India passed up a golden opportunity recently to deliberate and fix infirmities in its tax system.
Fiscal Options & Response to COVID-19 Epidemic (FORCE), the document produced by a group of young IRS officers is remarkable for an official document in its treatment of issues and imperatives at the time of health and economic emergencies. What seems to have annoyed their seniors is the suggestion that the wealthy, beyond a threshold, should be taxed more to meet resource needs.One of the foundational principles of taxation is that those who have better capacity to pay should pay more. In the post-industrial democratic world, generating wealth needs active support of the society (public) in which they operate and from which they draw labour, natural resources, and capital.
Healthy and skilled human resources and infrastructure have been developed with public money. Governments, elected by the society every few years for their own governance, provide the environment for business with tax incentives, stimulus packages, and bailouts when the situation calls.
By paying proportionate taxes, the wealthy keep their side of the bargain. But that is not the case any longer, as the Panama Papers, Paradise Papers, global studies, and other evidence show. That is why the world is intensely debating about taxing the wealthy more.
Here are some of the key reasons why it should be so.
I. Because wealth has surged up at alarming rate
Most of the global wealth has been sucked up in the past few decades, making the rich richer and the poor poorer.
According to Forbes magazine, 10 billionaires gained $51.3 billion or Rs 3.9 lakh crore (at exchange rate of Rs 76) in just a week between April 2 and 9 when the global economy was almost shut (except for a few essentials) and millions were losing their incomes and jobs.
They did this through the stock market. These billionaires included Jeff Bezos, Mark Zuckerberg, Warren Buffett, Elon Musk, Bill Gates, and India's very own Mukesh Ambani. Ambani got richer by $5 billion or Rs 38,000 crore.
Washington-based Institute for Policy Studies (IPS) mapped daily updates provided by Forbes for a longer period and found that the wealth of ultra-wealthy Americans went up by $282 billion between March 18 and April 10.
It made another revelation: Between 1980 and 2020 the tax obligation of America's billionaires decreased by 79%.
Here are some statistics about India.
Oxfam's January 2020 report 'Time to Care' said, in 2019 the wealth of top 1% Indians went up by 46% while that of the bottom 50% by 3%. In 2018, those figures stood at 39% and 3%, respectively.
In 2019, the top 1% Indians held 42.5% of national wealth, that is, more than 4 times the wealth of 953 million people constituting the bottom 70%. The bottom 50% held just 2.5% of national wealth.
According to the Credit Suisse's 'Global Wealth Report of 2019', there were 7,59,000 dollar millionaires in India 2019, up from 725,000 in 2018 and 34,000 in 2010.
How many of them paid tax?
The Income Tax Department tweeted on February 13, 2020, that in FY19, only 3,16,000 individuals had declared income above Rs 50 lakh. (One million USD equals to Rs 7.6 crore at exchange rate of Rs 76.)
This wasn't always the case.
French economists Piketty and Chancel point out in their 2017 study that during 1951-1980, the bottom 50% held 28% of total growth and their incomes grew faster than the average. During that period, incomes of the top 0.1% decreased.
The trend reversed during 1980-2015.
At the global level, Oxfam's 2020 report said world's 2,153 dollar billionaires had more wealth than 4.6 billion people or 60% of the world population in 2019 and the number of dollar millionaires had gone up by 1.1 million in one year to 46.8 million.
II. Because they evade and avoid tax
India has been wooing foreign investment with a rare passion. One headline from July 2019 was telling: "Google, Facebook made Rs 10,000 crore; paid Rs 200 crore as tax in India". That is just 2%.
This is a global trend, not unique to India.
In December 2019, a UK-based transparency campaign group Fair Tax Mark calculated that Google, Facebook and four other US tech giants, described as the Silicon Six (others being Amazon, Netflix, Apple, and Microsoft) had avoided paying $100 billion tax (Rs 760,000 crore) between 2010 and 2019.
According to OECD-G20's anti-tax avoidance initiative, 'Action Plan on Base Erosion and Profit Shifting' (BEPS), tax avoidance amounts to $240 billion every year (Rs 18.24 lakh crore).
How multinational corporations (MNCs) evade or avoid tax is well-known. Tax havens (zero-tax or low-tax jurisdictions), shell companies, profit-shifting, etc. are now familiar words.
