Piketty’s Tax Plan to Lower Inequality in India is Slightly Rickety

thomas piketty
This is something I wanted to write last week but could not given that Satyajit Das’s three part interview took up all the space.

The French economist Thomas Piketty was in Delhi recently to launch the Hindi edition of his book Capital in the Twenty First Century, among other things. During the course of an interview to The Hindu, Piketty said: “I hope the Indian elite will behave much more responsibly [in paying more taxes] than the western elite did in the 20th century.”

Piketty wants India’s elite to pay more tax to ensure that the income inequality in India comes down. In another interview to the Mint newspaper Piketty said: “India is a relatively high inequality country with a very strong legacy of extreme inequality for centuries between groups.”

Piketty feels that India’s income inequality is close to that of Brazil and South Africa with the top 10% making 50-60% of the total income. Piketty also feels that the income inequality in India may have gone up in the recent past. As he told The Times of India in an interview in November 2015: “The share of India’s national income going to top percentiles declined in the decades following independence, but has been rising since the 1980s-1990s, and is now back to pre-Independence levels, or maybe has surpassed them. The problem is that we do not really know, because it has become impossible to access income tax statistics.”

This income inequality can be addressed by taxing the rich more, feels Piketty.

[In fact, everyone does not agree with Piketty’s view of income inequality in India. Here is another view.

As Tim Harford writes in The Undercover Economist Strikes Back: “There simply isn’t enough money in India yet for it to be unequal.”

Harford explained what he meant by this in an interview to me where he said: “The World Bank economist Branko Milanovic has this idea of the “inequality possibility frontier”. Imagine an extremely poor subsistence society. Then imagine some class of plutocrats, who somehow confiscate wealth and spend it themselves. How much can they take? The answer is: not much if the society is to survive, because the poor cannot dip below the average income because the average income is barely enough to keep you alive. Now imagine a much richer society. This, in principle, could be far more unequal because the poor could still survive on a tiny fraction of the average income. Milanovic and co-authors were interested not only in how unequal a society is, but how unequal it is relative to how unequal it could possibly be. My point was that despite important gains over the past twenty years, India is still a very poor society. There’s a limit to how unequal it can get until it gets richer – which should make us worry about the inequality we do see.”]

Let’s get back to Piketty. Taxing the rich more was one of the main points that Piketty made in his book Capital in the Twenty First Century. As he writes: “The historical evidence suggests that with only 10-15 percent of national income in tax receipts, it is impossible or a state to fulfil much more than its traditional regalian responsibilities: after paying for a proper police force and judicial system, there is not much left to pay for education and health. Another possible choice is to pay everyone—police, judges, teachers, and nurses—poorly, in which case it is unlikely that any of these public services will work well.”

How do things look in India’s case? If we look at the annual budget of the government of India for 2015-2016, it’s tax revenue amounts to around 6.5% of the nominal gross domestic product (or national income). This is well below the limit that Piketty talks about.

It is very clear that the central government needs to collect more taxes than it currently is. There is no denying that. Piketty feels that it is time that India’s rich pay more taxes. He also suggests that India’s rich should be taxed more. It is important to realise here that the rich are not going to pay higher taxes on their own and hence, they need to be taxed more.

As Piketty told The Hindu: “India has zero wealth tax,” with the underlying message being that India needs to tax those who have wealth.

There are two issues here essentially: taxes and inequality. Let’s talk about inequality first. As Satyajit Das, an economic commentator and the author of The Age of Stagnation put it to me: “There are several sides to inequality. There is a moral and ethical dimension. There are arguments of fairness. There are arguments of proper incentives for achievement and skill. Each person will have a different view on that.”

But the economic argument is simpler. And what is that? As Das puts it: “First, empirical research suggests that an increase in income inequality by 1 Gini point decreases the annual growth in GDP per capita by around 0.2 percent.” Gini coefficient is a measurement of inequality where a gini coefficient of zero expresses perfect equality whereas a gini coefficient of one expresses maximal inequality.

To put it in simple English greater inequality of income leads to slower economic growth. And why is that? Das has an answer: “Higher income households have a lower marginal propensity to consume, spending a lower portion of each incremental dollar of income than those with lower incomes. US households earning US$35,000 have a marginal propensity to consume an amount from each additional dollar of income which is around three times that of a household with an income of US$200,000.”

