Sunday, August 30

Waxing Tax Too

In response to Friday evening post, one of my left-leaning intellectual (tautology, really!) friends called me for a not-so-quick tete-a-tete. Though certainly short of acrimony, the censorious tone of this conversation was hard to miss. The upshot of the lesson in economic history - or indeed its trigger - lay in how my blog piece in question had seemingly glossed over the Black Economy of India (emphasis as supplied), the continued advance of this Public Enemy Number One, and the calamitous consequences thereof. In other words, direct taxation reform was a condemnable (the word bourgeois was carefully avoided) distraction.

Frankly, this set me thinking. It does not require Keynesian genius to deduce skews in any economic structure hampered by the presence of an illegal economy. The news gets worse if this parallel economy breasts the tape at one-fifth the total as ours arguably does. So how does this work? In simple terms high preponderance and resultant cultural acceptance make such an economy difficult to unravel. Again, unfettered access to markets minus the burden of tax makes its cash transactions cheaper. The consequently uncompetitive legal economy thence loses marketshare, profit and investible surplus. Clogging growth implies less employment and more pressure on government – and in a regime of floundering tax collections. Need to shore up revenues to fund government spending pushes tax rates north, potentially incentivizing further tax evasion and hence growth for the illegal economy.

So far so good (or bad), in theory. In our case, one could well retrace the path to the days we made our ‘tryst with destiny’. Illegal economic activity had mushroomed in the run-up to independence, typical of wartime economics across centuries, and got a further boost with post 1947 nation-building economic action. Again, the Nehruvian model was resource hungry – revenue had to fund substantial public sector investments. The result was aggressive taxation coupled with a maze of incentives ostensibly put in place to foster savings. The fledgling Indian state just did not have the wherewithal to overcome the resultant tax administration challenges.

As it turned out, our successive few decades saw a pronounced socialistic tilt in policy. The consequent license raj added further question-marks of intention to the existing deficiencies in capability of the tax regime. While profiteering via artificial supply imbalances had been around for years, under the quota-permit system policy formulation as well as enforcement became tools for malfeasance. (This in fact stays the biggest reason for celebrating the open-door approach in Direct Tax Code reform in my last post.)

Be these as it may, the most potent constituent of the parallel economy was the hawala-hundi system that allowed its ill-gotten gains to find their way to safe havens as much as to become a tool to finance new trades – and eventually, politics. Hence, even as the formal economy was constrained with pricing, taxation, forex and current/ capital account convertibility restrictions, enormous money transfers via the illegal market became a fact of life. If cash was in play as input or output (and what nefarious purpose doesn’t do both!) the answer in form of this high velocity-instant speed-currency agnostic money system became the oil greasing the Black Economy.

As various studies humiliatingly point out, the endemic corruption such an all-pervasive Black Economy breeds, can sap individual will away. One does need to conduct Buddha’s Three Questions experiment to know it is well nigh impossible to not have encountered cash-is-king in life if registering a property (such guinea pigs are not far to seek!), selling your car down even sundry household expenses. When the PM-in-waiting laments distribution losses, one sits up and takes notice!

Whither the disconnect with my more learned friend, one may ask. It lies in the essentially populist, two-dimensional corrective action he and his ilk typically advocate. Increasing taxes and duties changes the risk-reward equation making evasion more lucrative; adding more legislative muscle to our inefficient executive breeds more corruption; and expecting a proletariat revolution to solve world hunger is, frankly, quite far-fetched.

So whence the solution? There must be many (only followers of Marx have the liberty to merely preach symptoms without offering a meaningful cure!) and for today, let me merely place the Korea model (if one plug be allowed) for consideration. This involves a large-scale and comprehensive adoption of cards as the sole payment mechanism for multitude of transactions (over a ceiling value, potentially) for individuals. Being electronic, on transaction speed and high-velocity rotations, credit/ debit cards can easily counter the ‘good’ in the Black Economy value-proposition. With increasing computerization, e-banking can work well in tandem with such a payment system, also addressing the Government’s benefit end-user discovery issue. The data explosion thus generated would do wonders for risk mitigation for any self respecting funding institution – also helping buyer and seller price credit right. The government could use this information to plug tax evasion at lower cost, greater accuracy and faster speed. And if a clincher was needed, for a terrorism frontline state as ours, one can well imagine the benefits in better enforcement.

But, better not to stretch my ‘one plug’ luck too much, even for the hand that feeds etc!