatsApped a doubt he had. He wanted to know if petrol and diesel prices were high because the Narendra Modi government had to repay oil bonds, which had been issued by United Progressive Alliance (UPA) government more than a decade back.

To repay these oil bonds, money is needed. This has led to significantly higher central government taxes on petrol and diesel, which has in turn led to higher pump prices.

However convincing the argument may sound, it’s wrong. 100% wrong. And I have been saying this for a few years now.

Of course, my saying this hardly makes a difference, given that every time petrol and diesel prices rise, WhatsApp starts buzzing all over again with forwards blaming oil bonds issued by the UPA for high petrol and diesel prices. Currently, the price of petrol is more than Rs 100 per litre in several parts of the country.

This high price is on account of a higher excise duty collected by the central government in order to compensate for a fall in corporate tax collections. In that sense, you and I are bearing the cost of lower corporate taxes, in the form of a higher price of petrol and diesel. 

Let’s try and understand the issue of high petrol and diesel prices, and why things are the way they are, in some detail.

1) Crude oil prices have risen between last year and now. In June 2020, the average price of the Indian basket of crude oil was at $40.63 per barrel. As of June 16, 2021, the price was at $73.18 per barrel. Clearly, this is one reason behind the rise in petrol and diesel prices, but this isn’t the only reason, and not even the main one.

2) Before getting into any other detail, let’s understand what oil bonds are. These bonds were issued by the UPA government to the oil marketing companies (Indian Oil, Bharat Petroleum, Hindustan Petroleum), for the under-recoveries (the difference between the administrative price and the cost) they suffered when selling petrol, diesel, kerosene and domestic cooking gas, below their cost. This happened up until 2009-2010. Officially, these bonds are referred to as special securities issued to oil marketing companies in lieu of cash subsidy.

Instead of compensating companies immediately for the subsidy offered by them, by giving them money, the government gave them oil bonds, which would pay annual interest and mature a few years down the line. By doing this, the government expenditure during those years didn’t go up. This helped control the fiscal deficit in those years, when oil bonds were issued. Fiscal deficit is the difference between what a government earns and what it spends.

3) Of course, these bonds would mature over the years and the government of the day would have to repay them. And that would need money.
So what is the value of these bonds which the government still needs to repay?  In a question raised in the Rajya Sabha in December 2018, the government had said: “The current outstanding balance on account of Government of India (GoI) Special Bonds issued to the Public Sector Oil Marketing Companies (OMCs) in lieu of cash subsidy is about Rs 1.30 lakh crore.”

So, two and a half years back, the value of the outstanding oil bonds had stood at around Rs 1.30 lakh crore. What’s the latest number? Take a look at the following table. It has been sourced from the latest government budget. It lists out the different oil bonds that are still to be repaid, with their maturity dates.

Source: https://www.indiabudget.gov.in/doc/rec/allrec.pdf

What does this table tell us? It tells us that as of March 2021, the total outstanding oil bonds issued by the government stood at Rs 1,30,923 crore. Or the same as what the government had told the Rajya Sabha in December 2018.

4) In fact, the amount of outstanding oil bonds has barely changed during Modi government’s tenure. Look at the following tabled sourced from the 2014-15 budget, presented in July 2014, after Narendra Modi became prime minister.

Source: https://www.indiabudget.gov.in/budget2014-2015/ub2014-15/rec/annex6e.pdf

As of March 2014, the total outstanding oil bonds stood at Rs 1,34,423 crore. Two different oil bonds with maturity amounts of Rs 1,750 crore each, matured in 2014-15, on March 7, 2015, and March 23, 2015, respectively. This brought down to the total outstanding oil bonds to Rs 1,30,923 crore, and which is the current outstanding amount as well.  

The point being that the government hasn’t had to repay any outstanding oil bonds since March 2015. Of course, it has had to pay an interest on these oil bonds, like it does on all other bonds.

How much is this interest? As the government told the Rajya Sabha in December 2018: “The annual aggregated amount of Rs 9,989.96 crore was paid every year during 2015-16 to 2017-18 and the similar amount is required to be paid in the current financial year.”