Inequality comes with a huge social cost as well. As Das puts it: “Widening disparities in income level also impose direct costs such as life expectancy, crime levels, literacy and health. Rising inequality is associated with higher crime rates, particularly violent and property offences, poorer health, as well as family breakdowns and drug use. Unequal societies are affected by diseases of poverty, such as TB, malaria and gastrointestinal illnesses arising from poor nutrition and hygiene, inadequate housing, and a lack of
sanitation and access to timely health services
.”

What all this clearly tells us is that income inequality is a problem. Is taxing the rich more really a solution to this?

It is worth asking here in the Indian context who are the rich when it comes to paying taxes? It is worth remembering here that in his February 2013 budget speech, the then finance minister P Chidambaram had estimated that India had only 42,800 people with a taxable income of Rs 1 crore or more.

As Piketty said in one of his interviews it is next to impossible to get hold of income statistics in India. Nevertheless, some progress has been made in the recent past. Akhilesh Tilotia of Kotak Institutional Equities, who is also the author of The Making of India, has done some excellent analysis on this front.

As Tilotia writes in a research note titled How Many Crorepatis in India released in early December 2015: “As e-filing of income taxes becomes the norm and the government gives out glimpses of data, it is now possible to estimate the number of entities in various slabs of incomes. Data suggests that over the four-year period of FY2011-14, the number of non-corporate entities reporting incomes > Rs10 million [or Rs 1 crore] has gone up 3 times to 63,589.” A non-corporate assesse includes “individuals, Hindu undivided families, partnerships, association of persons, etc.” This is around 0.5% of India’s population writes Tilotia.

What does this tell us? This tells us very clearly that very few of India’s rich actually pay taxes. So increasing the tax rates, as Piketty suggest, is really not a solution because the government will end up taxing the same set of people who are already paying a major part of India’s taxes.

Take the case of wealth tax. The finance minister Arun Jaitley abolished the wealth tax in the budget speech he made in February 2015. As Jaitley said during the course of his speech: “The total wealth tax collection in the country was Rs 1,008 crore in 2013-14.”

This basically means two things: a) Very few people in India bothered paying wealth tax. b) The income tax department was not in a position to get more people to pay wealth tax.

Also, it is worth remembering here that many Congress finance ministers since independence drove a substantial part of the Indian economy underground by having very high rates of income tax. The marginal rate of income tax even reached 97% at a certain point of time.

So a higher income tax rate is clearly not a solution to reduce income inequality in India. The solution is to bring more and more Indians who should be paying income tax, but do not, under the tax bracket. This means simplifying the income tax system. It also means making the income tax department more efficient through the use of information technology. And finally, it means reducing corruption in the department.

That is the solution to reducing income inequality in India. Higher tax rates are clearly not the way to go about it.

This column originally appeared in the Vivek Kaul’s Diary on February 1, 2016.

Why the Swacch Bharat cess is a terrible idea

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The government announced a new Swacch Bharat cess, yesterday. The cess will amount to 0.5% on all services, pushing up the rate of service tax to 14.5%, from the current 14%. The cess will come into effect from November 15, later this month.

As the press release announcing the decision said: “Swachh Bharat Cess is not another tax but a step towards involving each and every citizen in making contribution to Swachh Bharat…The proceeds from this cess will be exclusively used for Swachh Bharat initiatives.”

This decision is in continuation with something the finance minister Arun Jaitley had announced in the budget speech he made on February 28, earlier this year. As Jaitley had said on that occasion: “It is also proposed to have an enabling provision to levy Swachh Bharat Cess at a rate of 2% or less on all or certain services if need arises. This Cess will be effective from a date to be notified. Resources generated from this cess will be utilised for financing and promoting initiatives towards Swachh Bharat.”

Thankfully, the government has resisted the temptation to increase the rate of service tax by 2%, through the cess route and settled at 0.5%.

There are multiple reasons why this is a bad decision. As the press release said: “Swachh Bharat Cess is not another tax but a step towards involving each and every citizen in making contribution to Swachh Bharat.” What this clearly tells us is that the Swacch Bharat initiative is an important initiative for the government, as it should be.

And given that, it should be financed out through the primary revenues of the government and not through a cess. If the Swacch Bharat initiative is deemed to be important then it should have first claim on the revenues of the government and shouldn’t be financed through a cess.

