BTT – the sparring continues!

Before I get into the intricacies of my 4^th post on BTT, let me start with a small hypothetical story.

A foreign buyer walks into a garment factory in Mumbai, to inspect the material that was ordered. It was a big consignment and he insisted on personally inspecting the batch, and it could be shipped only after his approval. He randomly picked up one shirt from a stack, of let’s say a batch of ten thousand shirts. Lo and behold, he found that one button was missing from that shirt. He was hugely outraged, berated the vendor, rejected the whole batch, and went back to “far-far-away”, from where he had come.

As providence would have it and little did he know that in the entire batch, that was the only shirt that did not have a button! The vendor of course sold off the material as “export-rejects”, and made some money, but did take a loss. The buyer made an even bigger loss, as he had to buy material at much higher rates at the last minute from Bangladesh, not exactly as per what he wanted, missed half the season, but was not unhappy about having outrightly rejected that batch from the “unreliable” Indian vendor. Again as providence would again have it, there were more than 10 shirts in the new batch he had bought from Bangladesh, but these were not caught during the inspection, but did get “caught” by the end-buyer at the store, and eventually were thrown away as trash.

The story doesn’t end there. Lets now imagine a woman who goes to buy an expensive Sari, finds a small hole in the one she likes, bargains with the shop-keeper, gets a discount, goes home, expertly darns it, wears the sari and is very happy with her “deal”.

I am not trying to cast a value-judgement on who is a better buyer here, as opinions may vary. What is clear in this story is, who the “Indian” buyer of the two is (and no not just because she was buying a sari).

There is one last example on buying behaviour that I want to give you. I have only heard this story from a friend about the alcoholic beverages industry in India, and therefore do not lay claim to its veracity. Apparently, scotch is imported in wooden casks, and then bottled in India for sale. Now, if in the finishing line, during inspection, they find a misprint or a slight colour mismatch on the box cover of the bottle, they discard it……not just the cover, but the entire filled bottle. This is the strong quality control practiced in a scotch bottling operation. Impressive, isn’t it?

So thank you for indulging me in this interesting aside, but what does this have to do with the debate on the Banking Transaction Tax (BTT)? Ostensibly, it does not have much to do with it, but actually quite a lot.

You see, I am apparently a “vendor” trying to sell you a new concept, the BTT. You are a sharp and perceptive buyer. Now you need to decide what kind of buyer you are, because the stance you take vis-a-vis that value proposition, will decide whether you will get convinced to “buy-into” this concept or not!

There is a typical strategy used by critics when they want to clearly dismiss a proposal, even if it is 99% good (you also have to realize that there is absolutely nothing in this world which is 100% flawless). They will immediately gloss over the immense positives about the proposal, and immediately come to the 1% which doesn’t work, or has an obvious flaw. Even if the flaw can be addressed, it becomes a stick to beat the proposal, by of course just ignoring the redressal mechanism; and god forbid, if there is an unaddressable flaw, then people go into raptures of glee. They themselves do not realize the irony of recommending that we throw out the entire proposal; forego the 99% benefit, just because of that 1% unaddressable flaw!

I have made patient attempts to address as many of the issues that I could identify in the BTT proposal, and also those that were pointed out to me by readers (of this blog and even on twitter). I have not claimed and do not claim that I have an answer to every issue identified. All I am saying is that I am convinced that the BTT proposal has merit, and with a little bit of effort by “experts”, all issues can be addressed, and it will be extremely beneficial to the economy, the people and the nation. I have not read anything till date that has made me change my mind (not that individually my opinion necessarily matters too much)!

The dismissive and derisive retorts continue (please read Here, Here and Here). Again, I used to respect T N Ninan, and was disgusted with his comments on BTT (Here). I also read the piece by Rajiv Shastri (Here), which makes an attempt at reasonable critiquing, but the disdain just comes through. Anyway, I did not see any position that he took which I have not addressed in my previous blogs, and hence am ignoring his piece.

I then finally came across the piece by Sanjeev Sanyal (Here). I did not expect him to be rude or derisive, and he wasn’t. I acknowledge him for that.

