Tax, Tax and More Tax

“This is a question too difficult for a mathematician. It should be asked of a philosopher"(when asked about completing his income tax form)” ― Albert Einstein

India is embarking on a breath-taking change in its tax regime, collapsing excise duty, countervailing duty and service tax, as also state levies like value added tax, octroi and entry tax, luxury tax. The intent is threefold:

• Make India a single-market removing the various infrastructure bottlenecks like multiple distribution hubs or stopping at state check-posts;
• Incentivize formalization of the economy (as buyer will not get tax credit if the supplier does not pay his tax);
• Up the effective Tax to GDP (see data table below) of the economy to allow higher spends on defense, social security and infrastructure - despite high corporate tax rate we have very low tax realization, although it is also because a large part of wealthy farmer population is taxed at Zero.

Now for the complication:

• Each entity is required to file 3 returns a month, 1 every quarter and 1 annually so that’s 41 and these are completely new forms;
• If a company is having four branches in four different states, all the four branches will be considered as a taxable person under each jurisdiction of state government, given they need to get credit for activities terminating in their state same returns have to be filed;
• Earlier certain services were not covered under VAT, ERP’s need to change to catch these transaction;
• Re-working of ERP’s and related incremental connectors / API is almost akin to a mini Y2K;
• Finally, if one does account for the taxes due even suppliers not filing matching tax credits, there are penalties and pay more you loose working capital.

So, the limited point is its going to be some serious work to get the new system implemented.

The single point agenda that the government seeks to address is enhance the tax to GDP ratio. For example, India’s defense to GDP is 2.4% or ~US$50bn, the strategic community believes that getting to US$100bn addresses Pakistan and 2x of that would make India China’s peer. Also, the push to indigenize and grow defense manufacturing to such volumes will have a positive effect on overall growth.

New tax to correct global trade imbalance

The massive global imbalance in savings and investment across countries have been at the heart of the global economic problem. These excessive savings generated in countries like China, Germany and Japan have to be absorbed and the largest country absorbing these savings is the US, despite productive capacities not growing at such pace. These excessive savings are absorbed in the form of foreign direct investment or portfolio flows. Open regimes like US, Canada or Australia have limited restrictions on capital flow, this excessive savings flow have three impacts:

• reducing interest rate;
• increasing exchange rates; and
• higher property prices.

This also manifests itself in art valuation or capital available for start-ups. Lower interest rate, cheaper goods via higher exchange rates and home equity from higher property prices enable higher imported consumption. Capital flows, consequently, is at the heart of the global imbalance.

Let’s take an example:

• Assume China and US are only two countries in the world. China exports 100 and imports 80 from US;
• In a growing economy like India, this deficit would have led to larger proportion of FDI in domestic factories or productive infrastructure than incremental debt or asset sales, matching the forex outflows;
• US is a very developed economy with trend growth of under 2% and consequently unable to absorb investment in productive assets like infrastructure or factories at a very high rate without government intervention (which is what Trump wants to do) and China has already built the assets required to support US consumption;
• This deficit consequently will now be funded via import of capital from China either into more debt or via sale of US assets;
• This has the effect as I mentioned above of reducing interest rate, increasing exchange rates and higher property prices and limited expansion in productive capacities so limited job growth;
• This in summary has been the story of the world for over a decade - Public debt and property prices (The US also had the best of the growth, increasing its hold on the list with 15 of the top 25 cities - Cushman and Wakefield) have risen while likes of Starbucks provide part-time employment which is taken to count employment levels.     

	Corp Tax Rate (%)	Tax Burden (%)	FDI Inflow (bn)	Public Debt (%)	Property Price since 2010
US	35	26	380	106	31.9%
China	25	19	136	44
Japan	24	30	(2)	248	9.2%
Germany	16	36	32	71	26.4%
Australia	30	28	22	37	36.1%
Canada	15	31	49	92	47.7%
UK	20	33	40	89	29.1%
Italy	28	44	20	133	-15.4%
Turkey	20	29	17	33
Mexico	30	20	30	54
India	35	17	44	67

Source: Heritage Foundation, BIS

Globally savings is equal to investment and difference between savings and investment in a country manifests in the form of trade difference (or import and export difference). Until the global economies begun to address the problem of capital flows, one side of the equation, trade imbalances will not adjust. The alternative is automatic system forced correction like the decline in southern European (like Italy) import is having on German industry or the sharp recession in Japan in the 1990s. The suppliers of these savings like Germany or China do not want to make the systemic changes, the receivers (i.e. US, UK or Australia) may have no choice but taxing such unwanted capital flows (i.e. residential property) to not only reduce the trade imbalance but also start pruning the very high levels of debt.  

“There is no worse tyranny than to force a man to pay for what he does not want merely because you think it would be good for him.” ― Robert A. Heinlein, The Moon is a Harsh Mistress