Second, any cess essentially ends up taxing the same set of people again. Over the years, the government has made very little effort in trying to expand the tax base by simplifying the tax system as well as cracking down on a large set of Indians who do not pay any tax. The annual report of the ministry of finance for 2014-15 puts the total number of income tax assesses in 2013-2014 at 4.7 crore. These includes individuals, families, trusts and corporates. Given a population of close to 125 crore, what this clearly tells us is that not many Indians pay income tax. And this is something that government needs to improve on, instead of taxing the same base over and over again.

Third, any new tax (as a cess is) adds to the complication of the tax system and this keeps people away from paying tax. Further, in the Indian case, a cess tends to be more of a permanent nature than ad hoc as it should be.

Take the case of the education cess on income tax. It has been around for a while now raising the question that isn’t education important enough to be financed out of the primary revenues of the government.

Fourth, while the government has come up with a Swacch Bharat cess, it is wasting thousands of crore on keeping loss making public sector enterprises alive.

Let’s take the example of Mahanagar Telephone Nigam Ltd(MTNL) which offers internet and telephone services in Mumbai and Delhi.

During the course of 2014-2015(the period between April 1, 2014 and March 31, 2015) the company’s income was at Rs 3,400 crore. Its expenditure on the other hand stood at a much higher Rs 5,284 crore. The government(or rather the tax payer) bore the loss of around Rs 1,900 crore.

Or take the case of the government owned airline Air India. The company has accumulated losses of Rs 20,000 crore. The airline keeps making losses. The government keeps putting more and more money into it.

As this August 2015 news-report by PTI points out: “The Finance Ministry today sought Parliament’s nod for making an additional equity infusion into Air India worth Rs 800 crore, less than half the amount sought by the Civil Aviation Ministry for the national carrier.” Thousands of crore have already been infused into Air India. And with so much money going towards such lost causes, it is not surprising that the government has had to introduce a new Swacch Bharat cess.

Fifth, the government can easily finance Swacch Bharat by selling the shares it owns in Axis Bank, Larsen and Toubro and ITC, through the Specified Undertaking of Unit Trust of India (SUUTI). These shares as on November 6, 2015, were worth Rs 53,472 crore. Some portion of these shares can be sold every year to finance Swacch Bharat. At the end of the day what is strategic about the government holding shares in ITC, a company which earns a major part of its revenue through selling cigarettes? The SUUTI’s holding in ITC is worth Rs 30,210.7 crore.

Sixth, by levying a cess for Swacch Bharat, the government is taking the moral incentive out of the equation. As Nitin Pai of the Takshashila Institution puts it: “Levying a cess dilutes the moral incentive that a borderline conscientious citizen faces. Instead of a gnawing feeling when she sees garbage in public places, the marginal citizen is likely to feel the same-old, “I’ve done my part but the government is not doing its job properly.””

Once all these reasons are taken into account the Swacch Bharat cess is a stupid idea. The Narendra Modi government could have done better than this.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Huffington Post India on Nov 7, 2015

How UPA govt subsidies helped generate black money and contributed to the real estate bubble

bubble
One of the points that I have made over and over again in the columns that I have written on black money is that theNarendra Modi government needs to concentrate on domestic black money as well.

Since coming to power in May last year, the Modi government has made a lot of noise and come up with legislation on trying to curb the black money leaving the shores of this country. Black money is essentially money which has been earned but on which tax has not been paid.

Nevertheless, it is important to realise that ultimately almost all the black money is domestic i.e. it is generated within the country when people earn money (through legal or illegal means) and do not pay any tax on it.

Given this, it is more important to concentrate on trying to bring down the total amount of black money being generated instead of trying to get back the black money that has already left India. One way to do this is to get more people under the income tax net. Efforts are being made on this front.

A PTI report points out that: “The income tax department has launched an ambitious drive to bring under its net 10 million new taxpayers, after the government recently asked the official to achieve the target within the current financial year.”

Region wise targets have been set. Pune leads the list with a target of more than 10 lakh new assesses. This is an interesting move and if it is successful this will lead to more people paying income tax and hence, the total amount of black money within the system will come down.

When the total amount of black money comes down, lesser black money will go into real estate. And this will help in ensuring that only those who really want homes to live in,will buy. This will help in controlling real estate prices.

