What Mainstream Media DID NOT TELL YOU About GST

On August 3, 2016, the Rajya Sabha, the upper house of Indian Parliament, finally passed the 122nd Constitutional Amendment Bill for the introduction of the Goods and Services Tax(GST).

The passing of the Bill will be looked at as an important achievement for the Modi government. Also, credit must be given to the Modi government for reaching out to the opposition and getting almost everyone on board (excluding the AIADMK party) to get the Bill passed in the Rajya Sabha.

To be honest, I didn’t think this would happen and which is what I had said in my past pieces. Nevertheless, the Bill could have been passed during the period 2009-2014, if the Bhartiya Janata Party, which is in power right now, hadn’t opposed it as vehemently as it did.

The television and the print media have gone totally gaga about the whole thing. If you were watching any television channel after the GST Bill was passed on August 3, you would think, looking at the excitement of the anchors, that the Indian per capita income had just crossed that of the United States.

The excitement of the mainstream media notwithstanding there is a lot that remains to be done for a Goods and Services Tax to become a reality. Here is what needs to happen on the legislative front:

a) The Constitutional Amendment Bill will first go back to the Lok Sabha in order to clear the amendments made to it in the Rajya Sabha. The Lok Sabha had earlier passed the Bill in May 2015. This should be fairly straightforward given that the Bhartiya Janata Party led National Democratic Alliance has the required numbers in the lower house of the Indian Parliament.

b) After this is done, 15 or more states will have to ratify the Constitutional Amendment Bill.

c) Then 29 states and two union territories will have to pass their own GST Bills.

d) The Parliament will have to pass the actual GST Act and the interstate GST Act, which will specific the structure of the tax and enable its collection.

As of now this seems doable given that the two Acts that need to be passed by the Parliament need a simple majority of more than 50 per cent and not two-thirds majority as was the case with the GST Constitutional Amendment Bill. Nevertheless, this will take time and when things take time, it is always possible that political parties change their mind.

Further, the GST Constitutional Amendment Bill will lead to the creation of the GST Council comprising of the finance minister of the union government, who will be its Chairperson, as well as the finance ministers of state governments. The GST Council will essentially go about setting the tax rates.

Before we go any further, it is important to understand what GST exactly is, and how will it help improve India’s taxation system.

What is GST?

India currently has many indirect taxes. Indirect tax is essentially a tax on goods as well as services and not income or profits, for that matter. India currently has a plethora of indirect taxes both at the state government level as well as the union government level. The GST will subsume many of these taxes. It hopes to have one indirect tax for the whole nation and this will convert the country into one unified common market.

The GST or value added tax(VAT), as it is known in other parts of the world, is already present in large parts of the world, as can be seen from the following chart.

Goods and Services Tax in India

How do things stand in India as of now?

Up until now, the Constitution empowers the Union government to levy an excise duty on manufacturing. Let’s take the case of a company which manufactures cars. It needs to pay an excise duty to the union government on every car that it manufactures. The current rate of excise duty is 12.5 per cent on small cars. While, the company pays this tax to the government, it ultimately recovers it from the end consumer who buys the car.

The union government can also levy a customs duty on exports as well as imports. Further, the constitution allows, the Union government to levy a service tax on the supply of services, which the state governments can’t.

On the other hand, the State governments are allowed to levy a value added tax(VAT) or a sales tax on the sale of goods. This division has essentially led to a multiplicity of taxes.

As the Report of the Select Committee of the Rajya Sabha on the 122nd Amendment Bill of the Indian Constitution presented in July 2015 points out: “This exclusive division of fiscal powers has led to a multiplicity of indirect taxes in the country. In addition, central sales tax (CST) is levied on inter-State sale of goods by the Central Government, but collected and retained by the exporting States. Further, many States levy an entry tax on the entry of goods in local areas.”

This multiplicity of taxes has led to an inherently complicated indirect tax structure. As the Select Committee Report points out: “Firstly, there is no uniformity of tax rates and structure across States. Secondly, there is cascading of taxes due to ‘tax on tax’. No credit of excise duty and service tax paid at the stage of manufacture is available to the traders while paying the State level sales tax or VAT, and vice-versa. Further, no credit of State taxes paid in one State can be availed in other States. Hence, the prices of goods and services get artificially inflated to the extent of this ‘tax on tax’.”

Let’s understand this through an example

Let’s take the case of a dealer in one state buying goods from another state worth Rs 1,00,000. As the goods are moving from one state to another, on this, he has to pay a central sales tax of Rs 2,000 (2 per cent of Rs 1,00,000). His effective purchase price works out to Rs 1,02,000. On this he builds a margin of Rs 8,000 and his sales price works out to Rs 1,10,000.

When he sells this good, the state sales tax (or the value added tax) will be charged on Rs 1,10,000. If the tax rate is 5 per cent, then it will work out to Rs 5,500 (5 per cent of Rs 1,10,000). This means that the final price of the good would be Rs 1,15,500 (Rs 1,10,000 + Rs 5,500).

