Imagine No Taxes

25 comments Written on January 3rd, 2014 by
Categories: Articles, IncomeTax
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At Pragati, I write: Imagine No Taxes.

Nitin Gadkari, former BJP president, is quoted by NDTV Profit saying that they’re considering a total abolition of income, sales and excise taxes. Instead, the government will institute a 1 percent to 1.5 perecent expenditure tax, and sell or auction assets like coal and oil blocks.

At first, the suggestion of a zero tax state sounds impossible. But there are those states that run without taxes, many of which are in the Middle East. Revenue can come from many sources, such as dividends from state owned companies, sales or auctions of assets, licence fees for certain businesses, and so on. There are obvious advantages to a zero tax regime. There is no need for income tax collection and the whole infrastructure behind it. The lack of taxes gives people more in their pockets to spend or save.

How could India do it? There are two ways to balance the budget, if you remove a large revenue item (taxes). You either replace that revenue with something else, or you cut expenses accordingly. Income tax earns Rs 6.6 trillion, and Customs, Service and Excise taxes earn Rs 5.65 trillion. Net of the states’ share taxes earn the Union Rs 8.9 trillion rupees. Replacing this is quite a challenge.

Some suggestions involve taxing transactions instead. The “Private Consumption” part of the GDP is about 60 percent, or about 60 trillion rupees;  if transactions add up to about this amount, a 1 percent transaction tax will give around Rs 600 billion (Rs 60,000 crores). Even if we push that up to Rs 1 trillion, that’s just 10 percent of revenue foregone that is replaced.

India could retain customs duties (for good imported) which are slated to raise Rs 1.8 trillion.

We could sell assets, like stakes in public sector banks, PSU entities and the Railways. And auction national assets like spectrum or coal and oil blocks. The figures being touted are ludicrous, such as Rs 24 trillion for coal and oil allocations; that amount is about 30 percent of the total amount of rupees in the country but it is quite likely we could raise, in the short term, around Rs 2 trillion by all these sales.

However, it is unlikely this is a long term sustainable measure. You can only sell assets as long as you have assets, and very quickly we’ll run out of things to sell. The nature of the beast is to use such asset sales to bridge the gap while expenses are cut down dramatically over the longer term.

How would we cut expenses? Let’s first analyse the government spending we do. The Indian Union government will spend over Rs 16 trillion this year, as in the budget. Of this, the biggest ticket non-capex items are defence, interest payments  and subsidies. We cannot do away with the first two.

With no tax collection, the cost of collecting taxes, maintaining employees on the payroll for ensuring paperwork is collated and collected is superfluous. So if those employees are removed, the corresponding costs can be lowered. This only yields about Rs 90 billion or Rs 9,000 cr though. A significant amount of time will be saved in terms of not having to file tax returns or defend the use of a few bills to an income tax officer.

And then, the government should begin to cut its functions to a fraction of its current operation, eliminating entire departments and ministries alike. We don’t really need a Ministry of Steel, a Ministry of Shipping, or a Ministry of Textiles – these should all come under a general commerce ministry.

The problem? You have that many jobless government employees. You have that many jobless chartered accountants and tax preparers. You have a significant amount of effort in getting these employees trained to do other jobs, and the cost of that will have to be borne, at least partially, by the government. There is the political challenge of facing the wrath of these people in the meantime.

And then, there’s the small point that even if everyone leaves a cushy government job peacefully, they still get a cushy government pension which the government will have to pay for anyhow. Without this substantial reduction in costs, the plan might not make a lot of sense.

We have decided to move to a General Sales and Service Tax (GST) regime, with each service or product with a fixed tax percentage. This revenue is shared between states and the Union. Even if the Union were to give up its own share, the states will demand theirs. Unless all states agree to move to a “smaller government” concept, states will need to revenue to pay their bills.

Lowering of subsidies is important, and not very popular. Cutting oil subsidies to zero (and raising oil prices correspondingly) and reducing the fertiliser and food subsidies can save us over Rs 3 trillion in a year. We should disband the Food Corporation of India (FCI) operations of buying at high prices from farmers which only provides “food insecurity”.

There is a medium term path to reach this noble goal. First, the idea should be to welcome more people in the taxable system, while reducing the friction involved in taxation. That can be achieved by lowering the marginal tax rate substantially – to as low as 10 percent for income taxes, as low as a 2 percent sales or excise tax while we plan to cut expenditure.

The lowering of government expenses will cut into GDP for a while. Government expenses are around 10 perecent of GDP, and the rest of the GDP will take a little time to catch up. But a low tax regime attracts investments both from India and abroad, so the longer term impact is definitely positive.

There is also a potential impact of dual tax avoidance treaties. A low-tax regime means your country can be used for laundering money, and every other country will want to rewrite their agreements with India.

