Axe Effect

The Mindboggling Tax Cut

Madhavankutty Pillai has no specialisations whatsoever. He is among the last of the generalists. And also Open chief of bureau, Mumbai  
Page 1 of 1
A radical zero-tax proposal that was first mooted in interior Maharashtra is now a national point of debate
Only death is certain; taxes can still be eliminated. This is the subject of an interesting debate that India has been witnessing, of late, ever since some leaders of the BJP mooted the idea of replacing all direct and indirect taxes Indians pay with a single tax on every bank transaction. The germ of this radical suggestion goes back to the mid-90s, to the town of Aurangabad in Maharashtra. At an industrial estate there, Anil Bokil, a mechanical engineer running a precision manufacturing unit, began to notice that small vendors like fitters and turners were getting laid off or going out of business. This was the fallout of economic liberalisation and the competition it brought in. These men had skills, but no resources to get back on their feet. A group of over 80 such families found themselves bankrupt and Bokil stepped in to help them.

Bokil realised quickly that one of the main obstacles was their lack of access to credit; without documentation or security, banks wouldn’t give them loans. He organised them into a cooperative called Tiny Industries and they successfully set up a unique business model. Their website explains it: ‘Today [Tiny Industries Co-op Industrial Estate] houses 50 units with combined monthly revenue of Rs 80 lacs per month…What appears like one workshop is actually a cluster of interdependent machines. Each machine operator is also the owner of that machine. The job moves through the machines as per the operations required. In the larger picture, the job moves through various units within TINY in the same way. The customer does not have to go to multiple vendors and the TINY units get to share the job as well as the resources.’

Meanwhile, the experience had converted Bokil himself. He gave up his business and became a full-time social worker. He had had no interest in economics, but was suddenly curious about the economy. Why was capital scarce? How was it that only those who had capital got capital? Why did an economy have such anomalies? Such questions bothered him. After a few years of study and reflection, he arrived at a five-point solution to what he saw as fundamental problems of India’s economy. He wrote a Marathi paper on it and the first presentation he gave was to a group of close friends in Aurangabad. The next was at a forum in Nashik at the invitation of an economist who had heard of his ideas.

Since then, Bokil’s life has revolved around taking those ideas to people. “I have given more than 2000 presentations,” he says. As more people, especially professionals like engineers and chartered accountants, got interested in his ideas, it led to the formation of an organisation called Arthakranti Pratishthan to disseminate them. In the political establishment, a section of the BJP, which includes Nitin Gadkari and Subramanian Swamy, has shown particularly strong interest in turning the ideas into policy. Arthakranti, though, claims to be apolitical. “We have gone with this to leaders of every political party. We have no political inclinations. The idea was open to everyone. The BJP took it up,” says Bokil.

The ideas are now known as the ‘Arthakranti Proposal’ in popular parlance, and its five points of action are as follows:

» India’s existing taxation system will be withdrawn completely. This means all direct and indirect taxes like Income Tax, Corporate Tax, Sales, Excise, VAT, etcetera, will cease to exist. The only exceptions are Customs and Import duties because they are needed to protect local trade.

» The axed taxes will be replaced by a tax on all bank transactions, with the receiver having to pay. As an example, imagine its rate at 2 per cent. If someone gives you a cheque of Rs 100 and you deposit it in a bank, Rs 98 will be put into your account and Rs 2 will be deducted. This will be credited to different levels of government automatically. Of the Rs 2, 70 paise will go to the Centre, 60 paise to the state, and 35 paise to the local government within whose jurisdiction the bank account lies. The bank will also get 35 paise as an incentive to be part of the process. Arthakranti says all these rates and ratios are notional. The government of the day will decide them.

» Cash transactions won’t be taxed.

» High denomination currency notes of above Rs 50—that is, Rs 100, Rs 500 and Rs 1,000—will be withdrawn.

» Single cash transactions will be restricted to an upper limit. If it is fixed at say, Rs 2,000, then transactions above it can be made but will have no legal protection. So, if you buy a phone for Rs 7,000 in Rs 50 notes, then you can’t go to a consumer court if it’s damaged. You can buy a Rs 1 crore house with Rs 50 notes, but the government will not register it.

These five points are it. They make up the proposal’s overhaul of India’s taxation system. It is so radical that many dismiss it. Some editorials have called it hare-brained, while one asked the BJP to move on to something serious. Arthakranti says that almost inevitably all those who deride them focus on bits and pieces, and the proposal only makes sense if it is considered in its entirety. “In debates, people are selectively picking one or two points, but we never speak in fragments. We say if all this happens, then it is going to work,” says Narendra Khot, a member of Arthakranti in Mumbai.