In this case, the state sales tax is also being paid on the central sales tax of Rs 2,000 that has already been paid. Central sales tax paid while purchasing goods from one state is not available as an input tax credit while selling the goods in another state. This leads to a cascading effect as tax on tax needs to paid. In this case the cascading effect is Rs 100 (5 per cent of Rs 2,000 of central sale tax). This ultimately gets built into the price of goods, making them more expensive than they should be.

What are the practical implications of this?

The cascading effect and the fact that the indirect taxes already paid in one state cannot be deducted while paying indirect taxes in another state makes many Indian businesses uncompetitive. The Report on theRevenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST) (or better known as the Arvind Subramanian Committee Report) has an excellent example.

As the report points out: “Consider a simple example, where intermediate goods produced in Maharashtra go to Andhra Pradesh for production of a final good which in turn is sold in Tamil Nadu. Effectively, the goods will face an additional tax of 4 per cent, which will reduce the competitiveness of the goods produced in Andhra Pradesh compared with goods that can be imported directly to say Chennai from South and East Asian sources.”

This basically happens because goods move between states twice and a 2 per cent central sales tax has to be paid each time. As mentioned earlier, tax paid in one state cannot be deducted while paying more indirect taxes in another state. This essentially means that a programme like Make in India cannot take off in many cases.

What are the other implications?

Other than central sales tax, state governments levy entry taxes as well. These can be like octroi in order to fund a local municipal body or otherwise. These taxes are collected while goods are entering the state or a town. This explains to a large extent why trucks in India move as slowly as they do. This essentially drives up logistical costs.

As the Subramanian Committee report points out: “One study suggests that, for example, in one day, trucks in India drive just one-third of the distance of trucks in the US (280 kms vs 800 kms). This raises direct costs (wages to drivers, passed on to firms), indirect costs (firms keeping larger inventory), and location choices (locating closer to suppliers/customers instead of lowest-cost location in terms of wages, rent, etc.). Further, only about 40 per cent of the total travel time is spent driving, check points and other official stoppages take up almost one-quarter of total travel time. Eliminating check point delays could keep trucks moving almost 6 hours more per day, equivalent to additional 164 kms per day – pulling India above global average and to the level of Brazil. So, logistics costs (broadly defined, and including firms’ estimates of lost sales) are higher than the wage bill or the cost of power, and 3-4 times the international benchmarks.”This will be possible if GST becomes the order of the day. The entry taxes will be subsumed under GST. This will lead to a dismantling of check posts at state borders and there will be no need for trucks to be held up.

Around 72 per cent of Indian freight moves through roads. Hence, eliminating check posts will lead to a faster movement of goods through the length and breadth of the country. Crisil Research estimates that “eliminating delays at check posts will yield additional savings of 0.4-0.8% of sales [of companies].”

While, the state governments are yet to agree to removal of border check posts, as and when this happens, it will be one of the bigger benefits of the GST. If it doesn’t, it will make GST a little less useful.

What will GST do about all this?

The GST will subsume multiple indirect taxes. Take a look at the following table. It points out the indirect taxes which will come under GST and indirect taxes which won’t.

GST TAX table

While GST plans to subsume many indirect taxes it does leave out several taxes as well. Hence, in that sense GST is not a one nation one tax that it is being made out to be.

How will GST work?

The GST will take the cascading effect of tax on taxes out of the equation. It will allow input tax credit for indirect taxes that have already been paid irrespective of what kind of indirect taxes have been paid and where they have been paid.

Take a look at the following table:

Basic Information/Kind of TaxManufacturerWholesalerRetailerTotal
A. Transactions (exclusive of tax)
1. Sales6008001,2002,600
2. Purchases06008001,400
3. Value-added (A1-A2)6002004001,200
B. VAT/GST
4. Tax on sales (10% of A1)6080120260
5. Tax on purchases (10% of A2)06080140
6. Net tax liability (B4-B5)602040120
C. RST
7. Tax on retail sales (10% of A1/R)120120

Source: Professor Mukul Asher of the Lew Kuan Yew School of Public Policy, National University of Singapore

There are three levels in the above table- the manufacturer, the wholesaler and the retailer. Let’s start with the manufacturer who sells a product for Rs 600 to a wholesaler. He does not purchase any inputs and makes everything in house (I know this is an unrealistic assumption, but it just keeps the Maths a little simple).

On this, the manufacturer pays a tax at the rate of 10% which amounts to Rs 60. The wholesaler sells the product for Rs 800. On this he has to pay a tax at the rate of 10 per cent. This amounts to Rs 80, but he also gets credit for Rs 60 indirect tax which the manufacturer has already paid. Hence, his tax outflow amounts to Rs 20.

