Trash tax distortions to perk up economic efficiency & growth

By Naresh Minocha

Naresh Minocha, a veteran journalist, specializes in telecom, energy, chemicals, agriculture, economic reforms and governance. In
his over 32-years journalistic career, he has worked in different capacities for both Indian and foreign media organizations. These
include Financial Express, Indian Express, Business Standard, Business India, Tehelka, the Pioneer, erstwhile Asian Chemical
News, International Chemical Information Service and erstwhile asiatele.com. His current professional engagements include
Consulting Editor, taxindiaonline.com and Associate Editor, Gfiles Magazine. At taxindiaonline.com, he has been writing a popular
Column known as 'The Ice Cubes' since 2005.

Apr 19, 2017

THE flavor of fiscal policy as growth accelerator remains as refreshing as ever. The freshness implies the scope for
more fiscal corrections notwithstanding implementation of numerous tax and expenditure reforms in different
countries.

Multilateral institutions are thus once again putting on policy makers' platter the idea of tweaking fiscal policy to
spur economic development.

G20 Finance Ministers and Central Bank Governors, for instance, have pitched for such approach. In a Communiqu
issued after their meeting in Germany held last month, they observed: "Fiscal policy should be used flexibly and be
growth-friendly, prioritise high quality investment, and support reforms that would provide opportunities and
promote inclusiveness, while ensuring debt as a share of GDP is on a sustainable path".

The scope for growth-stimulating innovation, both on the taxation and the expenditure side, is ample in many
countries. The challenge lies in combining growth-aiding tax policies with expenditure policies that direct larger
investments in infrastructure, which acts as plank for growth of different sectors.

International Monetary Fund (IMF) has thus aptly focused on 'Upgrading the Tax System to Boost Productivity' in
its latest Fiscal Monitor released on 13th April 2017.

According to Fiscal Monitor, "Potential TFP (total factor productivity) gains from reducing resource misallocation
are substantial and could lift the annual real GDP growth rate by roughly 1 percentage point. Payoffs are higher
for emerging market and low-income developing countries than for advanced economies, with considerable variation
across countries."

TFP indicates the efficiency with which enterprises turn inputs into outputs. Aggregation of individual enterprises'
TFP gives us broad idea of an economy's TFP. It indicates how economy is utilizing its factors of production such as
labour and capital.

Fiscal Monitor says: "The poor use of existing resources within countriesreferred to here as resource
misallocationhas been found to be an important source of differences in TFP levels across countries and over time."
It adds: "Upgrading the design of their tax systems can help countries chip away at resource misallocation by
ensuring that firms' decisions are made for business and not tax reasons. Governments can eliminate distortions that
they themselves have created... significant TFP gains can be achieved if countries address tax treatments that
discriminate by asset type, sources of financing, or firm characteristics such as informality and size."

Fiscal Monitor suggests that governments should seek to minimize differentiated tax treatments across assets and
financing. This approach would help tilt firms' investment decisions toward assets that are more productive, rather
than more tax-favored.

It believes that the current debt bias feature of some tax systems not only distorts financing decisions but hampers
productivity as well, especially in the case of advanced economies.

This analysis obvious implies the need for the Governments to review their respective tax policies to create level-
playing field for enterprises in accessing and utilizing capital, labour, natural resources, etc.

The review would obviously necessitate removal of tax incentives that twist flow of equity, debt and grants (under
public private partnership projects) and other resources to certain sectors.

Put simply, this means the Governments would have resist corporate lobbies that engineered grant of tax incentives in
the first place and pull strings to retain sops forever.

The solution appears easier on paper but is difficult to implement in emerging economies like India where crony
capitalism has grown by leaps and bounds in spite of all loud thinking over fiscal transparency.

As noted by a World Bank study,"Tax reforms are not only technical and institutional in nature but also political.
Government support for tax reforms may fluctuate during the life of a project, a possibility that design, monitoring,
and supervision should reflect".

The study, released last month, focus on tax revenue mobilization by collating and comparing lessons drawn from
implementation of World Bank Group-supported tax and administrative reforms in 107 countries.

Reverting back to the issue of impact of taxes on TFP, it has been articulated by an IMF's working paper (WP) that
was issued a day after Fiscal Monitor's release.

Titled 'Tax Administration and Firm Performance: New Data and Evidence for Emerging Market and Developing
Economies', WP has deployed a Tax Administration Quality Index (TAQI). It uses country-specific information on
different dimensions of tax administration pertinent for the tax compliance burden faced by firms.

The index captures efforts to improve the quality and flow of information to taxpayers, simplify the structure of the
tax system, and streamline reporting requirements and procedures along different dimensions. This country-level
index is related to firm-level data from the World Bank Enterprise Surveys for 21 emerging market and developing
countries.

WP found"a positive and statistically significant effect of a lower compliance burden (i.e., a high TAQI score) on the
productivity of small and young firms."

IMF's staff discussion note (SDN) dated 3 rd April 2017 has also dwelt on productivity decline in many countries.

Titled 'Gone with the Headwinds: Global Productivity', SDN says: " The drop in total factor productivity (TFP)
growth following the global financial crisis has been widespread and persistent across advanced, emerging, and low-
income countries. And that declinealongside weak investment in the case of advanced economieshas been the main
contributor to output losses relative to pre-crisis trends."

In advanced economies, the challenge before the Governments is thus to attract back cash piles of multinational
corporations (MNCs) for investments in projects that create jobs and wealth.

President Donald Trump, for instance, has mulled tax innovations that discourage outflow of American corporate
capital abroad. Trump's package might well be a mix of reduction in corporate taxes and launch of destination-based
cash flow tax on imports. It would be a carrot and stick approach towards US MNCs that are holding their profits
abroad and market products that they manufacture abroad.

Governments in several emerging economies have not facilitated development of healthcare and education to match
the pace of population growth and people's aspirations. They have neither allocated adequate funds for these sectors
nor provided composite policy framework to expedite flow of private and foreign funds.

It is here pertinent to cite a study released earlier this month by Organization for Economic Cooperation and
Development (OECD). The study, captioned 'Taxation and Skills- How tax systems impact skills development in
OECD countries', says: " Investments in skills are a good investment for government, with every dollar invested being
more than fully repaid in additional tax revenues on average"

It adds: "The costs of failing to invest in skills will have consequences in the years ahead. A failure to invest in skills
today will not only impede the economic participation of individuals and restrain productivity growth, but will also
reduce future expected tax revenues, increase future expected levels of social expenditure, and jeopardise future
inclusive economic growth prospects."

A World Bank study on fiscal policy and economic growth published in 2007 has struck a similar chord. The study
explored public finance policies in the transition countries of Europe and Central Asia (ECA) and their likely effects
on economic growth.

It observes: "Evidence in this study supports the finding elsewhere in the literature that high levels of spending
in"unproductive"areas (most notably spending on public consumption and transfers) can have a negative impact on
growth, while spending in"productive"areas (investment, social sectors) can promote growth."

It adds: "Taxes that distort incentives for productive investment or employment can impede growth, and analysis in
this study concludes that such effect is likely to be compounded when governance is weak. In contrast, taxes that
create fewer economic distortions, such as taxes on consumption, are less likely to have a negative effect on growth."

All such studies show that distortions in tax and expenditure policies are hurting economic growth and economic
efficiency.

It is now up to the Governments to take leaf from these reports. They should revamp their fiscal policies, in tandem
with related policies, with the sole objective of releasing growth genie.