The Hindu Business Line : Three affirmative tax actions

Dr Manmohan Singh and Mr P. Chidambaram could include three affirmative tax actions in the 2005 Budget. There is nothing cosmetic about them. They foster merit and competitiveness among employers, potential employees and the self-employed, and within the government. The emphasis of the affirmative package is on doing, earning and growing, says G. Ramachandran.

THE Prime Minister, Dr Manmohan Singh, hates being a peripheral nibbler. He chomps his way to the core of economic issues with piercing swiftness. He has a record of providing practicable solutions. Therefore, it is significant that the issue of caste-based reservation (CBR) in the private sector has caught his attention. CBR in the private sector is an important objective of the United Progressive Alliance Government headed by Dr Manmohan Singh.

Dr Manmohan Singh expressed his resolve in October 2004 to expand employment opportunities in the private sector for India's underclass. He asserted that CBR is an idea whose time has come. Though he was not in favour of legislation, he said the private sector should voluntarily work towards reserving employment opportunities for the underclass.

What was, perhaps, left unsaid was that legislation might never yield the desired results of CBR. Mr P. Chidambaram, Dr Manmohan Singh's experienced and suave Finance Minister, has stoutly denied the possibility of any coercive CBR legislation. They have chosen to depend on voluntarism. It may well be their only choice.

Dysfunctional coercion

This author has argued in the past in favour of reservation in the private sector (Business Line, February 2, 2002 and August 27, 2004). However, analysis since then shows that any CBR legislation would fail to deliver the desired results.

CBR imposed by coercion could lead to a flight of entrepreneurs and entrepreneurial capital. It may shut off the inflows of global capital. If there is no incentive to those employing the underclass, employers could choose to stay out of business, relocate to, say, other South Asian countries or stagnate.

The last choice would be the most horrifying. Employers may fake their willing adherence to the coercive CBR law and then run their businesses without expanding employment and output. India's loss would then be China's gain. But India needs to win, and here is how it can.

Showing the way

Dr Manmohan Singh and Mr Chidambaram could include three affirmative tax actions in the Union Budget for 2005. First, allow an employment deduction from a firm's taxable profits. The deduction should be related to the payments made to the putative beneficiaries of CBR. Second, cut the rate of direct taxes and surcharges of employees and the self-employed who are the beneficiaries of CBR. Third, the magnitude of employment allowance and the tax cut or rebate should be directly proportional to the economy's growth rate.

The three affirmative actions would show that government knows how to implement an idea whose time has come. It would demonstrate its earnestness in enhancing the underclass's employability and incomes. It would showcase its utilitarian approach to the accomplishment of growth objectives. Moreover, it would show that India has the courage to invest in its citizens and their economic future. India needs tax laws that promote voluntary investments in human resources.

Understanding voluntarism

Dr Manmohan Singh is first an economist and then the nation's chief executive officer. He is a seasoned practitioner of the best that economics has to offer in the realm of self-interest. If people's self-interest can be stirred, coercive legislation becomes unnecessary.

Voluntarism is the foremost force in economics. It postulates that the will is the dominant factor that pushes people into action. Where an individual is unwilling, no force in the world will succeed in pushing that individual into any action. Voluntarism is based on self-determination and free choice. All theories and postulates of economic rationality are built on voluntarism.

From the perspective of voluntarism, it can be argued that coercive legislation aimed at CBR will not solve the economic and social problems of the underclass. If an employer has no desire to employ some people and the law says those people have to be employed, the employer may volunteer to shut down its Indian business. It may indefinitely put off expanding its business. The firm's entrepreneurs may flee India or choose to join the ranks of the unemployed. No one then gets a job. Coercive CBR would achieve nothing.

Utilitarianism with merit

Utilitarianism is another powerful force in economics. It asserts that the determining consideration of any action should be the usefulness of its consequences. The aim of any action should be the largest possible balance of pleasure over pain and the greatest gain of the greatest number. The three affirmative tax actions meet the utilitarian criteria.

The first affirmative action encourages employers of all sizes — small, medium and big — to employ more from the underclass and pay each one of them more. Self-interest would drive their actions, which would set off competition among employers to locate, nourish and hire the best from the underclass. The fear of jobless growth would cease to stalk the underclass.

This affirmative action provides the incentives to employers to set up pre-employment training facilities for those who deserve a better deal in life. They would then continually re-skill their employees with the objective of retaining them. Many employers may then voluntarily draw in all of their employees from the deserving underclass.

The second affirmative action encourages employees and the self-employed to keep more of their incomes to provide for the education, health and security of their families. This action would set off competition among them to earn more so that they can spend more on their families. With an income tax rebate, millions of households would begin to own their economic lives. They would not have to be dependent on or indebted to anyone.

Goal congruence

The third affirmative action encourages employers, employees, the self-employed, and government to work together towards achieving the highest possible rates of economic growth. This tax action rewards goal congruence and penalises shirking.

When high economic growth targets are set and then achieved, tax inflows to government would be high. The government can then afford to allow larger magnitudes of employment allowance and tax rebates.

When government fails to grow the economy handsomely, everyone would know. Everyone would be concerned too because it hurts everyone. By so balancing the rewards and penalties, India would have banished the free riders.

Making things work

First, the implementation of the affirmative actions requires the issuance of the permanent account number (PAN) by the income tax authorities to everyone who is 18 or more years old. Every PAN card and the centralised computer records should state whether the PAN holder is a beneficiary of CBR.

Second, all payments made by employers to all employees should state the payee's PAN. Payments made to permanent, casual, contractual and temporary employees and to the self-employed should be treated uniformly.

Third, proprietorships, partnerships, unincorporated firms, co-operatives, societies, private incorporated companies and public incorporated companies should be treated uniformly. All payers that are not exempt from taxation should be treated as employers. Fourth, every payment made by an employer in an assessment year to an employee who is a beneficiary of CBR should be allowed a deduction that is a multiple of the estimate of economic growth included in the Economic Survey. The multiplier could be two, three, four or more. If the estimate of annual economic growth is 7 per cent and the chosen multiplier is three, a rupee paid to an employee who is a beneficiary of CBR would qualify for a deduction of 21 paise as employment allowance. This should not affect any other deductibility.

Fifth, direct taxes and surcharges payable by the employed and self-employed should qualify for a CBR rebate. If the estimate of annual economic growth is 8 per cent and the chosen multiplier is four, the employed and self-employed who are beneficiaries of CBR would qualify for a tax rebate of 32 per cent. If their normal tax liability is Rs 100, they need to pay Rs 68.

Holistic growth

The three affirmative tax actions together constitute a powerful creative force. They serve the interests of the underclass, millions of self-employed, national economy and employers. It is apt and functional in an era where companies downsize and then outsource a large part of their operations.

There is nothing that is cosmetic about the three affirmative tax actions. They foster merit and competitiveness among employers, potential employees and the self-employed, and within government. They create an open field and then give everyone a fair chance to earn the employment deduction allowance and the CBR tax rebate. The emphasis of the affirmative package is on doing, earning and growing. The emphasis is not on taking, giving or displacing. May the era of doing, earning and growing begin.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com)

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