The retailer finally sells the product for Rs 1,200. On this he pays tax at the rate of 10%. This amounts to Rs 120. But he gets credit for Rs 80 (Rs 60 paid by the manufacturer and Rs 20 paid by the wholesaler). Hence, he actually pays a tax of Rs 40. In this way, there is no cascading effect and all the tax that has already been paid is taken into account.

What this also tells us is that GST is a destination based tax and will finally accrue to the government once the final customer has bought the good or the service. This explains why parties that rule states like Bihar and Uttar Pradesh have come out in its support. While these states may not have a large industrial base, they do have consumers.

How does all this help?

The GST has a self-policing feature built into it. As the Subramanian Committee report points out: “To claim input tax credit, each dealer has an incentive to request documentation from the dealer behind him in the value-added/tax chain. Provided, the chain is not broken through wide ranging exemptions, especially on intermediate goods, this self-policing feature can work very powerfully in the GST.”

As Crisil Research points out: “Since input tax credit will be available for all taxes paid earlier in the value chain, firms would require evidence of compliance from the preceding links to claim set-offs. Thus, they would prefer sourcing inputs from compliant firms. This could increasingly bring unorganised players under the tax net, thereby reducing their price competitiveness vs. organized players.” This will be one of the biggest benefits from the GST over the long-term as it will make the entire system more transparent.

This could also bring down the price competitiveness of unorganised players as they will have to go legitimate in order to keep their business going. This will increase their costs and could help the more organised players, who already have a strong information technology infrastructure in place. The following table shows the proportion of unorganised players sector wise.

GST Sector table

But there might be some starting troubles on this front. The onus is on the customer to prove that all the suppliers in the value chain have paid their share of taxes, if he wants to take the input tax credit. This is as per Section 16(11)(c) of the Act. Basically what the section says is that if a supplier has not furnished proper returns or made the correct payment, then the customers of the supplier cannot avail of the input tax credit. And if it has been given, it will be reversed.

What will be the rate of tax?

This is something that the GST council headed by the finance minister needs to decide on. The Subramanian Committee has basically recommended four rates of taxes. A rate of 2 to 6 per cent for precious metals. A low rate on goods of 12 per cent. A standard rate on goods and services between 16.9 per cent to 18.9 per cent. And a high rate on goods at 40 per cent.

It is important that the GST council chooses a reasonable rate of tax. The unweighted OECD average rate for GST was 19.1 per cent in 2014 and 18.7 per cent in 2012. The recommendation of the Subramanian committee of a standard rate of 16.9 per cent to 18.9 per cent is in line with the OECD average.

Given the current rate of service tax is 15 per cent (including the cesses), a tax rate of 16.9-18.9 per cent is likely to make services expensive in the short run. This basically means that stuff on which you pay service tax (from your mobile phone bills to your credit card bills) is likely to become more expensive.

Crisil Research expects inflation as measured by the consumer price index is likely to go up by 60 basis points in the short-term. This will be in line with global evidence where inflation does go up in the short-term wherever good and services tax is actually implemented.

The trouble is that the rate of inflation is already looking up. Also, by the time GST becomes the order of the day, the next Lok Sabha elections will be around one to two years away. Will the government be willing to take on this risk? In the run up to the Lok Sabha elections the rate of inflation as measured by the consumer price index anyway goes up, as the government increases subsidy spends.

Why states like the idea of GST?

The state governments have come around to the idea of GST primarily because it allows them to tax services, which isn’t the case as of now. The GST being adopted has a dual structure with both the union government as well as the state governments levying a GST. Both the central GST and the state GST will be levied on every transaction of supply of goods and services, happening within a state. The taxes will not be levied on exempted goods and services.

As Crisil Research points out: “Multiple exemptions exist under the present tax system – the Centre has ~300 items exempted from central excise duty, while the States (together) have ~90 items exempted from VAT. These will be merged into a Final synchronized exemption list under the GST regime.”

It needs to be mentioned here that longer the list of exempted goods and services, higher the standard rate of GST will have to be. Given this, the government will have to limit exemptions if it wants a proper GST.

Other than central and state GST, there will be an interstate GST for transactions happening between states and it will be collected by the union government. The interstate GST will be roughly equal to the central GST plus the state GST. Input tax credit will be available on interstate GST. The following chart shows how the interstate GST will work.

IGST Model

What are the potential areas of conflict?

The former finance minister P Chidambaram of the Congress party has been talking about a standard GST rate of 18 per cent. The Kerala finance minister Thomas Isaac has remarked that capping the 18 per cent rate is too low. Other finance ministers have said the same thing.

A report in The Times of India suggests that Isaac has recommended a standard rate of 22-24 per cent, in order to ensure that states do not lose out on revenue. The situation as of now seems to suggest a standard rate of 20 per cent or more, will be arrived at.

To this Arvind Subramanian, chief economic adviser to the ministry finance said that a standard rate of “higher than 18-19% will stoke inflation”. This is primarily because the tax on services which is currently at 15 per cent will see a huge jump.