Other than getting more people to pay income tax, the government also needs to concentrate on blocking leakages on the subsidy front. In 2004-2005, the total subsidies offered by the government stood at Rs 47,432 crore. By 2013-2014, this number had ballooned to Rs 2,54,632 crore. The total subsidies of the government had jumped by 5.4 times during the period. In comparison, the total expenditure of the government had jumped by only 3.15 times.

Only if the subsidies were reaching those for whom they were intended for, it would not have been a problem. In October 2009, Montek Singh Ahluwalia, the then deputy chairman of the Planning Commission had said: “a Plan panel study on PDS [public distribution system] found that only 16 paise out of a rupee was reaching the targeted poor.”

So where did the remaining 84 paise go? It was stolen in between. Obviously people who stole the subsidies would neither be declaring this money as income and nor be paying any income tax on it.

As Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research titled Real Estate: The unwind and its side effects: “Subsidies under the UPA regime grew at a staggeringCAGR[compounded annual growth rate] of 19% per annum…A substantial portion of these subsidies(30-50%) was pilfered by the political class and used by them to fund investment in gold and real estate.”

In comparison to Ahluwalia’s estimate, Mukherjee and Shekhar are being extremely conservative. Nevertheless, the point being made is the same—that government subsidies are terribly leaky. The politicians who stole this money obviously did not declare this as income. This black money then found its way into real estate and drove up real estate prices.

As a FICCI report on black money published in February 2015 points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

So what has happened since the UPA was voted out of power? In 2015-2016, the total amount of subsidies have been budgeted at Rs2,43,811 crore, which is lower than the Rs 2,54,632 crore that had been spent in 2013-2014. One reason for this is obviously a fall in oil prices. The number in 2014-2015 had stood at Rs 2,66,692 crore.

This cut in subsidies along with the fact that some subsidies are now directly being paid into bank accounts is likely to help bring down both black money as well as real estate prices. As Mukherjea and Shekhar write: “The NDA has cut subsidies sharply (down 9% in 2015-2016) and is shifting subsidies to Direct Benefit Transfer (DBT); at least 10% of the overall subsidies have already been moved to the DBT. As a result, the ability ofthe politician-and-builder to pilfer subsidies to fund real estate construction has been checked.”

While cutting down on subsidies further may not be politically possible, if more and more of subsidies are paid directly into the bank account of the beneficiaries, the total amount of black money within the system is likely to come down.

Taking these steps rather than chasing black money that has left the shores of this country makes more sense and will have a greater impact on bringing down real estate prices in India. This will go a long way in making homes affordable for those who want to buy homes to live in rather than to invest.

As Mukherjea and Shekhar put it: “the NDA Government is engineering a clamp down on black money in India. The 2015-2016 Union Budget explicitly aimed to disincentivise the black economy and curb the demand for physical assets. With the new Black Money Bill (which was passed by the Parliament on May 26) and with the Cabinet approving the Benami Transactions Bill in May this year, the crackdown on blackmoney will continue further.”

These steps need to continue.

(VivekKaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on July 20, 2015

 

10 things the Cobrapost sting tells us

king cobra

Vivek Kaul

Stings in India till now have been carried out to expose politicians. The Cobrapost sting is the first sting that has brought into the public domain the murky way in which the big Indian private banks operate. But more than just exposing the murky way in which big banks operate, the sting brings out in the open other uncomfortable truths as well.