Here is what a 2019 study by the International Monetary Fund (IMF), the global champion and driver of fiscal austerity, privatisation, and free capital flow found.
The non-OECD countries are losing 1.3% of their GDP or $200 billion of revenue every year because of profit-shifting (moving profit or revenue from the place of its generation to low or zero tax jurisdictions) and the OECD countries about 1% of GDP or close to $450 billion.
This estimate comes with a caveat: "The scale of profit shifting remains hard to assess."
The MNCs don't do country-by-country reporting (CbC) which makes it difficult to trace their financial flows between jurisdictions. The BEPS has been trying to fix it since 2012 with little progress.
Shell companies have emerged as conduits for illicit financial flows. The MNC operations have become so complex that even a European Parliament's 2018 study failed to identify how many shells were operating in its territory. It used three proxies to assess which countries of the union they could be more active in.
How do you regulate shell companies when even the European Parliament can't get a fix on it? India does not even have a legal definition of what a shell company is but recent financial scams saw them flooding out of the woodwork.
III. Because corporate tax has fallen very low
Here is another revelation from the IMF in July 2019.
An article meant for internal consumption maps the fall in corporate tax rate over the past 30 years, which is reproduced below and is self-explanatory.
This trend is problematic, it said, for two reasons: (i) the ease with which multinationals seem able to avoid tax, combined with the three-decade-long decline in corporate tax rates, undermines both tax revenue and faith in the fairness of the overall tax system and (ii) the current situation is especially harmful to low-income countries, depriving them of much-needed revenue to help them achieve higher economic growth, reduce poverty and meet the 2030 Sustainable Development Goals.
One of the reasons for this fall is tax incentives offered to FDI.
The IMF warns against this too. It says, "in developing countries, the race to the bottom has been largely characterised by the granting of tax incentives to secure Foreign Direct Investment (FDI), resulting in lower effective tax rates for MNCs."
Calling it dangerous, it adds, "tax incentives give rise to opportunities for tax avoidance and abuse, common abuses include existing firms transforming into new entities to qualify for incentives, domestic firms restructuring as foreign investors, overvaluation of assets, or the creation of fictitious investments."
India has been actively courting FDI for decades.
In the meanwhile, it slashed corporate tax for domestic companies in September 2019 to 22% (without exemptions), bringing the effective rate to 25.17% (with surcharge and cess). The relief was estimated at Rs 1.45 lakh crore.
This was when the economy had nose-dived for several consecutive quarters. Even after the lowering of personal tax slabs proposed in the FY21 budget (30% for income above Rs 15 lakh), the peak corporate tax rate remains lower than individual tax.
What did Indian companies do with Rs 1.45 lakh crore tax reliefs? Did they invest in growth and jobs? Nothing is known.
The US Congress looked at the impact of its 2017 corporate tax cut (personal tax and payroll tax were also cut) and found stock buybacks hit an all-time high of $1trillion in 2018. The stock buyback is being used as a tool to manipulate stock prices, but it drains out cash surpluses which could have been put to good use now instead of looking at bailouts.
In any case, does corporate tax cut leads to investment and job growth?
The US Congress report did not find any evidence. There was no surge in wages as promised and the investment growth that happened during the time was not due to the supply-side incentives, it concluded. Surely, the corporate tax cut led to a revenue loss of $40 billion. On the other hand, cut in personal taxes improved revenue collection by $45 billion, apparently due to boost in consumptions.
Nobel laureate Joseph Stiglitz explains it in financial terms, "Most investment at the margin is financed by debt, and the debt interest repayments are tax-deductible. So while the tax rate affects the return, it also affects the cost of capital in exactly a symmetric way. And so at the margin, there is essentially no effect on investment."
Does this hold any lessons for India?
IV. Because the more profit they make, the less they pay
India's tax foregone statements (now called 'revenue impact of tax incentives') have been drawing attention to the skewed tax incentive system for years. It points to two phenomena.
First, tax incentives and deductions are benefiting corporations more than individuals.
The following graph maps tax foregone as a percentage of tax collection for both corporations and individuals since FY06 and is self-explanatory.
Second, the effective tax rate for larger companies is lower than the smaller ones.