It remains to be seen what rate the GST council comprising of state finance ministers and the union finance minister come around to.

R Jagannathan writing for Firstpost makes this point in the context of small cars. An excise duty of 12.5 per cent is levied on small cars. Then there is the state level sales tax or value added tax of 12.5-14.5 per cent. The union budget this year added a one per cent infrastructure cess on cars. Over and above all this, some cities charge an octroi as well.

Hence, we are talking about an effective tax rate of around 28 per cent. If the standard rate of GST is 18-19 per cent then prices of small cars will come down. Crisil Research expects that the prices of small cars to come down by about 10 per cent.

But this is assuming that state finance ministers come around to the idea of 18 per cent standard rate of GST. As Jagannathan asks: “Why would any sensible finance minister at Centre or states reduce this to 18 percent?”This will continue to remain a tricky issue given that states need to subsume a whole host of taxes into the GST and are likely to demand (in fact they are already demanding) a standard rate of 20 per cent or more.

Also, there is the question of how will states compensate municipal corporations for taxes that are subsumed into the GST. Take the case of octroi. The Brihanmumbai Municipal Corporation makes a lot of money through octroi. If GST were to become the order of the day, the octroi will be subsumed into it.

As R Jagannathan writes in a column on Huffington Post India: “The Mumbai Municipal Corporation’s Octroi collections annually are in the range of Rs7,000-8,000 crore. Will GST collections in Maharashtra be enough to finance this revenue loss?” This is a question worth asking.

Further, the GST system as it has been envisaged will need a solid information technology backbone. This information technology system will essentially lead to a lot of lower level bureaucracy, which runs India’s indirect tax system, becoming useless. (Think of all those employees manning check posts on state borders for one).

While, the government does not fire employees, a move to GST will lead to the income from corruption for the lower level bureaucracy coming down. And this is unlikely to go down well with them. They, as always, remain in a position to create problems.

Also, in a recent interaction with a few economists, I was told that the state level bureaucracy remains unprepared for implementing the GST. The fact that GST is a destination based tax and not an origin based one, which is one of its core points, remains unclear to many of them.

The fiscal deficit conundrum

For the first five years, the union government will compensate the states for the loss of revenue arising because of GST. This is the known unknown that can really create a problem. If the compensation demands from states are more than what is expected, the fiscal deficit of the central government can shoot up. Fiscal deficit is the difference between what a government earns and what it spends.

In this scenario, achieving the fiscal deficit target that finance minister Arun Jaitley has set for the government will become difficult. In the budget speech made in February 2015, Jaitley had said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18. Running up a higher fiscal deficit will have its own set of repercussions.

What are the advantages of GST?

As we have already seen GST is basically a self-policing system and makes the entire system more transparent. The Subramanian Committee report points out that the GST “is a stark example of a tax believed to facilitate enforcement through a built-in incentive structure that generates a third party reported paper trail on transactions between firms, which makes it harder to hide the transaction from the government.”

This basically ensures that the tax collected by the government goes up. As analysts Saurabh Mukherjea, Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital point out: “Cross-country evidence suggests that the introduction of GST boosts the tax-to-GDP ratio by 1-2% points.” The analysts feel that GST will boost tax collection in India by bringing the unorganised sector which accounts for 59 per cent of India’s economy, under the purview of taxation.

While the rate of inflation is initially expected to go up, over the longer term, the inflation does come down as the cascading effect of indirect taxes is done away with and the cost of doing business comes down.

As the Ambit Cpital analysts point out: “Whilst the introduction of a single GST helped reduce inflation in New Zealand as well as Canada, inflation rose moderately in Australia and Thailand. However, the increase in inflation in Australia as well as Thailand was driven by unique factors such as domestic supply constraints. After adjusting for these factors, inflation in these two countries too was lower post GST implementation.”

And what about the GDP?

The finance minister Arun Jaitley has said in the past that GST is likely to push up the Indian GDP growth by 1 to 2 per cent. “This (GST) has the potential to push India’s GDP by one to two per cent,” Jaitley had said in April 2015. Jaitley’s statement was probably made on the basis of a December 2009 report brought out by National Council of Applied Economic Research(NCAER). In this report NCAER said that other things remaining the same the implementation of GST is likely to push up India’s GDP “somewhere within a range of 0.9-1.7%”.

The evidence on GST increasing GDP growth (or economic growth) is at best sketchy. As the Ambit Capital analysts point out: “Whilst it is difficult to assess the impact of GST on economic growth (as GDP growth is affected by a range of variables), cross-country evidence suggests that there is no clear evidence that the introduction of GST necessarily leads to higher GDP growth. Although the introduction of a single GST limits inefficiencies created by a heterogeneous taxation system, there is little evidence that it helps boost GDP growth rates.”

To conclude, there are many good things about the GST. Nevertheless, it is not a done deal yet and a few major issues remain, which will continue to test the Modi government in the days to come. Also, it is not the be all and end all, that the media is making it out to be. It is just one of the factors that will set India right in the years to come.

