Godfathers, Fathers and Mothers: A Viewpoint

    In my view, Nobel laureate and World renowned Philosopher-economist, Prof Amartya Sen was the intellectual godfather (in the sense of “godfather to a parents children”) of the UPAs statist welfare-socialism. PM Manmohan Singh and his friends and Associates had profound respect for Prof Sen’s intellectual capabilities. One could even go to the extent of saying that the former were intellectual Chela’s of the latter. Therefore, Prof. Sen’s admonitions relating to Social Welfare, Health, Education & Poverty, were treated virtually as “Gospel” or as “Ten Commandments” by the good doctor, his friends and associates.  Based on global comparative WDI data on Human Development Indicators and government expenditures, the commandments were simple and unambiguous: “Raise expenditures” on Health, Education, Child Development, Women’s development and other welfare programs.

    My observation & analysis suggests the following process thereafter: These recommendations were gladly and unquestioningly accepted by the Left wing of the Congress party whose inspiration was the Congress President, the Mother who gave birth to the UPA's Statist Welfare-Socialism (populism?).  Once accepted by the PM these issues therefore moved immediately to the Congress President led National Advisory Council (NAC) (as all politically remunerative welfare activities had to be attributed to 'the leader'). There, such programs, projects & policies were invariably sought to be loaded with numerous related and unrelated socialist objectives, statist-interventionist approaches and expenditure increases. Not infrequently the original intention of the PM, became a small part of an elaborate scheme of social engineering and business bashing.  These NAC modified (dare I say mangled) schemes, programs and laws returned to the government for execution (which then had to work out how much it would cost, where the money would come from and how they could actually be executed). The Mrs. Sonia Gandhi led NAC can therefore rightly be called the Father/Mother of this approach and can claim full credit for the programs, projects, laws, rules and regulations ordained by it.

       Experience of administering, monitoring and analyzing the numerous existing schemes was ignored or given short shrift. Experience and analysis suggested that without an improvement in the governance of multiplicity of such programs, more money would not have the effect that welfare economists sitting in the Developed countries expected.  One was convinced that without improvement in administration and reduction in absenteeism and corruption, there would be little impact of increased expenditure on health outcomes, educational achievements, pace of poverty reduction, malnutrition etc.[i]  It was suggested that governance improvement should be given equal, if not greater weight initially. The response to such doubts and suggestions was that governance issues could perhaps be addressed at a later stage.    Underlying this hint of future action on governance issues was a conviction that these socialist, welfare schemes, programs and laws would translate into a big electoral victory for the ruling party led, in the next election, by Shri Rahul Gandhi. 

    My earlier work on economic growth and the connection between economy and votes suggested otherwise:[ii] Unless growth was maintained through further policy reforms, a slowing growth rate would nullify any marginal political gains from inefficient, corruption ridden and unproductive welfare expenditures. Thus ineffective programs and slower growth would lose votes, not win them.

 

Only the potential extent of the loss was unclear till the BJP chose Shri Modi as its PM candidate for the 2014 general election. Sadly, the lessons have still not been learned by many politicians and their advisors.[iii]

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[i]  A Virmani, “Planning for Results: Public Accountability  Information System,” Working Paper No. 1/2007-PC, Planning Commission, March 2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm.

Arvind Virmani, “The Sudoku of Growth, Poverty and Malnutrition: Lessons For Lagging States,” Working Paper No. 2/2007-PC, Planning Commission, July  2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm .

[ii] Series of papers on growth at,  https://sites.google.com/site/drarvindvirmani/growth & Arvind Virmani, “ Economic Growth, Governance And Voting Behaviour: An Application to Indian Elections,” Working Paper No. 138, ICRIER, July 2004.  http://www.icrier.org/page.asp?MenuID=24&SubCatId=175&SubSubCatId=233 .

[iii]  http://dravirmani.blogspot.in/2014/01/per-capita-gdp-growth-and-vote-share.html

National Value Added Tax (NATVAT)

Introduction

   A 2002 policy paper, outlined a vision of National Value added tax (NATVAT) that it suggested could be put in place by 2010 through a constitutional amendment, after creating genuine Central VAT (CENVAT) and States VATs (STATVAT) within the existing constitutional limits.[i] Given the degree of interest in the Goods and Service Tax (GST) among industry, financial participants, economists and the general public, a version of the NATVAT, which differs somewhat from the GST  is outlined below.  The two differ in relatively minor but critically important details.  In my view these difference would have made it easier to get political acceptability for the NATVAT  from States.