Now let me take his assertions one by one. He first posits that even if this was to be implemented, it will be a two-step process, first where the current cash-based system is increasingly pushed into the formal financial system and only then move (if at all) into the BTT regime. Now I agree that aggressive steps need to be taken for the first part, including increasing banking coverage in rural areas, mobile banking, etc. What he fails to appreciate is that under the current system of high and complex taxation, the only ones who willingly comply are the middle classes, as they do not have any option (their salaries get taxed at source).

Literally everyone else is busy gaming the system, even as we debate, as that’s what past experience teaches us. When people find the system complex, unfair, usurious, and opaque, they will game it in every possible way, and justify their efforts in the process also. My position is that the simplicity (yes, I know people hate it for its simplicity) of BTT is what will drive people into the formal banking system, catalyzed by the technological changes, because they will realize that a 2% tax is not sufficient incentive for them to go to unreasonable lengths to game it. In my strong opinion, the two steps are to be taken in parallel, and not sequentially.

He then avers that “as pointed out by many economists” (I am sorry Sanjeev but I am not convinced by the case being made by them), that it is problematic at various levels, like fiscal federalism and cascading impact on prices. I have answered this before, but will do so again. If by fiscal federalism he means that the “right” of states to tax is being taken away, then that’s not true, as states will retain that right. For BTT to be implemented, even if it is done in stages, like happened with VAT, states will have to be convinced that they should “choose” not to levy any other tax, as their needs will be more than met by the BTT inflows.

If he means that they will not have a say on the distribution formula, then again I disagree, as I have myself suggested that the final formula for distribution between states and even to the “local governments” within states should be discussed, debated, and approved by say the National Development Council, based on a proposal that could be developed by the Planning Commission (or the Finance Commission), like say the Gadgil formula (or the much-maligned Raghuram Rajan formula also). This will be a very important part, and will take into account the needs as well as the achievements of states (like say population control). This is neither an insurmountable issue nor a show-stopper!

On cascading of prices, I have shown that even with 20 sequential transactions in a chain, the total impact of BTT on it would be around 16%, as opposed to 25-50% currently (impact of all taxes, not just income tax). If large conglomerates rejig their supply chains monolithically as a result of this, then so be it. I have done enough supply chain assignments in my life to know that “tax impact” is only one, and not even the most important issue based on which supply chain decisions are made.

All large corporates know that innovation engines exist in small companies, and they will not discard them, just for a 2% cost impact. I am anyway not convinced about the argument that I should propose a tax change only after having re-engineered each and every supply chain in India, for its possible impact. Companies will respond to changes in the tax regime, like they do even now, or will do if GST comes in. Are people advocating that we junk GST because it will engender changes in the supply chain (and yes it will), and that will cost money too? If not, then why should we needlessly erect such high barriers in front of BTT? Carl Jung had said, “The shoe that fits one person, pinches another; there is no recipe for living that suits all cases”! Ditto for a tax regime!

The next argument is bizarre, the one about gaming the system through accounting entries after netting off the cost of the transactions. Firstly, each company has cash-flow needs. Where will that come from, if all they will get is a netted off entry at the end of the year. Additionally, if entries are being made just to show revenues in different companies, then that current system is a misuse and will get curtailed under BTT. Funds would be transferred only if it makes economic sense, as there will be a cost of transferring the funds. This will drive saner behaviour and not insanity. As far barter systems and other misuses are concerned, why would people do it as “tax-avoidance” will not be criminalized under BTT.

If an entity (individual or corporate), wants to go to asinine lengths (please remember the Tide Detergent bars example given by Ila Pattnaik, mentioned in my earlier post), in order to save 2%, then frankly, so be it! There will be no “tax-man” coming knocking on the door, asking why they have done it! I just don’t understand the cause behind this irrational fear that BTT will drive “criminal” behaviour, when it is not a criminal act under a BTT regime to avoid the formal banking channel. You can’t legally enforce a cash transaction if it is over INR 2000, and can’t issue a legally valid invoice also, if you are ok with that, then my friend, be happy and save that 2%!

