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Mohan Murti

I was recently in Davos, Switzerland, attending the Annual Meeting of the World Economic Forum and one of the most personally enriching meetings I had was with Professor Xavier Sala-i-Martin, at Columbia University and Professor Michael E. Porter, Director of the Institute for Strategy and Competitiveness at Harvard Business School — both Gurus in their respective fields of management.

While Professor Sala-i-Martin developed the World Economic Forum’s ( http://www.gcr.weforum.org ) Global Competitiveness Index, Professor Porter developed the e Business Competitiveness Index for the WEF’s Global Competitiveness Report — evolved over the last three decades as the world’s most comprehensive and respected assessment of countries.

This year’s edition features a record 131 economies, accounting for more than 98 per cent of the world’s GDP. The US tops the overall ranking in The Global Competitiveness Report 2007-2008. Switzerland is in second position followed by four EU nations — Denmark, Sweden, Germany and Finland, respectively.

India has fallen five notches in the latest annual rankings. Last year, India was ranked 43 and was ahead of other BRIC markets. In the latest report, India was placed 48 in the list of 131 economies. China was ranked at 34.

While the report lauded India’s quality of business environment and efficiency of the labour and financial markets, it pointed to weaknesses in infrastructure and shortcomings in health services and education.

The report also includes comprehensive listings of the main strengths and weaknesses of countries, making it possible to identify key priorities for policy reform. The Indian government and organisations such as CII and FICCI must take a close look at the report and launch hands-on, proactive steps.

The main problem of the Finance Minister, Mr Chidambaram, who will announce the annual Budget later this month, is the stumpy, near-to-the-ground revenues.

While making the Budget, the Finance Minister will obviously be focusing on better mobilisation of earnings through direct and service taxes. While we can only wait and see what comes, it is clear is that only prudent monetary and fiscal policies can lead to productive economic transformation.

It is perhaps timely to take a look at the successful economies of Europe. The EU, taken as a whole, is a high tax area. The total tax ratio in the EU-27 amounted to 39.6 per cent in the GDP-weighted average, which is about 12 percentage points of GDP above those recorded in the US and Japan.

For the first time in decades, the German government recorded a budget surplus in 2007. The booming economy is one of the main reasons behind Germany’s budget surplus.

One tenth of 1 per cent may sound like a tiny amount but the figure signifies a big step for the entire country. It means that the federal government, the federal states, municipalities and the social insurance system achieved a surplus last year amounting to 0.1 per cent of Germany’s gross domestic product (GDP).

In other words, in terms of annual economic output, the amount of money the nation takes in this year will exceed the amount of money it spends by 0.1 per cent, or about €2.5 billion.

While France is not playing ball when it comes to European fiscal policy and wants to postpone balancing its books by two years, the Scandinavian countries have demonstrated that it is indeed possible to resist such temptations and produce surpluses for an extended period of time. Sweden has been running a surplus of at least 2 per cent of its GDP for the past three years. Denmark has been even more successful, achieving surpluses of over 3 per cent for many years now. The Scandinavians have apparently managed to control their urge to spend money.

Top personal income tax rates in EU differ very substantially, ranging from 16 per cent to 59 per cent. Many would expect high tax rates to yield high tax revenues, but the reverse is often the case. Germany is one of several countries that had higher tax rates than the US in 2000 but now levy a lower tax (38.9 per cent). Ireland has the OECD’s slowest rate at 12.5 per cent. France, Japan, and the UK may also reduce their rates in the next year.

Taxation of consumption is, in most EU countries, on an uptrend. The EU-27 arithmetic average went up by some 1.5 percentage points since that year and by half a point in 2005. The trend is particularly visible in the smaller Member States; several of these are new Member States, which, in the last years, have been increasing excise duties to conform to the EU minima.

The absolute levels of the income tax rates on capital differ widely within the EU, ranging from over 46 per cent in Denmark to a mere 8.1 per cent in Estonia, despite the general fall in corporate tax rates. The extreme case in this respect is France, where capital stocks/wealth taxation yields close to double the amount from the corporate income tax itself.

As Europe grows more affluent, about one euro out of every 15 in revenue derives from environmental taxes.

Various options for alternative tax bases are under discussion. An interesting alternative tax base is a tax on polluting activities. For example, car taxation will be based to a large extent in the future on their emissions.

Or, to tax products based on the pollution created by their fabrication process. Next, taxes on immovable properties (real-estate) is being considered an alternative instrument to raise additional revenues because they are difficult to relocate.

EU Member States have carried out important reforms of their tax systems. Almost all efforts have gone in the direction of broadening the tax base in order to reduce the rates.

This potentially brings economic benefits but also brings forward the question of a possible trade-off between efficiency and fairness.

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