Taxing Zenith

Thanks to US president Barak Obama, the new fashion of taxing super-rich has finally come to Indian shores. Prime Minister’s economic adviser C. Rangarajan recently suggested imposing surcharge on income of India’s neo crème de la crème. With an endorsement from the Finance Minister P. Chidambaram the idea of taxing super riches may become a reality in the forthcoming budget. This idea has a stock justification as Indian economy is reeling under the pressure of high fiscal deficit.  Political connotations also appear apt in the given scenario.   But proposal of this taxation seems to be a delicate choice for the finance minister as black economy dimension of higher taxation is no less befitting. Increased taxes on wealthiest elite may fuel the exodus of black money to tax-havens or stimulate them to move in to countries having lower income tax rates.

Current income tax rates are divided into three slabs of 10%, 20% and 30%. Earnings more than 15 lakh are taxed at the highest tax rate.  This range of taxation was last revised more than a decade ago in 1997 when people earning close to fifteen lakh used to be considered among top slot of income holders. Now annual income of a good chunk of Indian population has gone up to 40-50 lacs. Hence it is irrational that people earning 15 lakh and someone who earns just double of that is taxed at the same rate. Pranab Mukherjee in his recent presidential speech accepted the fact that the fruits of liberalization have been increasingly savored by a handful number of people. It didn't trickle down to the scale as was expected. Therefore taxing super rich, at least for the time being, is a concept in chorus with the political thinking of the existing government.

People standing at the peak of income pyramid have reached to the saturation of their consuming power. Their investments are landing at the dead assets like land or gold. While exempting or incentivizing lower income groups in tax rate stimulates general consumption and savings.

This is not all a wild guess that higher taxes may incite people to implicitly flood money towards tax sanctuaries. A latest research from National Institute of Public Finance and Policy (NIPFP), a Govt. think tank,   estimates that India’s current black money economy can be 30% of its Gross Domestic Product (GDP) nearly Rs 28 lakh crore. Income tax base in India is meager and only 5.6 percent taxpayers have a declared income of more than 10 lacs. However, the rate at which luxury cars, pent houses and other extremely expensive and swanky items are being sold in the country is a proof of a gross underreporting of income. Finance ministry has enough data of high value transactions to corroborate this enigma of wealth and rampant tax evasion.

It is historically proven that lower level of tax rates increases tax compliance and higher tax rates result into tax evasion. Therefore higher tax might be temporarily levied on well-heeled population as an instant remedy to the fiscal illness but economy is looking for the long term, stable and transparent tax regime. Widening tax base and strong setup for the prevention of tax evasion is the only panacea for our debilitated tax system.  

GAAR: A Grey Bargain

It is by nature that people try to tinker with tax laws to the best of their creative ability so that their tax liabilities can be avoided. Seemingly Indian policy makers have no problem if their tax laws are trampled which is why honorable Finance Minister P. Chidambaram has finally deferred the execution of General Anti Avoidance Rules (GAAR) by two years. In this era of complex capital flows, every mature economy strives to fight better with the prospect of tax avoidance by enterprises and investors in the guise of tax mitigation. Many countries such as China, Canada, and Australia have GAAR rules enshrined in their tax statute. UK and USA have recently tightened GAAR. It is unfortunate that India couldn’t muster courage to go for such stern and essential tax laws.

GAAR is the set of rules which empowers tax authorities to clampdown on transactions primarily driven towards tax-evasion. If implemented, instead of routing through courts, income tax officers can directly reach out to tax fraudulent by invoking GAAR provisions. It was earlier introduced in March 2012 by the then Finance Minister Pranab Mukherjee but giving in to intense outcry from domestic and foreign investors, PM Manmohan Singh while holding finance portfolio in July, appointed an expert committee headed by Parthasarathi Shome, a former advisor in the finance ministry, to review the GAAR recommendations and suggest a suitable way forward. It is by accepting Shome committee recommendations that Chidambaram has postponed the implementation of GAAR till FY 2015-16.

Lately, Mauritius has emerged as India’s favourite destination for overseas investment replacing Singapore. It is also a major source of capital inflows in India accounting for about 40% of total flows. India’s Double Tax Avoidance Treaty with Mauritius and Singapore is exceedingly manipulated by domestic and foreign investors to minimize their tax-liabilities. Voluminous investment is made via so called Mauritius and Singapore entities of multi-national-business targeting Indian market. This is popularly known as treaty shopping. Few Indian or foreign companies inflate volumes of transactions via continuous and frequent purchase and sale of particular security, commodity or asset, thus indulge in round-tripping trade to avoid capital gains taxes. This round tripping and treaty shopping swallows a good portion of revenues in India who is relentlessly reeling under huge deficits.

There is a school of thought who believes that autonomous power given to tax authorities will result into unnecessary harassment of entrepreneurs and industrialists. Investor sentiment will also be badly affected leading to less FII and FDI inflows. However, leveling these criticisms against GAAR is nothing but an attempt to secure undue interests of investors. The truth of black money converting into white by entering Indian markets through tax havens, as discussed above, is clearly opaque. Accountability of Income Tax Dept. can be maintained. It is not a big deal.  Removing shortcomings of tax laws to outwit its misuse is what is more important.

Global economic environment is quite insecure and uncertain. Seeing this, it is imperative to maintain decent level of law and order in the country. GAAR experience of other countries has rendered positive results to them. Foreign investment in those countries hasn’t come down as it is being feared in India. Govt must motivate fresh FII and FDI as core of its policy initiatives. But it is also paramount to have modern tax laws to avoid misuse. A judiciously tough tax regime makes a nation more credible in the long run.