The following table shows: (a) the effective tax rate for companies with Rs 10-50 crore of profit before tax (PBT) is higher than those with more than Rs 500 crore of PBT and (b) ratio of total income to PBT is higher for the former, indicating that larger companies are availing higher deductions and incentives compared to the smaller ones.
V. Because corporate loan defaults are routinely written off with public money
The RBI database shows that corporate entities routinely (every fiscal) default their bank loans, which are then routinely marked as non-performing assets (NPAs) and written off. This is a loss of public money.
Banks are then remonetised by the central government using more public money. This is a double whammy.
How much is being written off? The last such information was provided by the RBI in response to an RTI query on April 24, 2020.
It said Rs 68,607 crore of top 50 defaulters had been written off "as on" September 30, 2019.
The defaulters included companies run by fugitives Mehul Choksi and Vijay Mallya. The total amount written off would be far more if those of others (from 51 to the last) are accounted for.
The RBI reply did not reveal the period of write off. Given that this is done every fiscal year, this could just be for April-September 2019.
Interestingly, the RBI stopped giving write off data after August 2019 and also removed the data that existed till then. A copy of that datasheet saved in August 2019 shows that in FY18, the write off for public sector banks (PSBs) stood at Rs 1,29,503.6 crore. For FY17, it was Rs 81,990.8 crore.
In the meanwhile, the central government has been remonetising (recapitalising) PSBs because of write-offs of corporate loan defaults. Between FY15 and September 2019 (FY20), this amounted to Rs 3.16 lakh crore.
The truncated RBI database does provide information about gross and net NPAs and also the NPA ratios (gross and net NPAs as percentage of gross and net advances). NPA ratios reflect the financial health of banks. A rising graph of these ratios is a bad sign.
Here's how the health of PSBs looks.
The RBI has not updated the dataset for FY19 and FY20.
VI. Because tax compliance is routinely given a go by
India has been extremely lazy in enforcing critical checks and balances to ensure tax compliance.
Here is the latest example.
On April 24, the Finance Ministry issued a circular deferring tax audit reporting on the Goods and Services Tax (GST) and anti-tax avoidance General Anti-Avoidance Rules (GAAR) until March 31, 2021.
The logic, "Several representations were received by the Board with regards to difficulty in implementation of reporting requirements under clause 30C and clause 44 of the form 3CD of the Income Tax Rules 1962 in view of Global Pandemic due to COVID-19 virus..."
This COVID-19 excuse does not hold.
The GST was rolled out in July 2017.
Two-and-a-half years later, critical checks and balances are missing: (i) monthly filing of returns (GSTR-1) giving details of transactions is not enforced; penalty for not filing it was waived off until January 17, 2020 (ii) input tax credit (ITC) claims are made in summary declarations (GSTR-3B) and refunded without invoice-matching and (iii) tax audit reporting is not yet enforced.
The Comptroller and Auditor General's 2019 report pointed out how the absence of compliance mechanisms has led to a flurry of fraudulent tax refund claims. Many such fraudulent cases attracted media attention too.
Here is a point to ponder. If payment of GST, ITC claims and refunds remain operational during the COVID-19 pandemic, why providing these very details in a tax audit report, which would be submitted at the end of the fiscal, become a casualty?
Similar is the case with the GAAR.
The tax law requires a declaration of "impermissible avoidance arrangement" and details thereof in the tax audit report.
The GAAR was to be implemented first from April 2012. But protests led to constitution of the Parthasarathi Shome Committee of 2012, which recommended that it should be deferred by three years for "administrative grounds". Since then, deferment has become the rule.
If, COVID-19 really comes in the way of enforcing GAAR now, what prevented it between 2012 and 2020
Besides, tax audits are annual affairs carried out towards the end of every fiscal year, not the beginning. That time is one year away. So, why rule out anti-tax avoidance compliance at the beginning of the fiscal?
Clearly, the motive is questionable.
Repeatedly deferring tax compliance has consequences. It incentivises tax evasion and avoidance even more.
To sum up, it is easy to understand why governments pamper the wealthy by letting them get away with tax avoidance and evasion, reduce effective tax rates vis-a-vis others with lower capacity to pay, writing off loan defaults, extending bailouts or providing stimulus with public money without qualms.
This has been happening for a long time and may not change anytime soon. However, there is a very good case to hold the wealthy accountable for their share of responsibility in rebuilding the economy.