Indirect Taxes

Tax theory provides us a number of insights into the nature of indirect taxes that are best for a country.  The most important insight is that there should effectively be no tax (i.e. zero rate) on raw materials, intermediate goods, capital goods and services used for production of goods & services.  The second insight is that efficiency considerations drive the differentiated structure of consumer taxes towards higher rates on goods & services with low demand elasticity.  In the case of de-merit goods like cigarettes & tobacco products and (perhaps) hard liquor this proves easy to apply.  However, as necessities have lower elasticity of demand than luxuries this runs contrary to the equity objectives that tend to drive the tax structure in the opposite direction (assuming a reasonably strong desire for social equity as commonly professed in India).  The net result depends on the detailed elasticity.

There are two other lessons that involve a greater element of judgement:  That efficiency and equity considerations tend to balance each other and that a near-uniform structure of indirect taxes may be a useful starting point for a reasonably efficient and equitable tax system.  Another is that there is a case for taxing at a somewhat higher rate goods & services that are complementary with leisure (e.g. goods & service for entertainment), though the force of this argument is diluted in a large population countries (like India) with substantial or ‘hidden unemployment’ or ‘under-employment.

Why VAT

This is the appropriate point in which to bring in the problems of tax administration, evasion and corruption that loom so large in developing countries (emerging markets) and which this theoretical exercise has totally ignored.  Logically the structure of optimal taxes based on reality (varying administrative costs, evasion costs & corruption possibilities) would differ markedly from that given by the “ideal.” There is wide agreement among tax experts who advise governments on tax reform that these problems argue strongly for having an indirect tax structure that is simple and as close to uniformity as possible.  Complexity facilitates and encourages tax evasion and corruption.  It also provides an incentive for lobbying by powerful organised groups to obtain special favours for themselves.   This sets in motion a spiral of complexity, evasion & corruption that is not based on any empirical knowledge (of elasticity) and results in a tax structure that bears no relationship to the so-called ideal “optimal.” 

The second implication of this reality (administrative costs, evasion, corruption) is that the best way to implement a uniform structure of indirect taxes is through a value added tax.  A uniform value added tax (VAT) has the same efficiency & equity properties as a uniform sales tax on final finished consumer goods, but by collecting the tax at multiple points and in smaller doses it minimises the incentive for evasion.  It also has (in principle & if implemented properly) the property of catching at a later stage the tax evasion that has taken place at earlier stages of production/ value added.  These considerations have led an overwhelming majority of countries (not just developing but even developed) to replace their existing indirect taxes by a Value Added Tax.

An indirect tax structure for the country (Centre & States) that will be simple, efficient and equitable should ideally replace all central and state government taxes on goods and services.

National VAT

An ideal indirect structure for the country would consist of two sets of indirect taxes:  A single uniform rate National VAT on all goods and services (except for a limited number of pre-specified exemptions) and State (final) sales taxes on a dozen specified goods with a pre-specified upper limit on the sales tax rate for each of these goods.  The Central government would have the responsibility of setting the national VAT rate in consultation with the States and for administering it with the help of the States as needed.  Calculations done in the 2000s suggested that a VAT of 15% may be sufficient to ensure revenue neutrality with respect to existing Central & State indirect taxes.  The proceeds from this tax would be shared between the Central government and the States in the proportion necessary to ensure that there is no diminution of the States’ indirect tax revenues.  To ensure that the indirect system is equitable, and to support positive externalities, the following goods and services could be exempt from the VAT: Food, including processed (cereals, pulses, vegetables, fruits, milk & products and possibly sugar), Drugs, Medical Equipment & medical services (Diagnostic; Disability compensating or Disease preventing/curing), Environment friendly fuels (solar), Educational services and Knowledge services (Educational material, R&D, Testing, Consultancy).  There would also be a sales volume exemption of Rs. 5 lakh (say) based solely on the need for minimising compliance & administrative costs.  All other exemptions should be abolished.  Administration of the system for transactions up to some limit (Rs. 10/20 lakh say) could perhaps be decentralised to the States. States would also have to abolish Octroi one of the most inefficient taxes know,