This column originally appeared in Vivek Kaul’s Diary on August 5, 2016

Postscript: I will be taking a break from writing the Diary and will be back after August 15. Here is wishing everybody a Happy Independence Day in advance.

Here is More Evidence on India’s Love for Black Money

rupee

In the budget speech made on February 28, 2013, the then finance minister P Chidambaram 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.”

This statement caused a lot of hungama at that point of time. Recently, the revenue secretary Hasmukh Adhia made a similar sort of statement. “There are only 1.5 lakh individuals whose total income would be above Rs 50 lakh,” Adhia recently remarked.

This statement by Adhia has been largely ignored. It essentially implies two things: a) India is a poor country where very few people actually earn more than Rs 50 lakh. b) Very few Indians actually pay income tax and black money forms a major part of the Indian economy. Black money is money which has been earned, but on which tax has not been paid. While, there is no denying that India is a poor country, in this context the second option makes more sense.

In a country of close to 125 crore people, only 1.5 lakh individuals, or 0.012% of the population has an income of over Rs 50 lakh. This is a tad difficult to believe. The consumption patterns clearly prove otherwise.

One argument that can be made here is that many people earning over Rs 50 lakh are making money in forms that are tax-free, like capital gains and dividends from stocks. Dividend earned from stocks has been tax-free for a while now. In the budget presented in February earlier this year, the finance minister Arun Jaitley introduced a “tax at the rate of 10% of gross amount of dividend…payable by the recipients, that is, individuals, HUFs and firms receiving dividend in excess of Rs 10 lakh per annum.” (HUFs = Hindu Undivided Families).

While Chidambaram had used the phrase “taxable income”, Adhia just used the term “income”. So in Chidambaram’s case it is clear he meant that only 42,800 Indians had a taxable income of more than Rs 1 crore. Hence, there are more than 42,800 Indians making more than Rs 1 crore per year. This would include those who make money through capital gains and dividends from stocks, on which taxes need not be paid.

In Adhia’s case, he has just used the term “income”. Hence, the 1.5 lakh individuals who make more than Rs 50 lakh per year, would also include those who make money in forms, on which income tax does not have to be paid. It also includes those who make more than Rs 50 lakh per year, but whose taxable income is less than Rs 50 lakh, given that they make use of various deductions that are available.

Adhia’s statement was made in a certain context. In a notification put out on April 1, 2016, the ministry of finance had said: “With Assessment Year 2016-17, individuals and HUFs filing their returns of income in ITR-1, ITR-2, ITR-2A and ITR-4S, having income exceeding Rs.50 lakh will now be required to furnish information regarding assets and liabilities in Schedule-AL of the relevant ITR form.”

Basically those earning more than Rs 50 lakh would now have to declare their assets (cars, investments, property etc.) as well as liabilities (like loans being re-paid) while filing their income tax returns.

There were some protests against this move, which led Adhia to state that: “There are only 1.5 lakh individuals whose total income would be above Rs 50 lakh. This schedule in ITR only applies to ultra rich and will not affect the common man… 99.5 per cent taxpayers are not affected by this requirement. Only the ultra rich will have to give this information in their I-T Returns.”

On the face of it, this seems like another move on the part of the Narendra Modi government to crackdown on black money. While this might look like another move to tackle black money, to me it seems more like a classic bureaucratic exercise to harass those who are already paying income tax and following the law of the land.

The number 1.5 lakh is anyway so small that this lot of people is probably not in a position to hide its income given that most of it is tax deducted at source(TDS). Chances are that these individuals are either salaried and/or honest.

Hence, what is the point in making their income tax filings more complicated than it currently is? Is the chartered accountant(CA) lobby at work? Is it trying to ensure that filing income tax returns gets more complicated by the year, leading to more CAs being able to charge more?

I really don’t have answers for that. But in a country where conspiracy theories thrive, this one makes immense sense.

Also, from April 1, 2016, onwards, many high value transactions are to be reported to the income tax department.

These include: a) buying or selling of immovable property worth more than Rs 30 lakh. b) purchase of shares worth more than Rs 1 lakh or mutual funds worth more than Rs 2 lakh. c) payment of credit card bills more than Rs 2 lakh. d) investment of more than Rs 1 lakh in gold ETFs. e) investment of Rs 5 lakh or more in debentures or bonds of a company. f) cash deposit of more than Rs 10 lakh made into a savings bank account.

Hence, the government will have access to most of the information that it now wants from those earning more than Rs 50 lakh to declare in their income tax returns. Why is it still asking for this information? One possible explanation is that given the slow pace at which our bureaucracy works, the expectation is that this information will not be shared with the income tax department at a fast pace or on a regular basis. Hence, the department now wants the information coming to it directly. Again, I don’t have any evidence for this, but it makes for a good conspiracy theory.