Lowering taxes and removing subsidies will have both inflationary and disinflationary impacts. No subsidy of oil means a higher price for oil, but then a large chunk of the oil price is made of taxes, which will go away.

The concept of a smaller government and very low taxes might not be palatable to the public, who believe the government can lower market dictated prices by simply intervening in the market. Or that we can have, heaven forbid, private entities making profit. So the political damage of going down this route is very large, even if the economics dictates it is a more efficient method of growing our economy.  Even if it is achievable, can a government take that pain?

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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

25 comments “Imagine No Taxes”

Probably he is referring to the ArthaKranti proposal being promoted by Arthakranti Pratishthan since last few years. More details here: http://arthakranti.org

Deepak,
Your thesis is violating two of the premises of a modern government.
1. It needs to grow organically within a timescale.
2. It needs to borrow money from market to feed itself.
Though noble intention,it feels something like reverse thermodynamics where the sum is more than its parts! Wish we could live in there :-)

BTW, STT is very analogous concept al beit on Stock Exchgs.

By getting rid of 1000 & 500 rupee note, govt can force all high value transactions to happen via Banks and those which do not get accounted (e.g. real estate) shall automatically get accounted. Who knows, govt may receive more than what it receives today as receipts :)

Hard to imagine the no taxes scenario. Googled to find some fine examples of countries with tax revenue forming <2% of the GDP (UAE, Lithiuania, Guinea,..).

With no social security, proper healthcare, huge infrastructure expenses, I wonder why we still have so much debt? I am guessing we can actually cut back on both subsidies and interest payments.

To have a healthy GDP, I think it might become necessary to actually start exporting something substantial – develop our manufacturing, strengthen our research and product development,….

Thanks for the lovely post.

vsm,
It sounds like no tax scenario, but it isn’t. The low 1.5 (or 2%) transaction fee automatically done by the bank brings much more revenue than the current income tax for the government. Yet the citizens, will still be happy to pay mere transaction fee compared to much higher income tax that they have to pay.
The current tax system only taxes a small percent of people and everytime they are the ones that’s always burdened whenever govt tries to increase the revenue.
The transaction fee deduction will bring all the people into the economy thus increasing the revenues for Govt.

I disagree. A substantial number of transactions need to be done via transfers every day. For example, stock markets settle on a daily basis, and money needs to be moved from one account to another. Money markets do the same. All markets require constant moeny transfers.

Paying your credit card bill will require payment of 2%. Paying your income tax will mean another 2%. buying a mutual fund = 2%. Paying your maidservant by cheque means 2%. Paying anyone though a bank account = 2% – that is not good for consumer behaviour at all.

The Arthakranti proposal discusses all calculations, but the crux is the banking infrastructure required to dream this (forget implementation) is years away. What sounds more fascinating are the implications of abolition of black money and fake currency notes.

@Deepak can you cover these and financial implications in a follow up post ? Would be really nice to see your analysis on this.

Rudra,
The banking system in India is very much there, since they already do similar other regulatory reporting with RBI and income tax departments.

What’s you worry with implication of removing black money? It can only lead to good things.
No developed country has high currency denominations and it was for a reason. People can no longer ‘horde’ cash. Which is good for any financial system, as currency needs to serve only as medium and not to become a ‘hording’ asset. Gold, Silver etc are hording assets. But not currency.
Money in bank ( as opposed to cash in individuals locker) leads to higher volume of deposits with bank that will only flow bank into the financial system via loans to businesses and consumers which would bring down borrowing costs and further lead to boost of the economy.

Agree with you.

However, about subsidies in oil. There’s a federalism problem there. Subsidies are granted by the Centre but taxes are imposed by the States. Even if Centre removes subsidies, States are unlikely to cut taxes because while the Centre’s balance sheet improves, the States will not want to cut down on their tax revenue without something else to balance it.

The Arthakranti proposal essentially results in abolishing federalism in India leaving State Governments completely at the mercy of the Centre for almost every rupee of tax revenue.

Alok,
In the new system proposed, the States will get their share of taxes through transactions happening in their state.
Its an interesting point that you talk about federalism here, but frankly our politicians long killed federalism already. I do not think the new Arthakranthi proposal hurts federalism any more than the current tax system does.

Deepak,
You cannot use GDP as the basis for transaction volume. Transaction volume would be many times the GDP amount. Consider 1 lakh of amount when exchanged between 10 individuals/parties. It will lead to 10 transactions with each transaction incurring the 1.5 (or 2%) fee. Now the kicker here is that the fee applies to all parties (whoever gets the amount credited).

Consider also, that this brings the whole cash currency into the tax net which is twice the mainstream numbers.

Please take time to read through this PDF below and put forth your thoughts. I spent many hours already and I am convinced all formulation of Artha Kranthi put together would work well for India.

http://www.arthakranti.org/downloads/books/finish/8/13

Taxes almost has no correlation to govt spending. Before recommending such a proposal, you have to understand “recardian equvalence”. Let’s assume that annual govt budget is 100 ruppes. If 60 rupees are collected from taxes. the remaining 40 rupees are funded thru debt. Debt is basically deferred taxes and paid in the form of inflation.

