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Admin 2019-10-14

14 Oct 2019: The Hindu Editorial Analysis

1) On a tax policy that could work

  • Indian government should now be desperate to raise more tax revenues. It missed its tax targets massively in the last fiscal year, largely because of poor goods and services tax (GST) collections.
  • Its declared budgetary target for the current year requires tax receipts to increase by around 25%, when the first quarter increase was only 6% over the previous year.
  • In the misplaced belief that what is required to address the current slowdown is more tax relief to corporates, it has offered tax rate reductions to 25% of profits to companies that do not avail of other concessions, and further rebates to new companies.
  • So very significant tax shortfalls are likely even in the current year, unless the government takes proactive measures.
  • Looking at MNCs: But such measures need not - and should not take the form of the tax terrorism that this government has been prone to, or increasing GST rates, which would be regressive and counterproductive in the slowdown.
  • Fortunately, there are other measures that could provide significantly more tax revenues to the government. One obvious low-hanging fruit is a strategy to ensure that multinational companies (MNCs) actually pay their fair share of taxes.
  • It is well known that MNCs manage to avoid taxation in most countries, by shifting their declared costs and revenues through transfer pricing across subsidiaries, practices described as “base erosion and profit shifting” (BEPS). Matters have got even worse with digital companies, some of the largest of which make billions of dollars in profits across the globe, but pay barely any taxes anywhere.
  • The International Monetary Fund has estimated that countries lose $500 billion a year because of this. Also, it creates an uneven playing field, since domestic companies have to pay taxes that MNCs can avoid.
  • How the idea works: The Organisation for Economic Co-operation and Development (OECD) has now recognised this through its BEPS Initiative, and has even attempted a belated attempt to include developing countries through what it calls its inclusive process.
  • So far, this process has delivered a few benefits, but these are limited because it has continued to operate on the basis of the arm’s-length principle of treating the subsidiaries as separate entities.
  • But this can change if there is political will. The basic idea is breathtakingly simple, and has been proposed by the Independent Commission for the Reform of International Corporate Taxation, or ICRICT.
  • The idea is this: since an MNC actually functions as one entity, it should be treated that way for tax purposes.
  • So the total global profits of a multinational should be calculated, and then apportioned across countries according to some formula based on sales, employment and users (for digital companies).
  • This is something that is actually already used in the United States where state governments have the power to set direct and indirect tax rates.
  • Obviously, a minimum corporate tax should be internationally agreed upon for this to prevent companies shifting to low tax jurisdictions (ICRICT has suggested 25%). Then, each country can simply impose taxes on the MNCs operating in their jurisdictions, in terms of their own shares based on the formula.
  • It could be argued that this would only work if all countries agree, and certainly that is the ideal to be aimed at. But the beauty of this proposal is that just some large countries can move the debate and make it less advantageous for global companies to shift their profits around.
  • If the big markets such as the United States and the European Union together decided to tax according to this proposed principle, there would be little incentive for many MNCs to try and shift reported profits to other places.
  • Indeed, the Indian government has already proposed in a white paper that it could take such a unilateral initiative for digital companies.
  • The OECD BEPS Initiative will be meeting on October 19 to set out its own proposal, and for the first time, it is willing to consider the possibility of unitary taxation.
  • But there are some stings in the tail that may well render the proposed measures practically impotent. These concerns are set out clearly in a new report from ICRICT.
  • Key concerns: The biggest problem is the arbitrary separation between what OECD calls “routine” and “residual” profits, and the proposal that only residual profits will be subject to unitary taxation. This has no economic justification, since profits are anyway net of various costs and interest.
  • The proposal does not clearly specify the criteria for determining routine profits, instead suggesting that the “arm’s-length principle” will be used to decide this, which defeats the entire purpose.
  • As it happens, there is no system of corporate taxation anywhere in the world that makes such a distinction - so why should an international system rely on this?
  • Another concern is about the formula to be used to distribute taxable profits. The OECD suggests only sales revenues as the criterion, but developing countries would lose out from this because they are often the producers of commodities that are consumed in the advanced economies.
  • Instead, the G24 group of (some of the most influential) developing countries has proposed that a combination of sales/users and employment should be used, which makes much more sense.
  • It is important for the Indian government to look at this issue seriously and take a clear position at the OECD meeting, because the outcome will be very important for its own ability to raise tax revenues.
  • A government that is currently ineffective in battling both economic slowdown and declining tax revenues cannot afford to neglect this crucial opportunity.
  • But more public pressure may be required to make the government respond. Ensuring, with political will, that multinational companies actually pay their fair share of taxes is a feasible strategy.


2) On Nobel for Ethiopia PM: Prize for peace

  • The Norwegian Nobel Committee’s decision to award this year’s Peace Prize to Abiy Ahmed, the Prime Minister of Ethiopia, is both a recognition of his efforts for peace in East Africa and a reminder of the challenges ahead for him.
  • Mr. Abiy, who became Prime Minister in April 2018 after his predecessor Hailemariam Desalegn resigned amid a political crisis and social unrest, has taken steps to politically stabilise the country and establish peace on its borders.
  • The committee recognised in particular his “decisive initiative to resolve the border conflict with neighbouring Eritrea”. Eritrea, which got independence from Ethiopia in 1991, has fought a disastrous border war during 1998-2000 with its big neighbour. It split thousands of families and killed about 80,000 people.
  • In Eritrea, the dictatorship used the prolonged border conflict as a convenient excuse for conscription and repression of its critics, which led to a mass refugee outflow.
  • Mr. Abiy, immediately after assuming office, took steps to resume the stalled peace process. He led Ethiopia’s first state visit to Eritrea and met its President, Isaias Afwerki. Within days both countries declared the end of the border war.
  • Mr. Abiy, 43, had also initiated reforms at home, such as lifting the ban on opposition political parties, releasing political prisoners and jailed journalists and removing media curbs.
  • Half of his Cabinet members are women and his government has welcomed the dissidents who were living in exile to return. More important, Mr. Abiy, himself hailing from the Oromo ethnic group, persuaded the Oromo Liberation Front to join a wide-ranging peace process with the government.
  • But his biggest challenge is to calm ethnic tensions in his conflict-ridden country. Ethiopia is a multi-ethnic federation ruled by the Ethiopian People’s Revolutionary Democratic Front with a tight grip.
  • Mr. Abiy has loosened this grip and called for a pan-Ethiopian identity and a freer economy and polity. But his reform agenda was challenged by ethno-nationalists both within and outside his party.
  • His government remained a spectator when ethnic violence was unleashed in several parts of the country over the past year, and sub-nationalisms emerged stronger.
  • The Oromia and Amhara regions remain tense. Ethnic Gedeos and Gujis are in conflict in the south. Earlier this year, at least 5,22,000 Ethiopians were displaced by ethnic conflicts.
  • With the country set to go to elections next year, many fear that violence could escalate. Mr. Abiy has to arrest this slide of Ethiopia into an inter-ethnic civil war.
  • Being a Nobel peace prize winner, he should come up with a national action plan to end violence, ease ethnic tensions and resettle the thousands displaced by the violence. That should be as important for him as ending the war with Eritrea.