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Concepts & Tutorials

Tax Incentives Have Distorted Our Economy. Remove Them and We’ll Win.

I went on a twitter rant about how we deal with incentives:

What do you think?

Note: These are obvious simplifications; there is probably a good reason for every tax incentive. But there is such a thing as too much incentive, and like reservation for the “creamy layer”, it’s horrendously ineffective at some level. I believe that India has the chance to demonstrate to the world how a lower incentive system will work better.

By the way, you know why it’s so much more difficult to export than import? Because of duty drawbacks and export exemptions. If you export so much, you get x% back from the government. People abused this by exporting empty boxes. So now, every physical box has to be packed in the presence of a government official. Take away that incentive, and you’ll find that people squeeze out the margins from operations, and things get better with no bribe to be paid to a government official which is no longer a bottleneck for higher volume exports. And imagine the savings on government payroll when they don’t need that many people policing exports and signing cheques to release for exemptions.

I’d love to hear your thoughts!

  • lohit says:

    Certainly welcome adding long term capital gains tax on equity and removing deductions on housing. On a historical note, LTCG was present till 2004.
    The govt has now gone further by now adding a (imputed rent based) tax on inventory held by builders. I am no fan of builders, but this is dirigism run amock. First of all, builders are desperate to get rid of inventory. Secondly, if the builder holds on to inventory, that is his choice. Why should the govt be bothered ? We dont tax car companies for their inventory, so why this unfairness for builders ?

    • Lohit I think this is to equate tax with the taxation on unoccupied homes by anyone private. If you own a house and it’s not occupied, you have to pay tax on imputed rent. The law is being pushed on to builders. This doesn’t apply to cars – that is, if you own a car and don’t use it, there’s no imputed anything. So in that context laws are the same.
      A tax disincentive for housing (for keeping houses empty) can also be removed if they remove the incentives, of course, but that’s a different matter.

  • Kaushik says:

    One of the best quality basmati(Kohinoor Gold) is available 12£/10kg in UK supermarkets(Tesco) which is effectively 120 rupees/kg in indian currency translated. I wonder why in India it costs so much more for the same grade. Deepak you have rightly pointed out there is an over emphasis on exports which have distorted the domestic prices.

  • Hemant says:

    Well why not tax the Agricultural income ? At least here we can keep some higher limit, say till 25 lac or even if it is 1 cr,all these shoddy deals under that head will be taxed.

  • kiran says:

    Time for Arun Jaitley to move on, would love to see Deepak as our Aardhik Mantri..seriously..

  • Shan says:

    Interventions are
    always counter productive. Also read Henry Hazlitt’s “Economics in one lesson”.
    I agree entirely with what you said, but a smart investor tries to benefit from the facts instead of trying/hoping to change the facts.
    So people are disincentivised to serve the local market. How can you gain an edge if you know this?

    • Shan, This is not a post about gaining edges. The point is to attempt to change the system. If you want to assume the system exists and carry on, that’s what we do everyday anyhow, and we actually run a business that targets this. But the objective of this post isn’t to enhance business – but to make the point that incentives sometimes stand in the way of progress.

  • babu says:

    “When you see less capital go to housing, that capital will go elsewhere. Into businesses, into better investments. We’ll rock more.”
    Your lack of knowledge is only superseded by your lack of common sense and judgement.
    what better investments are available in india? 6% post-tax return FDs?
    The stock market is a big casino and insider trading is rampant. till the time SEBI has some tooth, the aam aadmi is better of investing their hard earned money in property.
    There has to be an effective use of capital. just because capital is cheap, even companies may start to squander it on non-core activities or out of the blue acquisitions.
    I could go on and on…

    • I am ignoring all the bull about my lack of whatever.
      India does have better investments – the stock market is NOT a big casino, and people have made long term wealth in it. Property is largely a bubble and deserves to be destroyed as an investment and be kept as a cash flow measure (if prices fall substantially you can get better rental returns)
      Plus you can invest in businesses directly – from startups, to funding small entrepreneurs, to debt funding at higher yields and all that.
      A misallocation to housing will be corrected if we remove these unnecessary incentives.

    • Nikhil says:

      Sorry I could not resist commenting.
      @babu: As a long time reader of this blog, I am angry and surprised that anyone would call out Deepak “lack of knowledge and common sense”. He has brilliant knowledge and sense of financial world. Kindly go through past posts on capital mind man. Think twice before writing crap.

  • JB says:

    I don’t agree on removing tax from LTCG in stocks. Currently LTCG is the only option available for middle class to save and invest somewhere without paying taxes.. As far as we think that stock market is not a casino but still the common person in India thinks that it is one big casino due to the unawareness and lack of financial literacy. LTCG was made tax free with the purpose that the commonest person must invest in equities and be part of India’s growth story. If you still look in our country we still have low single digit figure of our population investing in either equities or equity related mutual funds. If the LTCG is taxed then it would be very difficult to bring more people into equities and they would stick with either gold or real estate which have been their choice of investment for many generations.
    While regarding tax sops for exports I do think it is necessary.One must realize that India imports far more than it exports and if exports are not incentivised it would result in our currency to go downhill. While it is important to make good stuff for the local market, but one can’t take away the importance of exports in development of nation.
    Regarding your quote about IT, I think that IT majors have not made great software for anyone. If you look at the bulk of the IT companies, these are usually consulting and outsourcing firms taking advantage of wage difference. I have never heard a major software or an app that has ever been released by an Indian firm. They might be in the team of developers for the same but they have never themselves evolved to innovate something on their own.
    I would like to know your comments on these three issues.