If you are recommending zero taxes, govt spending wil have to be fully paid in the form of inflation, irrespective of the size of the govt budget (100 rupees or 100 crores of rupees).

rn

Let’s say the government spends 20 as interest paymnets, 80 as spending. Income is 60 from taxes, 40 from debt.

Let’s say it cuts taxes by 90% and spending by 90%. Then you have Rs. 8 in spending, 20 as interest = 28. Taxes wise you have Rs. 6 and have to borrow lesser (i.e. 22) And so on.

you are assuming that both interest rate and inflation will remain constant. In this example, there is now 54 rupees of excess money in circulation. If there is no physical productivity improvement – no commensurate increase in the goods and service, prices of goods and services will rise, fully absorbiing the newly found saving of 54 rupees. You have not discussed about any mechanism to “invest” in physical machines, r&d etc with the 54 rupees. (Buying stocks worth of 54 rupees is not the same as investing in physical machinaries or R&D).

You’re confusing money supply into this picture. Taxes is not money “out of circulation”. It’s the governments money to spend, or people’s money to spend. Both spend it (or invest it), just with different time lags. But you are right that initially there will be inflation, and that will be countered through higher interest rates. When it stabilizes, a lower tax regime will bring down inflation because private people are far better at investing and increasing productivity than the government has ever been (for example, the biggest productivity increases we see are in the SME sector, not in large sector or PSUs)

There is no excess money created in the system – in fact, with this scenario, a central bank can over time easily reduce money supply because of the lower debt requirement, by selling some government bonds to investors who now want it because the government is becoming more responsible.

Investments wise, buying stocks can help in the longer term, because robust demand means companies with high capex or R&D needs can get funded through investors at early stage levels, where the future listing in an IPO in a strong stock market has positive return expectations. Or, current companies can expand through IPOs, secondary offers or such by raising capital and providing liquidity through stock market exits for investors. It’s indirect but important that while buying stocks sounds like “expenditure” it really is something that helps build capital investment.

additional comments:
Smaller govt does not necessarily translate to lower taxes and vice versa. The ratio between taxes and debt is related the public tolerance to inflation, market interest rate and GDP growth rate. It is not really a political call. It is an economic variable.

Size

I don’t agree. Smaller government has the biggest impetus in createing a low tax regime. Debt is a different phenomenon.

size of the govt is a political call, where as the ratio between tax and debt is an economic decision.

Interesting food for thought.

I looked up the countries where there are no taxes in google. I found that most of them have a strong fund flow for meeting the requirements be it oil or tourism. In case of india such fund flow is lacking.

Financial inclusion. Very large chunk of the populace is outside the banking system. They will have difficulty if cash transactions are restricted.

Inflation. Now Rs 100 is the new base. Not even Rs 50. In this context, is curbing high denomination notes feasible?

The issue is being touted by BJP, as a poll plank. If you show some new scheme(however foolish, like zero power tariff etc), politicians think that they may win elections for the time being. Subsequently what was done, is not a big deal.

Now how low a tax is good. Anything less than current is good. For some zero is better. But is this reality and more importantly is it feasible?

Will leave it at that.

Brilliant. Could not agree with you more. Simplification of rules and harsh punishments for evasion, bribery are a better option.
Cheers
Bala

Hi,
- Not sure if this move to abolish taxes would lead to more black money in the system as people would love to avoid any kind of tax and might start dealing in cash more than what they are doing today.
- Also what happens to the employment in the ancillary industry of these tax consultants which purely run on this? There could be huge unemployment issue. But alternatively our courts might have less cases due to these various tax related disputes.

Regards
Namdev

We don’t need to worry about unemployed tax consultants. By that logic, should we have more sick people so that doctors are employed?

Article as published in Firstpost:, What are your thoughts Deepak on this?

http://www.firstpost.com/economy/go-ahead-mr-modi-heres-the-case-for-abolishing-income-tax-1324061.html

Very strange that he would want to only eliminate personal taxes? All corporates will just pay all their profits out to management as salaries :)

Some very good points raised.. Can taxes be consumption based? ieAbolish income tax and Categorize goods and service into necessaties. And charge indirect taxes accordingly – lowest in neccessaties – Food, Clothes less than certain value, Modest housing. Rest of the categories – tax higher. Biggest should be on things that use public assets – read cars and obviously status symbols. Increase property base value across country. And then Capital Gains tax should stay. This way Black money will be taxed also, atleast in my head! I didnt have time to do the maths, which will reveal the real flaws, but since everyone screams India as a consumption and service based economy, i guess consumption taxes could be way to go. Higher you spend, higher you pay!


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