Taxing Half-Truths

This is election season. So, in keeping with the mood of the day, we’ll deal with the familiar area where economics and politics interact and blend into each other. Every now and then, some politician will stand up and berate the centre for not providing enough funds for Mumbai city. The logical course for this now-so-familiar harangue is as follows: highlight the city’s enormous contribution to the centre via direct taxes paid and then blame the centre for usurping these funds without spending a dime on the Mumbai’s development. This gets repeated often and – like any other fragment of gossip -- acquires some modicum of legitimacy.

The truth is often far removed. Let’s tackle the issues one by one. First, the tax contribution. It is entirely true that Mumbai city collects and provides huge amounts of income tax to the centre. Figures and percentages keep varying, depending on which report you are reading or which politician you heard last. It is also true that only a fraction of that money gets back to the city for its further development. But, here begins the smokescreen.

The income tax collected by the city is indeed huge. But, is all of that generated by Mumbai city alone? Not really. Take the case of some of the highest corporate tax payers. For example, the country’s largest bank, State Bank of India, is among the top tax payers from Mumbai city. But, are its profits derived from this megapolis alone? Hardly. The bank has thousands of branches spread across the country, conducting banking business, making profits, which all show up in Mumbai because the bank’s headquarters are based in the city.

Take the case of another large private sector company, Hindustan Unilever Ltd. The company makes soaps, detergents, toothpastes and other such products across the country and sells them widely throughout into every corner of this vast landmass. But, when it comes to paying taxes on its total profits (which includes contributions from each and every sale that occurs in some village or tehsil), the lump-sum amount seems to emanate from Mumbai only because the MNC’s India headquarters are located in the city.

But, have you ever wondered why does everybody harp about direct taxes only? Why does nobody actually talk about Mumbai contribution to, say, the total excise duty kitty? The reason is: excise is collected at point of manufacture and most factories are spread out across the country, instead of being concentrated in one city or state or region.

The second part of the half-truth: does the government spend very little on the city’s development? Absolutely, no doubt about that. But, again there’s more too it than meets the eye -- under the federal structure of the country, the centre pools all the central taxes received from the different states and then allocates resources from this pool to different states, based on a formula devised by a finance commission (which is changed every five years). In addition, the centre also launched a scheme called Jawaharlal Nehru National Urban Renewal Management to improve the civic infrastructure of all major metro in the country. Resources are allocated based on certain criteria. People should ask: have the state government, or the city authorities, met all the conditions?

People should not get sold on half-truths about the city. Or get swayed by emotion-tweaking statements about the city’s contribution. In all of this, the city’s actual problems get dwarfed and its real contributions obfuscated.

ROI: Rely On Inspiration

In corporate finance, ROI (or, return on investment) is a well-known and quantifiable ratio. It has no ambiguities and has very little room for negotiation. But, the concept of ROI is now being extended to other areas as well which have ample space for manoeuvre and, sometimes, can even evoke the involvement of the super-natural. The on-going general elections have invested the temporal ROI concept with an otherworldly veneer.

In accounting terms, ROI is used to measure how effectively a corporation is using capital to generate profits. In simple terms, it is measured by dividing a company’s operating profits (adjusted for taxes) by its outstanding equity capital plus long-term debt. But, then, there are other versions of ROI as well. For example, in the stock market, return on investment measures the net gain made from investments compared to the cost of investments. And, then there is an ROI definition tailor-made to fit the IT department too, which presumably computes the efficacy of investment in all kinds of boxes versus the improvement in productivity or gains in efficiency, or whatever.

But all these measures are quite solid and leave little room for uncertainty. But, once the finance guy’s ROI concept travels to the advertising industry, it acquires a wee bit of grey zone. In traditional advertising, the ROI concept tried to measure the efficacy of advertising by pitting the bucks spent on advertising versus the money it generated by an increase in sales.

Now, this is not so easy to determine. Sales can increase for a variety of reasons, including the influence of advertising. There is no scientific method to prove that ‘x’ dollars spent on advertising and marketing leads to sales increasing by ‘y’ dollars. Then came the internet and the guys hit pay dirt. It then became easy to determine which banner ads got how many clicks, and how many of them then were converted into online sales. But, there still existed some room for doubt – there is no way of knowing how many people saw a banner ad on an internet site and then went purchased the product advertised from the shop on the street-corner.

To be fair, the guys with the calculators and the fancy spreadsheets seem to have made some progress and today there exist some proximate formulae for figuring out the ROI of an advertising campaign. While the ROI concept is basically a qualitative one in finance and accounting, in advertising and marketing it acquires a qualitative hue.

But, the general elections in India have imparted a completely speculative ring to the ROI term. The Times of India edition dated April 14 had an interesting, Hyderabad-datelined story on the front page: “In an agenda-less election, with political parties forced to bank only on the promise of more goodies, the crackdown on the flow of liquor and cash being transferred in vehicles is proving to be a big dampener for aspirants. Every car moving around in the city, and especially its outskirts, is being stopped at various points by cops led by the Election Commission-appointed DGP A K Mohanty, its licence plate noted and the boot and space under the seats thoroughly checked. Such checks have yielded a booty of Rs 23 crore in the last week, leaving many of the candidates apprehensive.”

It is well-known that currency in circulation shows a sharp jump in the weeks preceding an election. It has been noticed this year too. Writing in The Economic Times, dated March 6, Gayatri Nayak and Gaurav Pai observe: “As the world’s largest democratic exercise unfolds, parties and candidates are expected to mobilise and spend thousands of crores as part of their campaign. An immediate impact of all the spending by political parties is an increased volume of cash in the form of currency. This year too, like every other year, there has been a sharp jump in currency in circulation. Some traders in the foreign exchange market feel that with political parties reaching out for overseas funds, there will be a rise in remittances before the elections , as in most years when the country goes to the polls.”

