In The Age Of Excess Capital, Even IMF Now Thinks Higher Taxes Are Needed

The world of financial capitalism is coming around to the view that unbridled tax-spared capital flows driven by digital technology-led business models can be a threat to the idea of an equitable world economic order. In particular, undertaxed capital flows cheat low-income countries of valuable tax revenues when Big Tech generates high sales volumes without even having a physical establishment in these places.

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), has flagged this problem by underlining the need for a “rethink on international taxation” in an article in the Financial Times, especially when incomes may be generated in one geography and profits reported in lower-tax havens. Worse, even in the case of companies with a high physical presence (eg, Amazon in India), no taxes may be payable, for their tech-centric business models involve subsidising customers endlessly in order to create large platform monopolies while reporting operating losses.

Lagarde wrote that the IMF is considering the possibility of two new tax ideas, one of which involves all companies paying a minimum amount of tax to host countries, and another where withholding taxes can be imposed on “cross-border payments, such as fees for services charged by parent companies to local subsidiaries.”

Swaminathan S Anklesaria Aiyar, commenting on the Lagarde proposals in The Economic Times today (13 March), has suggested a cleaner idea: imposing a tax on gross revenues at the rate of 2 to 3 per cent, no matter what the actual level of losses. India is no stranger to taxes on turnover rather than profits, and already levies spectrum user charges on telecom gross revenues. Similarly, privatised airports like Delhi and Mumbai share a large proportion of their topline revenues with the Airports Authority of India (AAI). In the goods and services tax (GST) regime, small companies also pay taxes on turnover rather than value-adds.

Taxing turnover makes some sense in an age of “superabundant capital” – a phrase coined by Bain Capital – where business models are no longer about getting customers to pay as soon as possible, but about endlessly expanding a customer franchise at high initial costs till a company reaches the tipping point at which customers start paying small amount for services.

In the age of excess capital availability at low cost – as was the case in the period from 2008 and 2016 – investors have been willing to extend payback times to longer time horizons. The Peter Drucker norm, that the purpose of any business is to find a paying customer, is now being modified to first finding millions of non-paying customers and retaining them for long periods of time before figuring out how to make them pay for something.

This is the model on which Google and Facebook have been built. Amazon and other e-marketplaces like Flipkart use a variation of the model: they start with paying customers, but the customers essentially get heavily subsidised for long periods of time. Put simply, the Amazon model is to pour endless amounts of cash in subsidising sales till the customer becomes an Amazon junkie and begins to pay.

This model is essentially about creating platform and product monopolies by the use of cheap capital to knock out weaker competitors till you are the last one standing.

Capital is likely to remain superabundant, says a Bain Macro Trends Group study published in the Harvard Business Review in March 2017, because countries like China and India are financialising fast and by 2020 are expected to account for 40 per cent of global financial assets. One may add that India’s twin disruptions of demonetisation and the shift to the GST are forcing a quicker formalisation of the economy, a key component of which is financialisation of transactions.

Says the Bain article: “We found that global financial assets (which more or less represent the supply of capital invested or available for investment in the real economy) grew at an increasingly rapid pace – from $220 trillion in 1990 (about 6.5 times global GDP) to some $600 trillion in 2010 (9.5 times global GDP). We project that by 2020 the number will have expanded by half again – to about $900 trillion (measured in 2010 prices and exchange rates), or more than 10 times projected global GDP. At this rate, by 2025 global financial assets could easily surpass a quadrillion dollars.”

The other reason for superabundant capital, apart from the surpluses generated by the new tech capitalism, is the steady increase in the numbers of what Bain calls “peak savers”, that is people in the 45-59 working age group who both earn well and start saving large amounts of their earnings in anticipation of retirement. As the world ages, the peak savers’ group will only expand. In 2018, nearly half the world population was in the 25-64 prime age group, and a large proportion of them will be in the peak saver category.

Countries like India, which are cautiously trying to tax the digital tech giants and insisting on data localisation, are on the right track. In the 2018 Budget, Finance Minister Arun Jaitley expanded the definition of companies doing business in India to target not just those with a physical presence in the country, but even those with “significant economic presence”, which would include foreign companies “interacting with users” or “soliciting business in India through digital means.”

While these are good ideas – ideas whose time has come even according to powerful financial world voices like that of Christine Lagarde – the ultimate goal of all taxation should be a simple one: equalising taxation of income earned from capital and labour. It makes no sense in a world of excess capital to privilege income earned from deploying capital (low capital gains taxes, lower taxes on dividend income, etc) as opposed to income earned from labour, whether physical or mental. If capital continues to be privileged, it will make jobs growth even tougher than it already is.