His last averment is that if exceptions are continually made for different types of transactions, then BTT will also become as complicated as the current system. I strongly disagree, as a BTT regime will be “process-driven” and will not have any scope for discretion by the Bank. The current system kills because whether an expense should be allowed or disallowed, depends on the mood on that day, nature and level of the tax collector. This will all go away. I just can’t understand why people instead of saying thanks are pillorying BTT.

Once again, the biggest mistake that Sanjeev makes, like so many others, is in proffering a modified Income Tax structure, in place of BTT. BTT replaces all taxes, and hence should not be compared with one tax alone.

He messaged me on twitter the other day, asking “what was my problem if we just converged on a simplified version of Income tax and GST, and did away with all other taxes. I have answered this in my last post, and repeat, I do not want to do away with the benefit of junking the current tax collection machinery, both the rent-seeking bureaucracy, as well as the rent-paying intermediaries. They do not add any value to the process of tax collection, and this should be handed over to the Banks to do in a process-driven manner.

My co-commentator on CRI, Kalpesh Chavda, has posted a second piece on BTT (Here). I apologize as I land up-coming to his pieces always at the end and therefore probably do not do justice to his efforts. He has tried to prove, based on an excel sheet model, that the ratio of tax paid under BTT by a company, as measured against % of profit, goes lower as its profit margin goes up, which he finds unfair and hence violates the “canon of equity”. In my view, the canon of equity should be linked to the top-line (which BTT is) and not the bottom-line!

His assumption is flawed because he doesn’t take into account the impact of cost reduction due to the elimination of the current plethora of taxes. He feels that this will be netted off against “price reductions” in the market, which would be forced on them by the market. Even if I were to accept this logic (and I don’t), then price reduction in any market normally has an impact on demand, and hence sales will go and so will profits. Therefore keeping profits at the same level for current tax regime and the BTT regime is grossly incorrect.

Even in the second model, wherein he shows that in the same set-up, if cost goes down (and hence margin goes up), then the BTT tax paid as a % of profit goes down as margins go up. The flaw in the model here is that if costs go down from 95 to 60, then no rational company in the world will keep price fixed at 100, but reduce it and go for higher sales. Also, since BTT is anchored to the top line, and if top-line remains fixed, then irrespective of what happens to the bottom line, its ratio with top line will remain fixed too. It is not directly impacted by, or impacting the bottom-line. This is akin to saying that if my auditor charges 0.1% of sales as audit fees, then the audit fees as a ratio of profits will go down as profits go up. There is no connection between the two. Audit fees, like BTT, is just a cost. Treat it like that.

To me this is “analysis-paralysis” and “death by excel”. This is getting into the realm of what kind of strategy should an individual company follow, to best manage the impact of a tax regime which takes away most of the compliance hassles and drastically reduces the rate. Besides a “thank you”, I am not interested in finding out how the company will react. That’s the job of a management, and if they are able to survive in today’s ridiculously bizarre tax regime, they will be able to survive in a simplified and “low-tax” BTT regime also.

Let me also confess one more thing. I am not a “tax practitioner”, and nor am I a Chartered Accountant. I am using my brains to try and understand a new system which has been proposed, and I am convinced that it will work. I am sure that my “economic wisdom” will not even fit on a pin-head, let alone a postage stamp. Beyond indulging in a reasonable discussion, I am unable to answer constantly changing goalposts which BTT is supposed to meet, even if the current system meets none of them. This is a hugely unfair battle and a mission impossible. However, I will keep at it!

I also had the pleasure of meeting with the Arthakranti people recently. Upon meeting them, I was surprised to see the amount of work they have done, including data modelling and revenue flow estimations. I am even more convinced about this system now. When they decide to bring this out in the public domain is their call. Till then, I will continue to rebut the illogic of what I see being presented as arguments against BTT.

Sample some more arguments being made. Gautam Chikermane recently tweeted: “BTT would create friction in transactions and slow down velocity of money – not good”. Now what does this even mean? If anything, BTT will enhance the “velocity of money” as governments will get their moneys directly from banks maybe even on a daily basis!

Just yesterday, someone asked me a question “BTT is silly, isn’t it”? Beyond a point, I just agree with people and leave it to them to figure it out for themselves.

I promise that my next post will be on the roadmap for a changeover to a BTT regime.