Also, the moot question is what is the government doing to expand the tax base? Is it looking at the right places for people and institutions which are avoiding to pay income tax? Take the recent data on money supply released by the Reserve Bank of India.

Between March 2015 and March 2016, the currency with the public went up by 15% or Rs 2.08 lakh crore. Between March 2014 and March 2015, the jump had been 10.6% or Rs 1.33 lakh crore. So why this sudden jump?

The RBI governor Raghuram Rajan explained this in an interaction with the media after presenting the first monetary policy statement for this financial year on April 5. He explained that assembly elections are currently on in several states. Around this time, the cash in hands of the public increases.

As Rajan said: “you can guess as to reasons why…we also guess.” This increase is not only in the states that go to elections but also in neighbouring states. Having said that, this explains only a part of the increase.

This money that has gone out of the banking system to finance elections, is very easy to track. The income tax department can easily check if tax has been paid on this income. Typically, black money finances elections. But given that this money is financing assembly elections, and politicians are involved, the chances of anything like this happening are remote.

The column originally appeared on Vivek Kaul’s  Diary on April 7, 2016

Mr Jaitley, You Just Made Every Honest Tax Payer Feel Like An Idiot

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010The finance minister Arun Jaitley presented his third budget today. It was expected that Jaitley would take steps towards improving the number of Indians who pay tax. But that doesn’t seem to have happened, instead he has proposed to launch an amnesty scheme for those who have black money within the country.

The point to increase the number of Indians who pay tax was an important part of the Economic Survey which was tabled before the Parliament on Friday i.e. February 26, 2016. As the Economic Survey points out: “Controlling for the level of democracy, India’s ratio of taxpayers to voting age population is significantly less than that of comparable countries. This implies that while at present about 4 per cent of citizens who vote pay taxes, the percentage should be about 23.”

The Survey further points out that around 85% of the country is outside the tax net. One clear impact of this is that the government is not able to raise enough taxes as it could. The other impact of not enough people paying tax to the government, is that a huge amount of black money builds up in the Indian financial system. The prime minister Narendra Modi had talked a lot about getting the black money that has left the Indian shores back to India, in the run up to the Lok Sabha elections of 2014.

After coming to power, the government did try and launch a scheme to get people to declare their overseas black money and pay a tax as well as a fine on it.

On this “declared” black money, the government planned to charge a tax of 30 per cent and a penalty of 30 per cent. During the compliance period offered by the government, 638 declarants declared assets and income amounting to Rs 4,147 crore. The amount collected was very low, given the huge amount of black money within the country. What this told us clearly is that the government’s plan to uncover black money was a complete damp squib.

The point is that it is next to impossible to get back black money that has left the shores of this country. It could have found its way into any of the around seventy tax havens, all across the world. Even the United States has not succeeded on this front.

Despite this, the Modi government continues to be obsessed with the idea of getting back black money from abroad.  As Jaitley said during the course of his speech: “Our Government is fully committed to remove black money from the economy. Having given one opportunity for evaded income to be declared once, we would then like to focus all our resources for bringing people with black money to books.”

Further, Jaitley also proposed an amnesty scheme for people who have black money within the country. As he said: “I propose a limited period Compliance Window for domestic taxpayers to declare undisclosed income or income represented in the form of any asset and clear up their past tax transgressions by paying tax at 30%, and surcharge at 7.5% and penalty at 7.5%, which is a total of 45% of the undisclosed income.”

Those who declare black money within this compliance window will not face any scrutiny or enquiry under the Income Tax Act or the Wealth Tax Act. They will also have immunity from any prosecution as well.

There are a few points that need to be raised here. First and foremost, the question is how will Jaitley and company get around the Supreme Court on this. The last time such a scheme was launched was in 1997, when P Chidambaram was the finance minister of India. This led to a declaration of Rs 33,000 crore of undisclosed income on which the government collected Rs 10,000 crore tax.

Nevertheless, this led to a lot of outrage and the government had to commit to the court (essentially Chidambaram and the then revenue secretary NK Singh) that there wouldn’t be any amnesty scheme in the future. The question is how will the government get around this?

Also, any amnesty scheme makes the people who honestly pay their taxes look like fools. It tells them they would have been better off not paying taxes. In fact, in his last budget speech in February 2015, the finance minister Jaitley had said: “The problems of poverty and inequity cannot be eliminated unless generation of black money and its concealment is dealt with effectively and forcefully.”

Doesn’t a black money amnesty scheme lead to greater inequity now, Mr Jaitley? 

Further, in June 2015, the union cabinet launched the “Housing for All by 2022” scheme. If the government is serious about this, it needs to some better thinking on how to stop the generation of domestic black money. Jaitley’s budget clearly missed out on that front.

In the past, the Modi government has also opposed the idea of bringing political parties under the ambit of the Right to Information Act. This is not surprising given that it is black money that continues to finance the election costs of the political parties of this country.  It needs to be said that any other political party in power would have possibly done the same.