Final Sales Taxes

In addition, the State government would have the right to levy sales taxes on a limited set of final, finished consumer goods (to ensure that there is no cascading & no taxation of intermediate goods).   The maximum total tax on any good or service should not exceed 50%. At this point, the incentive for tax evasion becomes so strong that corruption is sure to follow. This means that with a VAT rate of 15%, the sales tax must not exceed 35% (upper limit/maximum).  Such a high rate could however be applied only to de-merit goods such as tobacco products (cigarettes, cigars, chewing tobacco) and hard liquor.   Fuels with negative environmental externality, such as petrol & diesel, could be subject to a maximum sales tax of 25%.  The same maximum rate could also apply to cars and low (< 5%) alcohol beverages like beer & wine.  A few other items such as Air travel, Air Conditioners, Motor cycles/scooters & home entertainment products (excluding radio & TV), Entertainment services like cinema, Hotels & Restaurants service, could be subject to a maximum sales tax of 15% (i.e. 0% to 15%), as the VAT would replace the existing set of entertainment taxes, expenditure tax, sales tax etc.

 Across the world, Sales taxes are normally levied at the point of sale to the consumer.  Because of evasion & related problems, India follows the practice of “first point sales tax,” where the tax is collected at the point of sale by the producer.  Strictly speaking this is better termed as an excise tax.  However, as long as cascading and multiple taxation are avoided and all States follow the same method, either method can be adopted. Both the national VAT and the State Sales taxes would apply to imported consumer goods & services in the same way as they do to domestically produced ones.  The final point of sale collection (of sales tax) has the merit that each State can collect its own sales tax on imported goods.  If the first point Sales tax (excise) methodology is adopted then an excise/sales/SAD tax will also have to be collected (on the specified set of goods) at the customs point on behalf of the States.  This creates undue complexity if the States have different rates of tax on the same good. Imported goods would enter the VAT chain at the point of entry into the country and from there on be treated exactly as if they had been produced in India.

Administration & Evasion

 The single rate NATVAT allows a drastic simplification in administration & compliance,  which is the great advantage of a true VAT.  This simplification is based on a complete transformation of the collection and administration machinery.  It has the following related elements:

·         An invoice and accounts based system of checking in place of routine physical checking.

·         Basic data on the company (and its production units, warehouses, depots etc) would be entered once given an appropriate code number (VAN on the lines of PAN) and stored on the computer.   It would not have to be entered on every invoice as at present.

·         A simplified invoice form that focuses on values of inputs and outputs subject to the single VAT rate, and the source and destination of the inputs and outputs respectively (again represented by VAN).  This is most effective if there is a single uniform base NATVAT rate with all goods treated equally on both the input and output side with respect to this rate.  In this case the sale or invoice form would only require the total value of goods sold and the code number (VAN) of the originating and destination units.

·         Monthly, quarterly or annual aggregation of the sales and purchase slips depending on volume of business (i.e. SSI have to do only annual aggregation, and only the largest units have to do monthly aggregation).  The aggregation would involve showing total value of purchases and sales by seller & buyer respectively, during the relevant period.

·        A comprehensive computerisation of these aggregate returns, which allow cross checking of inputs, outputs value added and CENVAT paid, so as to detect evasion. Direct e- filing could be required for VAT payers above a certain size (Rs. 10 crore say).

·         This could be supplemented by industry wide database, which can be used to identify flow of goods and services entirely outside the VAT chain.

Conclusion

   In comparison to a Goods and Services Tax (GST) as proposed, the National VAT (NATVAT) greatly simplifies administration of the national system of indirect taxes, and would help in drastically reducing tax evasion. At the same time gives some flexibility to states to levy a half a dozen final sales taxes, so that they can meet fluctuations in revenues and expenditure by varying some taxes under their direct control.

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[i] Arvind Virmani, “Towards a Competitive Economy: VAT and Customs Duty Reform,” Planning Commission Working Paper No. 4/2002-PC, April 2002.  http://www.planningcommission.nic.in/reports/wrkpapers/wp_vat

Economic Growth and the New Government

with Prof Charan Singh, IIMB

Introduction

The new government has recently assumed office. The country is waiting with hope for new policy direction to revive the economy, especially given the disastrous growth record in the last two years (4.6% average).  To revive the sagging growth in the economy the need is to correct the mistakes of the previous government and re-establish confidence. In addition, it is a good opportunity to undertake fundamental economic policy and institutional reforms, in the first two years. Therefore, it is a good time to reflect on the vision for the economy and suggest agenda for reforms that the next government can consider. The government needs to sweep out the Fabian Socialist (or Nehru-Indira) Model of development that ensured that the License-Permit-Quota Raj seeped into every nook and corner of the Indian economy. This Statist model is unsuited to a young, proud, modern India that wants “equality of opportunity” and “equal treatment” from the Government it elects and the bureaucracy of “public servants” instead of humiliation, harassment and worse from a “Mai-Baap” Sarkar. And this is possible because of the thumping majority that BJP has received at the elections.