Fare affair

Central Govt. has finally mustered courage to go for a bold and long-awaited treatment of Indian Railways through fare hikes. The nasty politics of Railways has already taken a heavy toll from this most important economic infrastructure. It took over a decade to Govt. to revise passenger tariff but this is certainly something which should ideally be done on yearly basis. It appears that political leadership has lastly realized that railways can not survive with populist policies and it is imperative to keep revising tariffs in order to keep this mass public transport healthy and moving. For that, Govt. must follow up this decision of fare-hikes with expeditiously establishing a mechanism which keeps regulating the rail fares as per market modalities.

Indian Railways is grappling with over-socialization and over-politicization of the sector. A good chunk of Indian population depends on railways to commute between far-off places. It was no doubt designed for the social benefit but gradually our politicians made it a source of offering political freebies to allure citizens. Political motives of various Govt. didn’t let the railways flourish with the changing times. Railways Ministry failed to understand that it is an economic infrastructure not a Govt. hospital or MNREGA scheme which can be run on subsidized rates. Railways lies in one of the few most important and basic infrastructures of any country. It is unfortunate that on one hand Indian Railways is in dilapidated condition, on the other it is the most expensive railways among other countries.

Monopolization of the Govt. in Railways led it to the crisis it is facing now. It kept on increasing freight fares and didn't touch passenger fares at all, just opposite of what profit-making railways in other countries do. Govt. irrationally increased its fares which resulted into squeezed cargo business of Railways. People relies more on roads to carry their heavy goods and freight trains are used to only carry perishable goods like coal, iron, grain, cereals and fertilizers. Consequently, they don’t make much profit. Instead of freight fare hikes Govt. must think of increasing freight carrying capacity so that the cargo business of railways can flourish.

Railways is reeling under huge losses due to all round loss making operations in goods and passenger segments which results in general level of low productivity. Neither does it make profit nor provide safety and decent amenities to public. Modern travelers are repelled from it and general public flooded it. Modernization of the railways is a must. It is desirable that Ministry goes for network expansion across the country and increase number of trains deployed. Well facilitated platforms and coaches, dedicated corridors, double-decker trains are also needed.

Tariff hikes for passenger trains is welcome but it is high time for Ministry of Railways to realize the dire need of setting up Railway Tariff Regulatory Authority. After all the decision of fixing freight and passenger fare must be kept aloof from political meddling and be regulated by independent and pragmatic authority. Political monopolization of the sector must also come to an end and Public Private Partnership must be encouraged. All going on PPPs projects must be expedited and scaled up. All this would only be possible if Indian Railways falls in the ambit of someone who is genuinely concerned with the economics of railways, not politics of the same.

A Glittering Risk

Gold must not glisten so much so that it makes Indian economy lose its already fading shine. Rising inclination towards gold investment among Indian populace is a cause of serious trouble for the country. It is one of the potential factors behind ballooning current account deficit, which has widened to an all time high of $22.3 billion, or 5.4% of gross domestic product, in the July-September quarter. Current account deficit (CAD) is measured by the difference between a country's exports of goods, services and transfers and total imports within a time period.

Reserve Bank of India, in its recent Financial Stability Report, showed concern over increasing gold imports. As per its draft report “Gold imports have continued to be high and have accounted for, on an average, over two-thirds of the CAD during the last three years. While India’s share in international trade is less than 2 per cent and that in world GDP is less than 6 per cent in Purchasing Power Parity terms, it accounts for a quarter of world demand for gold.”

The investment sentiment in the economy is at its all time low. High inflation is robbing returns on bank savings while mutual funds and equity are not offering attractive returns either. Gold seems to be the safest option for people to invest their hard-earned money. It is a global phenomenon as people tend to go for gold because it provides them a sure hedge against growing inflation and in an insecure economic environment. Only difference is that their gold trading is paper-based unlike ours. Recently SBI proposed an idea of virtual trading of gold instead that of physical. Gold-linked financial instruments, gold bonds etc must be introduced which yield similar returns as this yellow metal does in physical form. Such paper based gold trading might reduce the problem of physical possession of gold which leads to higher import of gold.

According to the most recent available data from the World Gold Council, India's gold demand during the January-September period of 2012 was 607.6 metric tons, down 24% from a year earlier. It could happen because Govt. had doubled the customs duty on standard gold bars to 4%, and non-standard gold bars was doubled to 10%. But a closer data study reveals that gold imports did fall to 131 tons in the April-June quarter but again rose 9% to 223.1 tons in the July-September quarter. A sharp recovery in Q3 is also likely due to peak festival and wedding season buying. Hence Govt. effort of increasing import duties on gold in the current fiscal year, eventually, bore no fruits.  Yet Finance Minister P. Chidambaram again intends to resort to making gold imports costlier. He must also keep in mind that expensive retail price of gold might lead to smuggling of the same. Govt has also asked gold import agencies such as MMTC and STC to lower the volume and value of gold imports.

Gold loans disbursed by banks and other Non Banking Financial Companies (NBFCs) pose a threat to financial stability of banks in India. They lend borrowed cash from banks to people in exchange of gold. RBI says that the bank-debt of these gold-loans companies have increased by 200% over the period of one year. Indian banks will be in trouble if ever NBFCs falter in the wake of volatility in gold price. As per RBI guidelines, these companies can only provide 60% of loan against the value of collateral gold.

Predictions are against any betterment of economic condition in year 2013. This negative sentiment will buttress the trend of gold investment further because real profit through any other savings policies is meager given lower interest rates and inflation. Govt. must understand that bumping up import duties on gold import is not a solution. He would do well if he tries to drift people’s attention away from this yellow metal by offering equally valuable financial products and inflation-indexed policies. Higher gold import is actually not the only problem. Recycling of gold scrap, huge stock of idle gold which is highest in the country and gold-smuggling are few other challenges needing immediate concern. It’s high time that Govt. pursues a viable gold policy.