The moot point here then is: how do candidates know whether the cash spent (or liquor bottles -- the proxy for currency in many areas of the country -- handed out) is actually translating into votes or not? In some areas, some political parties possibly ensure that through muscle power and the menacing barrel of a gun pressed against the temple. But, otherwise, it is damn difficult to figure out the ROI on the cash doled out. The logic must be: Pay the cash and hope for the best. In poll parlance, ROI probably stands for Rely On Inspiration.

THREE JOKERS IN A PACK!

Finally, it all boils down to only three variables – politics, monsoons and the budget in July. A combination of these three in varying degrees is going to determine the future of the economy – as well as the speed of recovery from the current economic slowdown. Brrrr... that’s a damn spine-chilling, peace-of-mind-wrecking thought!!!

First, there is no way you can avoid the political fallout of the impending elections on the economic future of this country. Whichever political blend rises to the top after the electoral churn -- whether it is the Congress (in various combinations with its old allies, including with or without the Left Front), the NDA, the Third front, or even the Fourth Front – their economic policy, and their strategy to extricate the economy from the current morass, is going to be closely watched.

This political combine’s socio-political philosophy – some of which is nothing but a vulgar manifestation of crony capitalism -- will also be critical in framing the July budget, which also has a large role to play on how the economy pans out in the next couple of years. Suppose, in a replay of the 1996 freak outcomes, what if some poor, hapless soul gets chosen as the consensus prime minister? Will you trust your economic policy to him?

The current source of economic pride – that India’s GDP is still growing at over 5% -- lies in the villages and the semi-urban settlements. Their source of consumption power flows from a number of propitious barrels – the loan waivers (which has spotty distribution), the NREG, the rising minimum support price for rice and wheat, etc. But, god forbid, one bad monsoon and it all goes...poof!...up in smoke.

The frightening bit about all the three variables is that you and I seemingly have no control over any of these factors. But, we do have control over one lever. And, that’s our vote. Make it count, guys .

Statosphere: Where The Figures Don't Meet

There are many jokes about statistics and the tricks that numbers play. Behind any jumble of numbers, what you see is not always what you expect to get. Any arrangement of numbers can be interpreted differently by different people. So, it was not entirely surprising when the telecom ministry last week ordered an audit of the country’s top mobile operators. The beef? The ministry feels that mobile operators, to avoid paying the government a higher licence fee, are misrepresenting their revenues. Telecom operators are expected to pay a licence fee to the government, which is calculated as a percentage of their revenues. Some services attract a lower percentage compared to some others – for example, while revenues from long distance services attract a licence fee of only 6%, some other mobile services attract 10%, leaving ample room for arbitrage. But, what’s surprising is the discovery made by the ministry – some mobile companies were reporting one set of numbers to the Telecom Regulatory Authority of India, and a completely different set to stock exchanges.
Today’s column is not concerned with the telecom regulatory infractions but is suitably spurred by the interesting example of two sets of balance sheets, representing the same core numbers. Statistical discrepancies have become a way of life in this country. At the platinum jubilee celebrations of the Indian Statistical Institute in Kolkata, in December 2006, prime minister Manmohan Singh observed: “Another key issue has been the discrepancy in the estimates of the same variable from two different sources. The classic example is the difference between the National Accounts and National Sample Survey estimates on consumption expenditure. The present system has also not been able to provide adequate information on basic socio-economic indicators that are crucial for micro level planning.”
This is a concern expressed even by the high level committee on estimation of savings and investment, chaired by C Rangarajan (former chairman of the prime minister’s economic advisory council), which submitted its report recently. At the macro level, the report traces how committee after committee has pointed out the statistical discrepancies between savings and investments estimates, with savings far exceeding investment numbers. For example, the report notes how the Chelliah expert group had noted that the order of discrepancy in 1994-95 was almost 2% of GDP. Many other similar examples abound in the macro-economy.
At the micro level, there is the absurd situation of the same issue being reported differently by different ministries. Take the example of the cotton crop. Curiously, both the textile ministry and the agriculture ministry provide their own estimates on the annual cotton crop and, predictably, both are widely divergent. This has been happening over many years and arises primarily because the two ministries use different methodologies. For example, take the crop estimate of 2004-05: the textile ministry reported it as 243 lakh bales of 170 kg each, while the agriculture ministry number was 16.43 million bales (of the same size, or 164.3 lakh bales). The advance estimates for 2007-08 were similarly at variance: 315 lakh bales versus 258.1 lakh bales, respectively.
The same kind of statistical discrepancy has existed even in the trade deficit figures presented by Reserve Bank of India and the numbers generated by the commerce ministry, with the central bank’s trade deficit estimate typically being higher than the ministry’s. The difference arises largely in imports estimates, with the RBI number based on foreign exchange paid on the day of the import rather than the year’s average rate used by the commerce ministry in its calculations. But, more importantly, the RBI’s numbers include defence imports, which never have to pass through customs scrutiny (and therefore escape getting caught in the commerce ministry’s statistical dragnet) but have to be paid with hard foreign currency.
But, despite these manifest discrepancies (some of which exist even in the developed economies), this column’s heart goes out to the unseen and unheard class of professionals called statisticians who have been given the unthankful job of collecting data from across this vast country, teeming with diversity unknown to any other nation-state, using technology that’s horribly outdated and given budgets that are constantly shrinking. And, despite all this, the fact that they still manage to distil some semblance of sense into that thicket of numbers -- which is then used by policy makers to drive decisions and massaged by politicians for gaining mileage – is creditworthy. Spare a thought for them too when you next boast of how India’s going to grow by over 5%, when the rest of the world economy is shrinking. Without them, you wouldn’t have had a clue.