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

The column originally appeared on Huffington Post India on February 29, 2016

Mr Chidambaram, please don’t fudge data to say that Manmohan was better than Modi

Former finance minister P Chidambaram did a smart thing before the last Lok Sabha elections—he decided not to contest. His son Karti Chidambaram contested instead of him, in the Sivaganga constituency in Tamil Nadu. The junior Chidambaram got around 1.04 lakh votes in a five cornered contest and lost his deposit, having not managed to secure more than one-sixth of the votes polled.

Unlike other Congress leaders, the senior Chidambaram has managed to keep himself partly busy, by writing a Sunday column for The Indian Express. In this column, the former finance minister, tries to tell us every week how the ten year rule of the Congress led United Progressive Alliance (UPA) had been good for the country and how the economy has been in trouble since the Narendra Modi government took over.

The latest column is along similar lines. In this column Chidambaram tries telling us that the Congress led UPA government had left the country in a good shape and the Narendra Modi government has screwed up things, since taking over in May last year.

As Chidambaram writes: “Let us look at the hard data that would be relevant to ‘development’ and ‘jobs’. There are more red lights than green. Yet the GDP(Gross Domestic Product) is estimated to have grown at 7.4 per cent in 2014-15, although the RBI has warned of a downward revision.”

Long story short—Chidambaram seems to believe that the GDP may not have grown by 7.4% between April 1, 2014 and March 31, 2015. And honestly, he may be right about it.

The ministry of statistics and programme implementation released the Gross Domestic Product(GDP) number for 2014-2015 on February 9, 2015. A new method was used to calculate the GDP and as per this method, the GDP growth in the financial year 2014-2015 would come in at 7.4%. This was significantly higher than the 5.5% growth that had been forecast by the Reserve Bank of India, earlier.

The trouble is that the real numbers don’t show this economic growth. Car sales grew by a minuscule 3.9% in 2014-2015. Exports contracted by 1.23%. The total indirect tax collections at Rs 5,46,479 crore were 12.5% lower than the original target of Rs 6,24,902 crore. When it comes lending by banks, it grew by 8.6% between March 21, 2014 and March 20, 2015. In comparison, it had grown by 14% between March 22, 2013 and March 21, 2014.

The Economic Survey released by the ministry of finance today towards the end of February 2015 stated: “The stock of stalled projects at the end of December 2014 stood at Rs 8.8 lakh crore or 7 per cent of GDP.” Further, corporate profitability was dull as well in the latter half of the financial year (October 2014 to March 2015).

It is worth remembering that the numbers highlighted above are real numbers, unlike the GDP which is a theoretical construct. The real numbers make it difficult to believe that the economy grew by 7.4% in 2014-2015. And given that Chidambaram is right in saying what he has in his column. Or so it seems.

The interesting bit comes next, where Chidambaram writes: “I predicted that the economy will revive in 2013-14. It did, and when the UPA passed on the baton to the NDA in May 2014, the GDP had recorded a growth rate of 6.9 per cent in 2013-14.”

So, Chidambaram is basically saying that in 2013-2014, when the Congress led UPA government was in power, all was well. The economy grew by 6.9% and the Congress led UPA passed on a healthy economy to the Narendra Modi government.

Now what is wrong with this argument? Several things. First, you don’t need a PhD in Economics (or an MBA from Harvard, which Chidambaram has), to tell you that 7.4% economic growth (which happened in 2014-2015) is higher than the 6.9% economic growth (which happened in 2013-2014).

Secondly, what Chidambaram does not tell us is that the 6.9% number is also a revised number, which has been calculated as per the new GDP method released by the ministry of statistics and programme implementation. The economic growth as per the old method had been at 5%.

So the point is that Chidambaram does not believe the 7.4% economic growth number as per the new model. But he believes the 6.9% economic growth number which is also as per the new model. And therein lies his double standard.

If he believes in the 6.9% number then he has to believe in the 7.4% number as well because the method involved in calculating them is the same. And that being the case, 7.4% is higher than 6.9%.

