Budget 2017: Unless Narendra Modi govt changes its Nehruvian mindset on criminal taxation level, growth will remain a pipe-dream, says Surjit Bhalla

By: |
New Delhi | Updated: January 28, 2017 11:07:22 AM

There has been a lot of well-intentioned talk about the need for employment growth in manufacturing in India. Most of us (including myself) have attributed the low rate of employment growth to antique, and counter-productive, labour laws.

One of the lasting bad legacies of Nehru’s India, and that incorporates all governments (including Modi’s BJP-led one) is the belief that profits are “bad”, that entrepreneurs are unclean. (Reuters)One of the lasting bad legacies of Nehru’s India, and that incorporates all governments (including Modi’s BJP-led one) is the belief that profits are “bad”, that entrepreneurs are unclean. (Reuters)

There has been a lot of well-intentioned talk about the need for employment growth in manufacturing in India. Most of us (including myself) have attributed the low rate of employment growth to antique, and counter-productive, labour laws. Some of us have suggested that part of the reason for the dismal state of manufacturing in India is because of the high real interest rate regime. But none of us has dared to suggest that the real cause of the lack of job creation in India is the high rate of taxation of profits for Indian firms.

One of the lasting bad legacies of Nehru’s India, and that incorporates all governments (including Modi’s BJP-led one) is the belief that profits are “bad”, that entrepreneurs are unclean. Hence, the consistent policy of not just high taxation of productive activities, but extremely high taxation. The Modi government correctly realised that the major impediment to job creation and industrial growth in India was our rotten standing in the World Bank’s index of Ease of Doing Business (WB-EoDB). Hence, the ambitious target, applauded by all, of putting India in the top 50 countries within a short span of three years. Well, the government did bring about reforms (some BJP states have moved on labour reforms, a model bankruptcy law was introduced, and GST legislation was passed). In addition, FM Jaitley began the process of reducing corporate tax rates to 25 % by 2019.

Like all others, I was shocked to learn that, despite India’s reform efforts, the World Bank had barely moved the needle on our EoDB ranking; it moved a few notches in the first year, and for the last two years, the ranking has been stuck at 130 (actually 131 in the 2016 edition and 130 in the 2017 edition). On examination of the voluminous data on EoDB for close to 200 countries, I am no longer shocked.

I am deeply saddened. And confident of the following prediction. Unless the government begins to change its Nehruvian mind-set on the high, indeed criminal, taxation level of Indian corporates, Make in India, accelerated growth in manufacturing, etc, will remain a pipe-dream.

I want to offer two sets of statistics in support of this pessimism (if the Budget does not begin to change the policy of high taxation). First, the comparative nature of manufacturing growth in India. One indicator is the maximum average 10-year growth, i.e., what is the best a country has been able to achieve over any consecutive 10 year period. For 79 non-oil developing countries with population over 1 million, India ranks 44th. The maximum rate of decadal manufacturing growth in India was 8.2% (2003-2012). In contrast, for Pakistan, the maximum is 12.2%, for Bangladesh 10.3%, for Indonesia 13.6% and for Vietnam 11.9%. Oh yes, and China was 13%.

The second statistic is the nature of taxation of corporate profits. In my previous article, (“Taxation: The enemy within”, The Financial Express, January 25) I had documented the extremely high nature of corporate taxes in India. For the same countries listed above—the main competitors of India—the level of taxation in the current year (World Bank Ease of Doing Business data) is: Pakistan, 33.5%, Bangladesh 34.4%, Indonesia 30.6%, Vietnam 39.4% and China 68%. Ever since the deceleration in China’s GDP growth began a few years ago, the buzz among Indian economists has been as to how Indian manufacturing, and manufacturing exports, can benefit from China vacating the low-end manufacturing space.

You May Also Want To Watch:

One of the most labour-intensive industries is textiles, and India has been a long-term player in this field. So long-term and unsuccessful that both Bangladesh and Vietnam, significantly behind us a few years ago, are rapidly catching up. Five years ago, India exported $33 billion worth of textiles, with Bangladesh $19.1 billion, and Vietnam $16.8 billion. In 2015, Indian textile exports were at $37.2 billion, Bangladesh at $28.1 billion and Vietnam, $27.3 billion.