Given that, the outstanding amount of oil bonds didn’t change through 2018-19, 2019-20 and 2020-21, the government would have paid the same amount as interest in each of these years, as it did during 2015-16 to 2017-18.

How does the situation look in 2021-22, the current financial year? As can be seen from both the tables (I know the tables are not very clear. If you really want to verify the data, the source of the tables is available just below them. All you need to do is click), Rs 5,000 crore of bonds are due to be repaid on October 16 and November 28, respectively, later this year. This amounts to Rs 10,000 crore in total.

Over and above this, interest needs to be repaid on the outstanding bonds. Given that Rs 10,000 crore worth of bonds of the total Rs 1,30,923 crore of oil bonds, will be repaid during this financial year, the interest to be paid on the remaining bonds will be less than Rs 9,989.96 crore that the government has been paying year on year. A back of the envelope calculation tells us that the interest to be paid this year should amount to around Rs 9,500 crore.

Hence, in total, the government needs Rs 19,500 crore to repay oil bonds as well as pay interest on them during 2021-22. When it comes to government finances, this is small change.

5) If we look at the excise duty collected on petroleum products over the years, data from Petroleum Planning and Analysis Cell tells us that it stood at Rs 99,068 crore in 2014-15, the financial year in which Narendra Modi was sworn in as prime minister.

The number reached Rs 2,23,057 crore in 2019-20. It touched Rs 2,35,811 crore between April and December 2020, the first nine months of 2020-21. Given this, it would have crossed Rs 3,00,000 crore during 2020-21.

In 2021-22, the central government expects to collect more than Rs 3,00,000 crore through excise duties on petroleum products. A look at this year’s budget tells us that the government hopes to collect Rs 74,350 crore on special additional duty of excise on motor spirit(petrol) and Rs 1,98,000 crore through duty of excise on motor spirit and high-speed diesel oil (road and infrastructure cess). Just this adds to close to Rs 2.75 lakh crore.

Over and above this, one needs to pay a basic excise duty on every litre of petrol and diesel purchased, and there is an agriculture infrastructure and development cess to be paid as well. Clearly, this year, the government will earn more than Rs 3 lakh crore from different kinds of excise duties on petroleum products.

From February 2, 2021, the total excise duty on petrol and diesel has stood at Rs 32.90 per litre and Rs 31.80 per litre, respectively. The total central excise duties on petrol and diesel have been rising since 2014. They had stood at Rs 10.38 per litre and Rs 4.52 per litre in March 2014.

In fact, even in April 2020, they had stood at Rs 22.98 per litre and Rs 18.83 per litre, respectively.

Between April last year and now, the petrol price is higher by close to Rs 10 per litre just because of higher central government taxes on it. When it comes to diesel, it is higher by close to Rs 13 per litre because of this.

6) There is another small reason for higher prices as well. The state government taxes on petrol and diesel are ad valorem, that is they are a certain percentage of the price charged to dealers plus the excise duty of the central government plus the dealer commission on every litre of petrol and diesel sold.

Take a look at the following table, which has the detail for petrol sold in Delhi.

Source: https://www.bharatpetroleum.com/pdf/MS_Webupload_16.06.2021.pdf.

The price of petrol charged to dealers in Delhi by Bharat Petroleum was at Rs 37.68 per litre as on June 16. On this there was an excise duty charged by the central government of Rs 32.90 per litre along with a dealer commission of Rs 3.80 per litre. This adds up to Rs 74.38 per litre.

On this, the Delhi government charges a value added tax of 30%, which amounts to Rs 22.32 per litre. This leads to a retail selling price of Rs 96.70 per litre (Rs 74.38 plus Rs 22.32) in Delhi.

Like, the Delhi government, other state governments also charge a value added tax or a sales tax on petrol and diesel sold in their respective territories. The 30% tax charged by the Delhi government is ad valorem. Hence, if the petrol price charged to dealers goes up as oil price goes up, the tax collected by the Delhi government also goes up.