    • LTCG freeness hasn’t helped. Volumes are flat from 2007! We should absolutely remove it and instead, tell people they can make greater returns in the long run anyhow.
      India exports a lot of things that are not incentivized. and if we don’t incentivize exports we will build better stuff for Indians, and then other people will want that stuff too. (Pepsi, coke and McDonalds were built to serve Americans, and now they are worldwide, and they didn’t succeed because of incentives, for example)
      IT – yes, innovation hasn’t come from IT majors. That’s beacuse they didn’t have to. They were able to pay people more because tehir profits were not taxed. The work they could offer was of coolies, and they could keep doing that cheaper as the rupee fell. That model is now under threat because wages in India are up, and they’re up largely because the guys who build FOR india are the ones that get funded and can pay much higher. We nnever innovated becaue we didn’t need to , and we didn’t need to because of too many incentives.

      • JB says:

        Volumes have picked up and if you can see there is much greater domestic participation in mutual funds now then it was previously held. The recent rally is almost entirely supported by domestic investors as compared to FII’s. It is very wrong to compare it from 2007 where we witnessed one of the major erosion of wealth from the markets due to the depression. Historically whenever such an event happens it does takes years for the common person to have trust in equities again. Also one has to see what we gain and what we lose by having such a move. No wonder we could gain tax money but it would also come at a cost of far less retail participation which the government actually wants.
        By merely saying that people can make long term wealth one can’t attract capital from the common person. The equity mutual fund industry is well into two decades and that is adequate time to for saying and educating but the fact remains that the participation is still less as compared to other major economies in the world.
        I do agree with your point on exports and innovation in IT. The major threat of IT companies is now growing automation. It is tough to believe but the algorithms these day can be used to replace even lawyers and authors. I am not even talking about things that could happen in future but the things that already exist now. With growing artificial intelligence, better machine learning and continuously improving algorithms most of white collar jobs including yours and mine could be easily handled by an algorithm 🙂

        • Jiten, most people invest in FDS. A factor of 50x more money comes into FDs every year compared to equities. And FDs have no tax incentives. The same with equities will happen even if you remove tax incentives.
          I believe that when you remove subsidies and incentives you actually will encourage a broader economy rather than a directed one.

  • Raghav Kheria says:

    Hi Deepak,
    I am an exporter and I can safely say that interest subvention has no impact on the competitiveness of exporters. Govt should focus more on infrastructure, labour laws, ease of doing business to make us competitive. We are forced to hire contract workers and pay them on a per piece basis because the moment we hire permanent workers, their productivity goes down drastically. And you know what will happen if they are terminated!
    There should definitely be some kind of LTCG. People will still invest in equities so there is nothing to lose for anyone.

    • Thanks Raghav! This is great input. I agree that if we ease the doing of business we will benefit dramatically. Would love to hear if your exports suffer because of the export procedures. Labour I understand – there’s no point with permanent labour I agree, and the only way to incentivize is to pay per piece. We need to allow as many contractors as required, but at some level we should see certain things ensured (like perhaps PF, health insurance, holidays etc)

  • Sreekanth Yelicherla says:

    You are a genius!!

  • Prasun says:

    Do a longer post on no 4?

  • Sushila says:

    Why not tax every birth? Great Long term benefits

  • Manickkam says:

    Hi Deepak,
    Excellent comments. I totally agree on the comments made about tax sops affecting investments and business.
    As the people in power need the support of capitalists, who want and need these tax sops for them, it may not go away completely. This is a good callout for a better system.
    May be along with ‘Make in India’ campaign, if we remove tax sops from exports and give those for local inventory creation, this would help the economy.
    Also, the real estate is the most skewed sector and taxes indeed play a major role in people buying more than one homes. Builders are essentially living in this with crazy prices.
    Hope it comes into action. Can a common man help in driving these decisions someway.
    Thanks,
    Manickkam

  • Getafix says:

    A zero tax on capital gains means speculation is incentivized, while honest, hard work is dis-incentivized in the form of income and other taxes.
    There are going to be long term repercussions of this policy encouraging citizens to be less productive and instead spend their time and money in the casinos that the stock and other asset markets are.

  • work_ant says:

    Good points.
    One way to look at it is that the Govt uses subsidies, exceptions & incentives to make for its own inefficiency. Since Govt had underperformed in Infra, Education & Banking they gave incentives to IT sector and the trickle effect led to an education & Infra boom. The boom has now become a bubble but still it cannot be denied that we now have an ecosystem that can create/nurture startups. This is of course simplification but you can see the pattern.
    So in essence removal of subsidies means that Govt has to be efficient & effective in doing what its core functional responsibilities are. Without that improvement, subsidy removal may create a negative effect.

  • Ranjeet says:

    Great post and ideas. Just one question Deepak. Will taking off Export oriented tax sops not hurt India’s export business and hurt our Forex position?