To understand the proposal, they say you have to first understand why it was necessary. Bokil makes an interesting argument. He asks you to consider how individuals and institutions chalk out their budgets. They look at how much they earn and then decide on their expenses. But the Government does exactly the opposite. “First, there is the expenditure plan, and according to that plan, they chalk out a taxation or revenue plan. The Government can plan for any tax limit. So hypothetically no government should be in a deficit. So how has India been in a state of deficit for decades?” he asks. “Something is wrong.” The problem, as he sees it, are leakages—both during tax collection and State expenditure (that is, black money and corrupt money, respectively). There exists a gigantic parallel economy which the Government simply can’t tax.

While it is impossible to assess the size of this economy because it is underground, one of the slides in the Arthakranti presentation indicates how huge it could be. It takes the year 2010-11 as an example when the total currency in circulation was Rs 9.5 lakh crore while demand deposits (money held in banks) added up to Rs 7.2 lakh crore. India is among the few large countries in the world where demand deposits are less than the currency in circulation. “The global average [of demand deposits] is four to five times the currency in circulation,” says Khot, “In the UK, it is extraordinary. They have 17 times. Here in India, the ratio is less than 1. It means that a huge amount of money is actually circulating outside the banking system.”

The sum of demand deposits and currency in circulation is what Indians use for day-to-day transactions. This is called ‘Narrow Money’, which for that year was Rs 9.5 + Rs 7.2 = Rs 16.7 lakh crore. The proposal, if implemented, hopes to make all that currency part of the banking system. This way, all Narrow Money can be taxed. “Considering a moderate assumption that 20 per cent of this Narrow Money moves only one transaction a day, you collect Rs 15.8 lakh crore for the Centre and State [that year],” he says. That is about Rs 4 lakh crore more than the Government’s total tax revenues of around Rs 11 lakh crore in 2010-11. Khot says that these are conservative estimates; in reality, he believes, it will be much more.

The first two points of the proposal— replacing of all taxes with the BTT—are to simplify the taxation system at a point where taxes can be collected easily: banks. The money collected can be passed on instantly to the Government. And since banks themselves get a share of it, they get abundant capital to lend.

The other three points of the proposal are to push everyone into the banking system. The elimination of all currency notes above Rs 50 is essential to the plan so that large cash transactions are not possible anymore—for example, in buying a flat, it is standard practice to pay part of it in black, but it is really difficult to pay Rs 10-20 lakh in Rs 50 notes. Large denominations, goes the logic, facilitate black transactions. Taking away legal security for cash deals above Rs 2,000 (or some such threshold) will also ensure that all payments are routed through banks. This would turn India’s entire economy white.

As for public acceptance, the argument goes that people would not mind a BTT of a low rate of 2 per cent or so. Also there is no effort required in paying it, even as the State makes more money than it does under the current system. The BTT also creates a trail for all transactions, and this would help catch criminals and terrorists. Banks, flush with cash, would be able to lend money to industry at lower rates—which would boost investment, economic growth and employment. This would create a virtuous circle. And bad money, which is what ails India, would become good.

Not everyone is convinced. Most economists have criticised the proposal. Ajit Ranade is one of them. The Mumbai-based economist recognises that India’s taxation system needs drastic reform, but doesn’t think BTT is the answer. For one, he says, most Indians don’t even have bank accounts. “How can we depend on the BTT when half the population don’t have bank accounts?” he asks. Also, he says, once the BTT is introduced, people will find ways to dodge it, and this might actually keep them from joining the banking system.

The idea of a BTT also subverts the basic principles of taxation, Ranade adds. Taxes are usually designed to serve a social- leavening purpose by their progressive rates of application. That is, they apply at higher rates to the richer lot who are better able to pay them, at lower rates to the less well-off, and at zero-rates to the poor. Direct taxes paid by people, such as Income Tax, are designed that way. Even indirect taxes on sales of goods and services— which are levied because direct taxation is too inefficient to fill up State coffers—can be imposed heavier on the sale of products and services used mostly by the rich. The BTT, however, does not take the tax burden bearer’s financial status into account. “The BTT taxes inputs,” says Ranade, “which is like an indirect tax.” Only, it is clearly regressive, since the rich and poor alike must bear this tax at the same rate, and losing Rs 2 on every Rs 100 would pinch those who live hand- to-mouth far more than those who have disposable money.

