The best solution to the problem of tax evasion is to simplify both the tax and the regulatory environment
Periodically for the past two years we have been bombarded with stories about the Greek financial mess. The Greeks and several other countries in the Eurozone have very large deficits. The bond vigilantes have been attacking these countries’ sovereign bonds, driving the level of interest to unsustainable levels. Since many of the local banks and often other Eurozone banks hold sovereign bonds as part of their mandatory reserves, a local fiscal crisis has metamorphosed into a European wide banking crisis. The Germans could help out. They could agree to shoulder part of the debt by allowing the Eurozone countries to issue Euro bonds backed by the credit of all of the countries. But they won’t. The simple reason is that they don’t feel responsible for a country where everyone evades taxes.
Certainly tax evasion is rampant in Greece. The Greek government’s tax revenue is about 52 billion euros a year. It is estimated that they lose up to 45 billion euros a year due to tax evasion. This is certainly an alarming number, but determining the size of tax evasion is perhaps nothing more than an educated guess. If you believe the number above, the tax evasion in Greece was 46% of potential revenue. According to the Greek Central Bank, it is one third, still a very large number.
Greece definitely collects less than the other members of the Eurozone. The average tax revenue for Eurozone members is about 40% of the gross domestic product (GDP). Greece collects only 33.2%. But it is just below the Czech Republic at 33.8% and Poland at 34.8% and well ahead of Switzerland at 29.4%. None of those countries seem to have a financial crisis. The reason Greece has troubles is that it spends more than it takes in. The gap is 13%. Interestingly the US is in a similar position. Its tax take is only 27% while it spends 40% of its GDP, the same amount as Greece.
Why can’t Greece collect taxes? Social scientists love to ascribe cultural aspects as reasons for poor tax collection. The Greeks have low “tax morale”. The Greeks view their society and government as corrupt. So they do not feel any moral obligation to support it with taxes. The act of breaking the law by not paying taxes is simply doing what everyone else in their society is doing. With a score of 80, Greece does not rank that high on Transparency International’s Corruption Index. But it is collects about a third of its GDP in taxes. China has a better score (75), but only collects 17% of its GDP. Malaysia’s score is 60, but only manages to collect 15% of the GDP.
Still I find the idea that the Greeks are somehow culturally doomed to be tax evaders rather simplistic. Law and economics studies have consistently shown that the probability of a criminal act is a function of the severity punishment and the risk of getting caught. Tax evasion is defined as using illegal means to avoid taxes. This usually involves some sort of misrepresentation or outright fraud. But a complex tax code with high marginal rates and a myriad of exemptions is one of the best ways to provide the legal means and the economic incentive to avoid the tax. In Japan tax rates are rather low and only 1% of wealth is held offshore. In Europe with high marginal rates the number is over 10%.
Ideally good tax laws have three goals: Equity, competitiveness and the generation of sufficient public revenue. They rarely achieve any of these goals because they are designed by politicians often to satisfy special interests. These provisions once enacted are almost impossible to get rid of no matter how foolish. In China small-to-medium sized companies have a gross profit margin near 10%, but the VAT (value-added tax) was 17%. If the companies actually complied, 90% would go out of business, so instead they all avoid the tax.
The size of tax evasion is directly correlated to the size of the underground economy. In Greece the underground economy is estimated to be about 27%, which means a lot of the commerce goes untaxed. The problems in Greece pale compared to Russia where the shadow economy is over 43%.
The best solution to the problem of tax evasion is to simplify both the tax and the regulatory environment. A system free of special deductions, credits, and exemptions is easier to use and enforce. Simplified regulations encourage firms to do business in the regular economy. But the complexity benefits a plethora of specific special interests which will fight tooth and nail to protect it. Politicians will only act when there is no alternative. To stop a crisis would take a simple rewriting of the law, but the law probably will not be rewritten until there is almost total collapse.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)
Although Turkey depended on the West, a beginning could be made to export products and services from India. The 54th part of a series describing the unknown triumphs and travails of doing international business
On the top floor of the Commestra Building, where we had our offices, there was a company dealing with teleprinters, which they were mostly importing from Germany and doing a turnkey job of installing and servicing them on a regular basis. A young man by name Nabil used to come to our office once in a while for a chat and to have coffee with us. He used to visit Saudi Arabia and had good connections there and was friendly with a couple of members of the ruling family. My interest was to see if we could push teleprinters from Hindustan Teleprinters made in Madras.
We made a small break-through, when they were able to get teleprinter rolls for use, but it was STC which eventually secured the contract for the first consignment of teleprinters from India. Occasionally, I used to get my telex messages from their office.
One such message was a briefing relating to a visit that I should make to cover Turkey. I was advised that both India and Turkey were in the same league as LDC countries—least developed countries— and the US wanted us to develop and increase our trade, for which some loans or grants were made available.
After a brief home work and exchange of messages with the Indian Embassy in Ankara, I went on a visit and planned to cover both the capital and their commercial centre, Istanbul. I spent a few days in Ankara and immediately after my initial discussions with the commercial secretary; he was kind enough to put me in touch with a couple of interested parties in the textile industry. As a matter of practice and to gather information on any country I visited, I made it a point to visit the chamber of commerce and industry, their ministry of trade itself so as to obtain best results.
The people were friendly and all the business people I met spoke English, though it was a little difficult to move about in the city where mostly Turkish was spoken. I remembered too that only a few years earlier, I had read about the establishment of RCD—Regional Cooperation and Development—a sort of treaty among Iran, Turkey and Pakistan, which encouraged trade and industry amongst these countries. Iran was surely making progress under the Shah and Turkey too was greatly influenced by Europe and making rapid developments. Unfortunately, Pakistan was more embroiled in internal strife; civilian and military, taking turns to control the country and was hardly making any progress.
