Common sense tells us that any expenditure that doesn't result in the creation of a long-term asset is not an attractive option. Most of the people and corporates do not like Taxes for the simple reason that they cannot see a tangible benefit because of it directly though most would agree that lack of them is going to cause a social unrest. Simply put, Tax is an expense for any individual / Corporate.
A traditional Fiscal policy revolves around managing the revenues by collecting taxes. Further, the capital investment made by private sector is manipulated by creating a Tax differential across industries. For eg., a lower taxes in IT industry will attract investments in IT Sector. This fiscal policy has an inherent flaw. By lowering the tax rate for IT industry, I am rewarding people who want to take risk. At the same time, companies who have been employing people for a long time and producing useful goods & services don't see any extra reward in continuing with their business at the same pace even though there is untapped market potential. Another disadvantage is that you can lower the tax rate yet not gain any capital inflows because of huge risks involved or because of lack of interest in the market opportunity. One such example can be the case of Micro Finance Institutions or Small Scale industries or Technology Start-ups etc..... The list goes on.
To have companies running in the above stated list, funds are required in large sums and govt cannot obviously have funds for all of them. And it cannot keep on raising taxes for higher revenues.
The basic problem that I am highlighting over here is the case of a govt that needs to have extra funds to carry out a number of its projects in its 5 year plans. One way is to fund them with taxes. The other way is to take loans. I propose a third way, i.e, seek equity participation of private sector in a compulsory way.
Lets assume that Corporate India pays 25% of its net profit as Tax to the govt. For simplicity's sake, govt. wants to focus primarily on building of Universities with world class research and this is the only focus of the govt. I suggest that the Govt, of India reduce the tax to 20% and charge 10% as Mandatory Equity Investment or Equity Convertible mandatory debentures. These form the capital of a new Special Purpose Vehicle whose sole objective is to invest in new Universities with Research as primary focus. Now, Govt can formulate a policy saying that 30% of the funds will be used directly by Govt. of India along with the loans it takes from nationalized banks / Treasury bills to directly build universities. The remaining 70% will be given as grants to Universities in exchange for Preferential shares / debentures that promise a minimum dividend / interest every year. The purpose of such a system is to ensure that the end entity (here it is the University) is legally bound to keep paying some money to the investor and hence has to be technically profit oriented and self sustainable. The SPV that invests or sets up the Universities will also be the collector of interests / dividends and makes the decisions for reinvesting those on a continuous basis as per its charter. The shares of this SPV are held in a pro-rate basis by the Companies who got the shares in exchange for the 10% Mandatory Equity Investment / Equity Convertible mandatory debentures. Now, the Govt should also list the shares of this SPV in all the Capital markets like BSE, NSE etc... so that the companies can trade these as normal securities. The issues of any lock in period or Taxation on Capital gain can be debated later.
The above approach of making Tax payers as an Equity owner in Self-sustainable ventures will have the following advantages:
- The Tax payer doesn't treat tax as an expense anymore. The company does see value in higher taxes as it is an investment
- The govt. can practically mop up extra funds without incurring any wrath from corporate side
- There is higher transparency and lower level of corruption in any program undertaken through such SPVs as these are legally bound to pay certain returns to their share holders and hence need to manage the business in a self sustainable way. And as the TAx payers are Preferential share owners with right to vote on certain issues, they can replace the management of the SPV and in this way the accountability of the management is maintained
- These SPVs are different from Public Sector Enterprises in the sense that the jobs in SPVs are equivalent to private jobs as Private players are the sole investors. These SPVs also have a profit motive and have some legal bindings to pay money to investors. Further, these SPVs donot come under the Govt as the govt is only involved in deciding the objective of the SPV at inception and it doesn't have any control on the operations
The above example of REducing corporate tax from 25% to 20% + 10% equity investment for a single focus can be expanded by the Govt. For instance, it can have 4 primary focus areas and this 10% is split into 4% for program A, 3% for program B, 2% for Program C and 1% for Program D. In this case, there will be 4 SPVs. Further, the govt can keep the # of programs fixed and change the programs every year to get funds for new programs.
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nice thought mate.. but i didn't understand the flaw that you are trying to highlight in the present system. Also, why do u think tax differential is a bad concept. After all, its trying to reward the risk. Taking the example which you mentioned, the company which has been in a sector for long time and still continuing in it and aiming at untapped market is in its comfort zone and must be having deep pockets which should enable it to diversify and move into any sector with a little bit of help from government. The government is doing exactly the same: encouraging investments in new, undeveloped, necessary sectors. If you observe, no government is encouraging pornography by reducing tax rates... because they know its not necessary for the development of the economy (bad example huh ? hehehe ). So the bottom line is: govts encourage investments in various sectors and tax differential is a method of doing it.
ReplyDeleteIf you are proposing that corporates should buy equity convertible mandatory debentures, i would imagine those mandatory debentures to be a crap. The mere fact that they are mandatory, make them illiquid.
Remember govt do not need to pay back the taxes it collects from individuals / corporates. Once you are abandoning tax and terming it as an investment, the basic question is liquidity. Can the corporates withdraw their money at their will ?
Finally, "equity convertible MANDATORY debentures" = "TAX". I feel just the terminology is different. Both of them are mandatory. In either of the cases govt allocates the money to different sectors depending on the importance. If you go for equity convertible mandatory debentures, you have the option of selling of some of the debentures/shares and making money if needed in future. But this option is already inherent in the tax system. In the present tax system, you can buy treasury securities and get tax exemption to that amount.
These are good thoughts. Your idea here is to have special purpose vehicles for development sectors. Currently, the tax payer does invest in government authorised investment options for tax exemption. By saying that corporates/individuals invest in specific sectors by way of SPVs, you are putting the onus on investors to choose a particular sector. The problem the Govt. has to then face is that of skewed investment. Any profit oriented investor would end up investing in low gestation, low fixed cost and high return investment rather than vice versa consequently leading to certain sectors getting ignored despite being important. E.g. Health care in remote villages might be a long gestation high fixed cost venture. Secondly, not all investors are financially literate. This could lead to a large chunk of investors locking in their investments without proper knowledge - which happens even amongst the educated class so often.
ReplyDeleteImagine that there would not have been the kind of tax exemptions for the IT sector. It would have been extremely difficult to reach this stage in a short time because IT would be as attractive an investment option as any other existing option. Neither could the govt, have created a SPV for the IT industry. Similarly, for the example you quoted - the SPV for research. How far can the Govt. go ? In 60 years, we have one IISc(not built by the Govt.) and 5 quality IITs. And what more do you think a SPV can do? I would suggest that investments in any sunrise industry and social sectors of importance must be given tax breaks/exemption/holiday so that we can ensure that the private sector itself can scale up rapidly yielding desired results.