Over and above this, when the central government increases the excise duty on petrol, the tax collected by the Delhi government (and all other governments) goes up because the state government charges a value added tax on dealer price plus excise duty plus dealer commission.

Hence, every time you and I buy petrol or diesel, we are paying a tax on tax. This is an anomaly that needs to be set right. And state governments need to charge a sales tax just on the dealer price and commission, and not on the central government excise duty as well.

7) A major reason for the central government implementing a high excise duty on petrol and diesel, lies in the fact that the government’s tax revenues as a proportion of the size of the Indian economy, measured by the gross domestic product (GDP), has been falling over the years.

Look at the following chart. It plots the ratio of gross tax revenue earned by the central government as a proportion of the GDP.


Source: Centre for Monitoring Indian Economy and Controller General of Accounts.

What does this chart show? It shows that the gross tax revenue as a percentage of the GDP reached an all-time high of 12.11% in 2007-08. The gross tax revenue was at 11.22% of the GDP in 2017-18 and fell to 10.25% of the GDP in 2020-21.

The recent fall has been more because of a fall in corporate tax collections. In 2017-18, the corporate tax collections amounted to a total of 3.34% of the GDP and fell to 2.32% of the GDP in 2020-21. This was despite the listed companies registering bumper profits during the financial year.

Corporate taxes have come down primarily on account of the base tax rate being cut from 30% to 22% in September 2019 and to 15% from the earlier 25% for new manufacturing companies.

In absolute terms, the total corporate tax collected in 2019-20 had stood at Rs 5.57 lakh crore. It fell to Rs 4.57 lakh crore in 2020-21, thanks to lower tax rates. The collections of the goods and services tax have also not gone along expected lines.

To compensate for this to some extent, the government has had to increase the excise duty on petroleum products. Hence, it is only fair to say that the cost of lower corporate tax rates for the government, is being borne by citizens in the form of higher petrol and diesel prices. There is no free lunch, as I keep reminding.

To conclude, while the revenue earned by the government can vary, its expenditure doesn’t. It usually goes up year on year. In 2017-18, the total expenditure to GDP ratio stood at 12.53%. This jumped to 17.47% in 2020-21. Of course, 2020-21, could very well be an anomaly given that the size of the economy (GDP) contracted.

Nevertheless, the expenditure in 2019-20 had also stood at a higher 13.20% of the GDP, while the gross tax collections fell. And someone had to pay for this. 

What Does Official Government Inflation Mean for You? 

For May 2021, inflation as measured by the consumer price index (CPI) stood at 6.3%. It was the highest since November 2020, when it had stood at 6.93%. 

Of course, this has been splashed all over the media since yesterday evening when the figures were published. But do you ever sit back and think about what does inflation really mean for you? (I mean why would anyone sit back and think about inflation, but nonetheless please humour me for a bit). If you haven’t, let me set the cat among the pigeons.

1) The government publishes inflation as measured by the CPI every month. So, when it says inflation in May 2021 stood at 6.3%, does it mean that inflation for you, dear reader, also stood at 6.3%? Or that you paid 6.3% more for things on an average in May 2021 than you did in May 2020? Have you ever thought about this?

The CPI consists of many items whose prices are regularly tracked by the government (specifically, by the ministry of statistics and programme implementation). All these items have a certain weight in the index.

So, food items overall have a weight of 39.06% of the index. The assumption here is that the average Indian makes nearly two-fifths of his expenditure every month on food.

If you are reading this, chances are your expenditure on food every month as a proportion of your total expenditure, is lower than 39.06%. I say this simply because you are reading this in English, and anyone who can read English in India, is likely to be better off than an average Indian.

Hence, inflation of 6.3%, isn’t your rate of inflation. It can be higher or lower than this, depending on stuff you regularly consume.

Take the case of petrol prices. They have risen by 62.28% in the last one year, if we look at the inflation as measured by the wholesale price index (this data as per inflation as measured by CPI, hasn’t been published in the recent months).