Apart from the poor, according to Ranade, exporters in particular will be harshly affected by BTT. “When you are exporting to global markets, you have a system of getting credits for the tax paid in the country,” he says, “The BTT system has no such provision for getting credit for exports. Our exporters can potentially be handicapped.” The economist believes the BTT’s biggest drawback is that it goes against the spirit of fiscal federalism, by which taxes should be collected at various appropriate levels of government— the Centre, state, municipality or panchayat. So, for example, property taxes are collected at the municipal level to provide services like local roads. “The BTT system is a national system,” says Ranade, “It completely takes away the rights of lower levels of government to tax local communities.”

In the future, once everyone has a unique identity like Aadhaar and access to a bank account, and transactions are mostly electronic, Ranade can see India move towards something like the Arthakranti Proposal. “In the current situation,” he says, “it is a bit too radical.” He however welcomes the debate it has sparked. “One must compliment them for bringing this idea of tax reform and unconventional solutions to our mainstream debate. There are lots of professionals working on the details, but there are some conceptual difficulties as well.”

There are other criticisms too. In an Economic Times article titled ‘Arthakranti Doesn’t Work’, one of the points that the economist Bibek Debroy raises is that transaction taxes have failed in other countries. Sanjeev Sanyal, global strategist at Deutsche Bank, wrote in Business Standard that ‘most mainstream economists… feel that it is a simplistic and untested proposal that is bound to fail.’ Besides the usual arguments against it, he sees one more flaw. ‘The proposal does not account for the way corporations, individuals and other economic agents would change their behaviour in a BTT world. For instance, businesses would change their supply chains such that they internalise many activities rather than outsource them to external vendors. This would reduce the number of financial transactions.’ With e-money transactions enabled by the internet, a parallel e- economy may spring up in the deep web that would be hard for the BTT to touch.

After Bokil first wrote the paper in Marathi, someone bought it to Anil Paranjpe in Pune, requesting him to translate it into English. Paranjpe is a US-returned civil engineer who joined the software industry later. He had left his full-time job and was starting a consultancy and had time on his hands. He translated the paper and his interest was piqued. Like Bokil, he too now gives presentations on the proposal and has met a wide variety of politicians, economists and bankers over the past decade. Some years back, they decided to put these ideas in the language of economists. Paranjpe and another Arthakranti member spent two years poring over 2,000 plus papers related to banking and taxation. They then prepared a report on the proposal, with 70 of those papers cited as references.

Paranjpe is emphatic that the proposal is not just a tax correction. “That is only one-third of the solution. The other third is to get people into banks. The remaining third is that once [this happens], banks should be in a position to give good credit to everybody. All three need to happen for the full benefits to be realised. Unfortunately, the topic got opened and is being discussed as a pure tax reform. What you want to see is for healthy money to be available to everybody including the Government.”

The premise of why it will work is that people are essentially honest. They avoid tax because it is complicated and irrational. Black money exists because people are forced to be dishonest—simplify it, and they will pay. If the proposal is implemented, it will mean a one-time amnesty for all black money so that it can be pushed into the white economy.

Paranjpe says they have cogent responses to the objections raised by economists. For instance, to the argument that BTT is regressive because it levies a flat rate on the rich and poor, their counter argument is that a rich man’s 2 per cent is far greater in rupee terms than a poor man’s. Moreover, the poor would still be able to resort to cash transactions under Rs 2,000 (or so) that attract no tax. To the point that transaction taxes have failed elsewhere, Paranjpe says they were all add-on taxes, and thus added burdens. The Arthakranti BTT would be the only tax to be paid, and at a low rate too, and so no one will grudge it. Companies would welcome it because it eliminates the army of employees they have to maintain for tax compliance. Plus, there won’t be any harassment by tax officials.

As a policy, argues Paranjpe, the BTT is eminently doable. “Has taxation been changed before? Hundreds of times. Tax rates reduced? Hundreds of times. Has currency compression been done? Hundreds of times. In India, it was done in 1978. In the US, the Nixon government removed US $1,000 and $10,000 bills [leaving $100 as the country’s highest currency denomination], forcing everyone to go through banks.”

The Arthakranti Proposal clubs together several measures to make it consistent and logical, say its advocates. But it would require political courage. Even the BJP has not accepted the idea so far, with leaders like Arun Jaitley and Yashwant Sinha unconvinced of it. Arthakranti says that objections arise mainly from looking at the idea from the existing system’s point of view. The proposal, however, seeks to overhaul it completely and create a new framework. “Can we go there and think in that framework? You will find your answers,” says Khot.