There was definite interest in setting up textile factories in Turkey. Many businessmen were keen to get connected to Indian fabric makers, but, everyone was keen to set up units on long-term investments in Turkey or coming to terms on joint ventures. Indian textiles were well-known and accepted.
After spending a few days in Ankara, I moved on to Istanbul and continued to meet a number of interested parties for products and services. The Turkish people were most westernised and businesslike, but, because of the thrust of offers and services with long-term aids from Western countries, their preference was leaning towards the west; but now, at least on the textile industry, they were ready to switch over to India.
Tourism in Turkey was as strongly built as it was in Lebanon. Besides, the Turks working abroad were growing by the day and were hoping to push themselves to become European in character and behaviour. The Turkish labour force abroad remitted huge amount of foreign exchange to the country.
Turkey was also secular thanks to the movement that started and Kemal Ataturk brought about symbol of hope and aspiration for the Turkish people. In more ways than one, he was the Mahatma Gandhi for their people. Though official religion is Islam, the Turks were very secular in character.
As a country Turkey had a lot of sites to see; one of the most popular places to visit is the Blue Mosque, which I believe was built in the sixteenth century. One can enjoy long walks in the grand covered bazaar of Istanbul, and if accompanied by a Turkish friend, become a bargain hunter and, of course, not only enjoy watching the belly dancing but eat the Turkish delight, as they have a wide variety of food that one can enjoy.
A trip on the Bosporus, the gateway to Istanbul, is yet another unforgettable experience.
On the whole, the country offered great potential for export of Indian goods and services. On my return, it took us some three days to prepare my report and two more days to simply type and send them to our head office. Meanwhile, I was able to alert our head office by telex messages on the urgent actions to be taken for the serious and specific enquiries received and within weeks we had a number of senior people from the textile industry actually stopping over at Beirut en route to Turkey.
My report on the engineering opportunities for export to Turkey was published as handy reference book, which I was told later that even our associate organization like STC officials used for furthering business development in that country. The encouraging response, as a result of this report, made me proud that I was making some contribution for export development from India.
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce and was associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts. From being the advisor to exporters, he took over the mantle of a trader, travelled far and wide, and switched over to setting up garment factories and then worked in the US. He can be contacted at [email protected].)
Nifty may move up to the level of 5,500
The market settled higher in the week on positive domestic factors and global cues, making it the fourth successive weekly gain. The draft guidelines on the general anti-avoidance rules (GAAR) released by the finance ministry on Thursday and the clarifications that followed from prime minister's office on Friday saw foreign investors cheering the move, pumping in Rs3046.76 crore in equities on Friday (according to BSE data).
The Sensex closed the week at 17,430, up 457 points (2.70%) and the Nifty surged 133 points (2.58%) to settle at 5,279. We may now see the index making an upmove to the level of 5,500, subject to dips.
The market erased all its gains and settled in the negative on Monday as the government's initiatives to boost growth did not meet market expectations. The range-bound market witnessed a good recovery in late trade on Tuesday which enabled a green close. Hopes of the prime minister ushering in reforms for boosting growth, after taking charge of the finance portfolio, pushed the market higher on Wednesday. Positive sentiments ahead of the outcome of the two-day EU summit saw the indices closing marginally higher on Thursday. News from the Eurozone helped the market close sharply higher on Friday.
All sectoral indices on the BSE settled higher in the week, led by BSE Power (up 5%) and BSE Metal (up 4%).
The top gainers on the Sensex were Tata Power (up 11%), Jindal Steel & Power (up 8%), Maruti Suzuki, ICICI Bank (up 6% each) and Tata Steel (up 5%). The main losers on the index were Tata Motors, Bharti Airtel (down 2% each) and Hindustan Unilever (down 1%).
The top performers on the Nifty were Tata Power (up 11%), Jindal Steel & Power (up 8%), Maruti Suzuki, ICICI Bank (up 6% each) and Tata Steel (up 5%). Cairn India (down 6%), BPCL (down 3%), Tata Motors, Bharti Airtel (down 2% each) and HUL (down 1%) settled at the bottom of the index at the end of the week.
The RBI on Monday increased the FII limit in government bonds by $5 billion to $20 billion, while allowing up to $10 billion from the overseas borrowings by India Inc for refinancing rupee loan.
Ratings agency Moody's has retained outlook on India's rating at stable despite the slowdown in GDP growth rate saying that it is unlikely to be even a medium-term feature.
The finance ministry on Thursday proposed a monetary limit for invoking the controversial GAAR in its draft guidelines. Although the draft did not specify the monetary limit, it said that those deals which are over a prescribed limit should be covered by GAAR provisions.
The guidelines further said that GAAR provisions would be invoked only in cases where foreign institutional investors (FIIs) choose to take the benefit of double tax avoidance treaties.
However, the Prime Minister's Office on Friday clarified that "These (draft guidelines) have not been seen by the prime minister and will be finalised with the approval of the prime minister, who holds the finance portfolio, only after considering the feedback received".
Morgan Stanley has upgraded Indian stocks to "equal weight" after being 'underweight' since the first quarter of 2011, saying India is now trading at a price to book multiple of 2.1x, close to the trough valuations of 2.0x in the 2002 and 2008 cycles.
On the global front, leaders at the European Union (EU) summit agreed on Friday that EU rescue funds could be used to stabilize bond markets, without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms. It was also agreed that a single supervisory body for euro zone banks, controlled by the European Central Bank, would be created by the end of the year-much faster than previously envisaged. The deal had followed Spain and Italy's earlier threat to withhold support for a growth package.