In inflation as measured by the wholesale price index, petrol prices have a weight of 1.6%. In inflation as measured by CPI, they have a weight of 2.19%. Your expenditure on petrol as a part of your overall expenditure, is likely to be more than this.

Also, on a slightly different note, rising petrol, diesel and gas prices, feed into food prices, because food needs to be moved from where it is produced to where it is consumed.

2) As people earn more, their spending on food as a proportion of their overall spending comes down. Also, within the food basket, spending on cereals comes down and spending on foods which have protein (eggs, pulses, meat, etc.), goes up. The spending on milk also goes up. 

When it comes to the CPI, this can simply be gauged from the fact that the weightage that food has in the urban part of the CPI is much lower than the rural one. When it comes to urban India, the weightage of food items in the CPI stands at 29.62%. In case of rural India, the weightage is much higher at 47.25%.

This is primarily because the average urban Indian earns more than an average rural Indian and hence, incurs a lower proportion of the overall expenditure on food.

Of course, as people earn more, their spending on items other than food increases and that starts to matter more. Even here the stuff that CPI measures and your regular consumption basket may not intersect. Let’s take the case of household goods and services, a heading under CPI.

This heading keeps track of inflation of bedsteads, almirahs, dressing tables, chairs, furniture, bathroom and sanitary equipment, bedsheets, mosquito nets, air conditioners, sewing machines (yes, still!), washing machines, invertors, refrigerators, etc. In May 2021, the inflation for all these items overall stood at 3.89%. 

Here is the thing. While these items are important in the overall scheme of comfortable middle class living, they do not have any impact on regular expenditure, given that they are one-off purchases. Hence, they don’t impact your regular consumption and, in the process, your regular inflation.

But this is a point that is not important for the government. The government is trying to figure out the rate of inflation for the society at large, so that this can help in other ways, like figuring out the adequate level of interest rates for one. 

3) But there is a flip side to the above point as well. The health inflation in the last one year has been 8.44%. Now anyone who has had to deal with India’s urban private health system in the last one year, will tell you that is a load of bunkum. Prices have gone through the roof and the rate of inflation doesn’t really capture it. 

Of course, going to the hospital is also not something that most people do regularly (I am not talking about basic visits to a personal physician here). Hence, anyone who has had to spend some time in a hospital this year, or has had to finance a close one’s stay, would have ended up spending a lot of money and paid significantly higher prices than last year. 

So, one-off expenditures during a particular year can really make a mess of your finances, and that is something the inflation as measured by CPI doesn’t really capture.

Also, on a slightly different note, as Madan Sabnavis, the Chief Economist of CARE Ratings puts it: “Problem with most of the inflation numbers relating to personal care, health, recreation, transport is that once prices are increased they would not come down and hence becomes a new base.”

The point being that inflation measures the rate of increase in price over a period of one year. Hence, the annual inflation itself may not be high, but that doesn’t necessarily mean that things are not expensive.

4) Different states have different rates of inflation in different years. In 2019-20, among large states, Kerala had the highest rate of inflation at 6.1%. Bihar had the lowest at 2.2%. 

Source: Reserve Bank of India. 

What does this mean? It means that the inflation you experience also depends on which part of the country you are in and the inflationary pressures it is experiencing during a particular year. Of course, within a state, whether you are in an urban area, or a rural one, also makes a difference.

5) Clearly, the official rate of inflation doesn’t tell you much about anything. Hence, what can you do about it? First and foremost, you need to do an expenditure audit and figure out the things you spend your money on regularly (you will be surprised). This shouldn’t be so difficult if you make purchases online or make payments digitally or use plastic money. 

The important point here is to identify the most important items and not every possible one, and keep track of expenditure on the important items, over a period. A simpler method is to just keep track of regular monthly expenditure and that too can give you some inkling which way your finances are headed, and whether you are spending more or less than you were doing in the past. 

This is not a totally foolproof and methodical system but more of a crude method to get around the uselessness of the official rate of inflation at an individual level, when it comes to consumption. Of course, there are other implications which I do keep talking about.