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

The column originally appeared on Firstpost on May 25, 2015   

Mr Chidambaram, falling inflation is not deflation

P-CHIDAMBARAM
The former finance minister P Chidambaram writes a weekly column for
The Indian Express newspaper. The latest column published on April 26, 2015, was headlined Across the Aisle: Inflation is bad, but is deflation good?.
Normally I never read economic columns written by politicians for the simple reason that you can never expect them to take a line which is different from their party line. And given that one knows what the party line is on most occasions, there is no point in reading the column. In most cases the politician tries to come up with reasons in order to defend the party line, irrespective of the fact whether that makes good economics or not.
But on this occasion I did read Chidambaram’s piece because the word ‘deflation’ caught my attention. The headline of the piece suggests that deflation is not good. Deflation is the opposite of inflation. Inflation is a situation in which prices are rising. Deflation is a situation in which prices are falling. Why is deflation not good? Once people figure out that prices are falling, they are likely to keep postponing their consumption in the hope of getting a better deal in the days to come.
If this happens, business revenues will most likely fall and so will economic growth. As business revenues fall, companies may try and maintain profits by firing people, among other things.
Those who get fired will spend money only on the most important things. Further, the firings will also have an impact on others who will fear that they might also get fired and in the process postpone expenditure. And so the deflationary cycle will work.
Hence, deflation is bad.
The only thing is that Chidambaram does not define deflation as a scenario of falling prices. As he writes: “Deflation and its consequences: The decline in the rate of inflation could be attributed to many reasons.”
Chidambaram essentially talks about a fall in the rate of inflation and defines that as deflation. A fall in the rate of inflation means that prices are rising, only that they are rising at a slower rate than they were earlier. This is very different from prices falling. The term Chidambaram should have used is disinflation, which essentially refers to a fall in the rate of inflation.
A former finance minister and a Harvard MBA to boot, should not be making a mistake in the usage of these terms. This is Economics 101.
In his column Chidambaram goes on to defend the economic policies followed by the Congress led UPA government between 2004 and 2014. Chidambaram writes that the current government has added to the woes of the farmer by “a paltry increase in Minimum Support Price (MSP), inefficient procurement, increase in prices of fertilisers, poor compensation for lost crop etc.” He goes on to suggest that the UPA tried to help the farmer in different ways: “introduction of MGNREGA in 2006 to supplement farm income/wages; farm loan waiver in 2008 to give partial relief from past debt; and generous increases in MSP between 2004 and 2014.”
Let’s look at these points one by one starting with the debt waiver which was made in 2008. The total amount of debt waived off to farmers was Rs 71,680 crore. While this one time waiver did not bring down any bank, it built in a huge moral hazard into the system. Economist Alan Blinder writes in
After the Music Stopped that the: “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”
The message that was sent to farmers was that in the future there was no need to repay your loans because eventually the government would waive it off. In a country where the banking penetration is low and that remains starved of credit, this was a very short sighted measure aimed at the May 2009 Lok Sabha elections.
Mahatma Gandhi National Rural Employment Guarantee Act(MGNREGA) was launched in 200 of the most backward districts of the country on February 2, 2006. It was extended to all rural districts from April 1, 2008. The scheme aims at providing at least 100 days of guaranteed employment in a financial year to every household whose adults are willing to do unskilled manual work.
The trouble was that MGNREGA essentially became another scheme where money was simply given away without any substantial assets being created.
As T H Chowdhary wrote for The Hindu Business Line in December 2011 “Villages cannot sustain so many unskilled labourers and not-so-literate labour. By creating useless “work” we are promoting dependency among the unfortunate rural, illiterate and unskilled population…An example of the village Angaluru in Krishna district will illustrate how good money is being thrown away for bad results. Out of 1,000 families, 800 had registered themselves as BPL, seeking work under NREGA. So far, it was 100 days at Rs. 100 per day. Even at this, 80,000 mandays of useful work in a year is impossible in a village and that too, year after year.”
Hence, MGNREGA essentially became an exercise of giving away money without any comparable increase in production and this led to high inflation.
These moves didn’t help the Congress led UPA government win many votes either. As Swaminathan Aiyar
wrote in a recent column in The Times of India: “The Congress claimed that its farm loan waiver and MGNREGA (its rural job scheme) won it the 2009 election. Really? Congress won only nine of 72 seats in three very poor states where these schemes should have helped most — Bihar, Chhattisgarh and Odisha.”
Chidambaram also wrote about the generous increase in the minimum support price or wheat and rice between 2004 and 2014. The
MSP is the price at which the government buys rice and wheat from the farmers, through the Food Corporation of India(FCI) and other state government agencies.
Between 2005-2006 and 2013-2014, the MSP of wheat was increased at an average rate of 14% per year.
In 2005-2006, the MSP for common paddy(rice) was Rs 570 per quintal. By 2013-2014 this had shot up to Rs 1310 per quintal, an increase in price of around 11% per year.
This rapid increase in the MSPs led to very high inflation in general and food inflation in particular, between 2008 and 2014.
 As economist Surjit Bhalla put it in a November 2013 column in The Indian Express “For each 10 per cent rise in previous years’ procurement prices, there is a predicted 3.3 per cent increase in the current year CPI…When the government raises the MSP, the prices of factors of production involved in the production of MSP products — land and labour — also go up.” Food inflation hurts the poor the most. Half of the expenditure of an average Indian family is on food. In case of the poor it is 60% (NSSO 2011).
To conclude, if the policies of the Congress led UPA were so pro-farmer, why did the lose the 2014 Lok Sabha election, so badly? Guess, Chidambaram’s next column can try answering that question as well. 

The column originally appeared on The Daily Reckoning on Apr 28, 2015