And what is the favourite explanation among “experts” about this lack of comparative performance? The rupee is over-valued. Now there are several different estimates of the valuation of the rupee floating around; my own guess is that the rupee is one of the most under-valued currencies in the world. But let us give the benefit of the doubt to those who think the exchange rate is over-valued, i.e., the rupee should depreciate. Assume for a moment that the rupee is 10% over-valued. If the margin of profit is 100 per unit, then a Bangladeshi firm post-tax takes home 65. With a 60% tax rate, the Indian firm takes home 40, i.e., the Indian firm takes home only two-thirds of the profit of a similar firm in Bangladesh. You can calculate how much of the exchange rate devaluation tail (tale) you want to wag to get Indian textile exports to be competitive again—the answer that it is not possible to do so via exchange rate change will remain.

I am not an expert on ancient texts, but where does it say that one should not look at evidence before coming to policy conclusions? And where does it say, going back to the inherited and prevalent mindset, that making money is evil and hence should be heavily taxed? My column has been titled No Proof Required for the better part of the last decade. Every time I think of changing the title, along come some experts who actually believe that one does not need proof to be logical, or convincing.

Take the case of the recent discussion about whether the Modi government should re-introduce taxation of long-term capital gains (LTCG)—and possibly increase tax on short-term capital gains (STCG) to 20-30% (from the present level of 15%). And why should Jaitley do that? Because the Indian rich should pay more taxes. What was the major rationale for demonetisation? To reduce corruption. How does black money/wealth happen? Primarily because of tax-evasion. How can you reduce tax-evasion/corruption? By imposing heavy penalties, including shooting the violators (as practised in some countries). Are there other methods possible? The only other method, known to man, woman, or policy maker, is by providing incentives in the form of tax rate reductions, not increases.

Again, let us give the benefit of the doubt to these worthy tax experts (as we did above to the exchange rate specialists). Using detailed ministry of finance data for the years 2011-12 to 2013-14, a period in which the Nifty increased by a cumulative 7.5%, cumulative long-term capital gains were R194 tc (thousand crore), short-term capital gains R61 tc, and capital losses were R152 tc. Net long-term capital gains was R(194-152) or 42 tc.

How much tax revenue did the government obtain from the stock market? About R25 tc, composed of R9 tc of STCG tax, and R16 tc of securities transaction tax. Even with a zero tax on LTCG, the government is obtaining revenue at close to a 25 % tax rate! Let me repeat. Total capital gains, short- and long-term—R(61+42) or103 tc. Total tax collected from the capital markets: STT equal to R16 tc, and STCG tax equal to R9 tc. Effective tax rate on stock market transactions—24.3 %. And that has to be among the highest, if not the highest, in the world. And some experts would want to raise it further!

There is no reason why the government should re-introduce LTCG. It is hoped our eminent experts recommending the same take time-out to look at the costs and benefits of each tax introduction, and how India stands in the ultra-competitive world. The goal of taxation is to maximise tax revenue, not to satisfy some sophomoric notions of morality, or confused notions of taxation. And taxes are obtained from productive economic activity, something we Indians systematically fail to encourage. And when you have unreasonable rates of taxation, you will logically encourage corruption. If we are going to change mind-sets, let us begin by changing our belief, and philosophy, and practice, of taxation.

The author is contributing editor, The Financial Express, and senior India analyst at Observatory Group, a New York-based macro policy advisory group. Views are personal. Twitter: @surjitbhalla

Do you know What is Wholesale Price Index (WPI), Public Debt, Finance Commission Grants & Other Transfers, Economic Survey, State Finance Commission? FE Knowledge Desk explains each of these and more in detail at Financial Express Explained. Also get Live BSE/NSE Stock Prices, latest NAV of Mutual Funds, Best equity funds, Top Gainers, Top Losers on Financial Express. Don’t forget to try our free Income Tax Calculator tool.