1990s and 2010s

There is a lesson to be learnt from the experience of the 1990s. The unshackling of the Indian economy during the mid- 1980s and early 1990s raised its real growth rate to 3.6 per cent points above the average growth of the world economy during 1992 to 2010 but since then the real growth differential has collapsed to less than 1.2 per cent point. The drop in the growth differential can be attributed to three domestic causes: First, an overemphasis on entitlements vis-a-vis empowerment; Second, deteriorating governance (including corruption allegations); and finally, failure to introduce policy, regulatory and institutional reforms, essential for sustaining growth and employment at its full potential. The fundamental objective of any Indian government must be to close the welfare gap of the Indian people with the rest of the World and provide employment opportunities through faster economic growth.

Employment Opportunities

  To take advantage of the demographic dividend, generate employment, and enhance public welfare, the government has to ensure that the economy revives to grow at its long term growth potential of 8 percent (or 6.5 percent per capita) per annum.  To help recovery, a reversal of the governance failures and regressive tax changes during 2010-13 could help. A return to the general philosophy of modernizing the tax system by reducing the plethora of State and  Central taxes to a few and simplifying these by reducing exemptions/ deductions and reducing marginal rates, is imperative. This also requires introduction of a GST or National VAT and approval of a new tax code.

 To revive growth, it is necessary that the government is able to establish credibility of its intentions. Therefore, it would be important to improve governance in terms of speed of decision making and ensuring implementation of those decisions. In view of the widespread allegations, a quick cleanup of the toxic residue left by the alleged scams would also help revive confidence in the government. Institutional reforms in political systems, police and judiciary would help to address the issue of pervasive, systemic corruption and restore good governance on a sustainable basis.

Laws

A review and revisit to a few controversial legal documents would also address the resentment of the larger public towards government’s policy making. Illustratively, some of these are - (a) Right to Education Act - proposed hike in salary structure of teachers so that thousands of charitable schools (NPO/NGOs) are not overwhelmed with losses; (b) Right to Food Act – the focus should be addressing the needs of genuinely hungry population and wasted/ stunted/malnourished children under 5 years of; (c) Land Acquisition Relief and Rehabilitation Act - laudable objective of fairness in compulsory acquisition of land has been converted into an expansive ecological and social agenda; and (d) Environment Protection Act which has become a bottleneck to investment because of its sweeping authority and expansive mandate. Similarly, need is to revise the Agricultural Produce Marketing Act and Essential Commodities Act which now serve to swell middlemen’s profits instead of helping farmers as originally anticipated.

Now that election is over, there is an urgent need is to rein in deficits, both fiscal and current account, and encourage domestic savings, and review fuel and food subsidies. Fiscal discipline would allow the RBI to ease monetary policy and stimulate investment and consumer durable demand without fear of increasing non-performing assets or inflation.

PSUs and Productivity

As empirical evidence suggests from cross-country experience, to stimulate productivity, there is also a need introduce competition in public sector monopolies.  The government could examine converting railways, ports and airports into publicly owned Ltd companies and set up professional independent regulatory structure to oversee their performance. Similarly, sale or disinvestment in competitive public sector units in industry and finance (e.g. steel, airlines, hotels, machinery; banks, insurance) could also be considered.  

To sustain higher growth, and facilitate trade and commerce, it is important to have good infrastructure both in rural and urban areas. Therefore, high quality national road network and encouragement to e-commerce would be the most cost effective stimulator of economic development. Finally, to ensure healthy population, and reduce disease, malnutrition and child mortality, sanitation projects need to be emphasized.

Conclusion[i]

A slew of fundamental reforms exploiting the inherent demand within India, especially rural, can sustain Indian GDP growth at over 8 percent for the next few decades despite global slowdown. It is not necessary to accomplish all the listed reforms but it would be essential to outline the broad direction of reforms and establish credibility in implementing them.

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A version of this article appeared in the Indian Express of Friday June 20, 2014, under the banner, "Now, rewrite the script."  http://indianexpress.com/article/opinion/editorials/now-rewrite-the-script/ .

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[i] For further details see, Arvind Virmani, “National Agenda For Growth and Welfare” Policy Paper No WsPp1/2014, January 2014. https://sites.google.com/site/drarvindvirmani/policy-papers .