1. The finance minister P Chidambaram in his recent budget speech had said “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs 1 crore per year.” Of course no one took that number seriously. We now know why.
The Cobrapost sting clearly shows us that there are many more people with a taxable income of more than Rs 1 crore. The straightforward and more than helpful way in which the banks were ready to help invest the black money of the ‘supposed’ politician that the Cobrapost reporter was fronting for, can only tell us one thing: Banks seem to be doing this regularly.
And given this we can only conclude that there are many people out there with taxable incomes of more than Rs 1 crore, who don’t pay tax, than just 42,800. While it’s an obvious conclusion that did not need this visual evidence, but it is still an important conclusion nonetheless.
2. The second thing that the sting tells us is that those who have black money do not keep all of it under their mattresses. A lot of it as we know goes into buying real estate (largely benami). But the holders of black money seem to like to diversify their hoarded “wealth”. As the Cobrapost press release points out “(Banks) accept huge amounts of cash and invest it in insurance products and gold.” The money invested in insurance products is in turn invested in stocks, government securities and financial securities issued by corporations. So hoarders of black money do seem to be following the age old investing principle of “don’t put all your eggs in one basket”. They seem to be buying everything. From gold. To real estate. To stocks. And even have money in fixed deposits with banks.
3. By investing at least in gold and fixed deposits, hoarders of black money also show us that they like to have some liquidity in the assets that they own. Real estate is not terribly liquid and neither are insurance policies.
4. The sting also shows our love for gold which goes with the large amount of black money in this country. Very small amounts of gold can be used to store a large amount of black money as wealth. India has lot of gold because Indians love it is the normal claim that is made, but India also has a lot of gold because there is a lot of black money floating around.
5. The good bit is that instead of just lying around under the mattresses of people, some of the black money is coming into the financial system. When people buy insurance policies which in turn buy either debt securities issued by the government or the private sector or invest in shares issued by a company getting listed on the stock exchange, they are in some way financing someone who needs the money. That is the ultimate job of any financial system. To move money from those who have it, to those who need it. Now what proportion of the total black money comes into the financial system, that no one has any clue off. But its better than people just channelising all their black money into land and other forms of real estate. Also as more of this money comes into the financial system the greater are its chances of being detected.
6. The other interesting thing is that banks are helping channelise black money into insurance and not mutual funds. The main reason for this is the fact that insurance companies pay a much higher commission than mutual funds do, even though mutual funds remain a much superior mode of investing. It also goes with the cross selling that banks tend to do these days given that almost all of them own insurance companies. So if you have ever wondered why the moment you enter a bank they try to sell you all kind of insurance policies and not attend to the need you really went there for, you now know the answer.
7. Another major reason for banks selling insurance and not mutual funds to this set of clientèle who wants to put its black money to work is the fact that the know your customer (KYC) norms for mutual funds are much stronger than those required to invest in insurance. This is clearly an anomaly that needs to be done away with. Either mutual fund KYC norms need to be weakened or insurance KYC norms need to be strengthened. If it was not for these KYC norms, mutual funds remain a better way of hoarding black money given that they are very liquid. You can buy a mutual fund today and sell out tomorrow (unless you are buying a tax saving mutual fund that comes with a lock-in of three years). The same is not possible in case of insurance which comes in with a minimum lock-in of five years. Hence, mutual funds also need to be provided equal access to black money as insurance has. Also someone who has a lot of black money and is wealthy, doesn’t really need to pay for the “pure” insurance that compulsorily comes with the investment oriented insurance plans.
8. The sting also tells us that banks have double standards. If you are ready to deposit/invest a lot of money with/through them, then they are more than ready to lay out the red carpet for you. If you are not, then try changing your address once and wait for all the proofs they want. Or try asking for a locker, and wait for the bank clerk/relationship manager to tell you that you will also have to open a fixed deposit of a few lakhs to get a locker. Meanwhile as the Cobrapost press release points banks “ allot lockers for the safekeeping of the illegitimate cash, including special large size lockers to accommodate crores of hard cash.” Or try depositing money and the bank clerk will give you a nasty look for having to count the total amount of money you are depositing. Whereas if you have black money, the bank will come to your residence to collect it. As the Cobrapost press release points out the bank will “personally come to the residence of the client to take the black money deal forward and collect the cash, even bring along counting machine.” Wow.
9. What the sting also tells us is that how simple it is to create a fake identity in this country. The rapist Bitti Mohanty could do it. So can you if you have black money. And the banks will help you with it. As the Cobrapost press release points out “ICICI Bank officials were ready to make a suitable profile for the client, such as showing him as an agriculturist or engaged in some business, so as to make the investment unquestionable. On the other hand, Axis Bank officials proved to be a notch above in inventing fraudulent means. Use “sundry” accounts of the bank, they suggested, to deposit all the illegal cash from where it is to be routed into investment. Either use accounts of other customers, for a fee, to transfer money abroad, or use some shell company and take away a chunk of foreign currency as expenses toward business-cum-leisure trips.”
10. And to conclude, what the sting clearly tells us is that everybody who pays Income Tax in this country is basically an idiot who is being taken for a royal ride. If you have a lot of black money and you are not paying tax on it, chances are somebody out there is waiting for you with a red carpet.
Please go find him.

The < a href="http://www.firstpost.com/business/10-things-that-the-cobrapost-sting-tells-us-about-banks-661376.html">article originally appeared on www.firstpost.com on March 14, 2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek)