The Hindu Business Line : Tax rationalisation — Should India follow Mauritius?

It is time that countries such as India woke up to the reality instead of blindly kow-towing the powerful. Tax rationalisation is already being forced on India by its competitive neighbours, and it may be in the country's interest to follow Mauritius' example. This path is not easy.

ATTRIBUTE it to the silly season or to the energy-sapping heat, but just about this time every year, one sees an involved debate on the need to close the Mauritius route to the foreign institutional investors.

The argument normally goes that the FIIs are getting away with murder as they neither pay taxes in India or Mauritius, where they claim domicile status.

That offends the fair-minded Indian who pays over 30 per cent in direct taxes and much more in an indirect form. It offends politicians because the self-righteous logic goes, "Hey! Here are these `clever' foreigners fleecing poor countries, while the poverty-stricken toil their guts out to make a place for themselves in the sun."

Of course, nobody goes deep into the issue that neither are all Indians poor, nor do all pay taxes. Also, very few concede that tax planning by those who pay taxes is as meticulous as their foreign counterparts.

Such selective logic helps build self-righteous indignation to a feverish pitch. The pitch would have been a little muted, had the actual beneficiary of the tax planning measures been a Mauritian, or a Mauritian company. As the popular adage goes, nobody resents the poor. But it is another matter when it comes to equals, and more than equals.

The main problem with the Mauritius route is that everyone knows that "treaty shoppers" in question are rich American transnational investors, often viewed with distaste as the birds of prey, constantly scouring the earth for attractive pickings.

Hence, everyone is up in arms against this mercenary investor clan. They also condemn countries that position themselves as tax havens. Yet, nobody bothers to look at issues in terms of competition.

If today, Indians are convinced — and they are to a large extent — that competition is good for them because it has widened consumer choices and enhanced incomes, then why is tax harmonisation, which curbs competition, desirable?

There are no takers for this argument, though there are many who will propound at length the benefits of globalisation and enhancement of global wealth by maximising synergies across markets.

Yet, let us look at the whole issue at a very fundamental level. If it is in society's interest for a country endowed with natural resources to export ore to those with knowledge and capital to convert it into steel, in third countries that offer labour advantage, only to sell it in yet another set of countries — then why does this not hold true for capital? Experience has shown that competition pushes down costs, and impediments to it push up prices. This is equally true of tax competition, where capital moves from high tax islands to low tax havens, resulting in the creation of wealth for the community as a whole.

The answer, of course, is that while free movement of capital is convenient for countries that have abundance of capital, tax competition is inconvenient.

It can suck out investments and saving from countries that have capital but impose higher tax rates and divert it to those which do not lure capital through lower rates.

Interestingly, countries that have capital and impose high tax rates are those, whose government are inefficient and/or carry the burden of a huge welfare bill. These countries do not want to cut their welfare spend and/or reform their governments.

They also do not want to make the sacrifices involved to foot their ambitious welfare spending through alternative means, such as through non-tax revenues or innovative funding mechanism. The net result is that they prefer to keep their tax rates high, and force others to follow suit.

To force others, one needs to be powerful. It is interesting that today, one finds that European countries at the helm of those that lead the assault on the tax havens. Using the offices of the OECD, the EU and the UN, they have been able to convince the US of the need for tax harmonisation, though the US itself qualifies for the status of a tax haven when compared to Europe — its taxes rates are far lower. This is, perhaps, one reason why it is the largest recipient of Foreign Direct Investment (FDI).

The pro-tax harmonisation group does not highlight the fact that the European experience shows that it only raises the tax rates for everyone concerned rather than depressing them across the board.

They also do not mention that their position is actually anti-globalisation, though they are very quick to espouse the cause of migration, which is nothing but the luring of brainpower from countries endowed with intellectual abilities with "friendly" migration policies.

It will undoubtedly an immense pressure on the government, whose combined fiscal deficit is now some 11 per cent of the GDP. Yet, look at the benefits. Tax competition will lure away capital from not only the neighbouring countries but also from the capital rich ones.

That capital will create additional income for the Government — at least an incorporation fee, as in the case of Mauritius for permitting foreign companies to set up mailbox addresses on its soil — or result in investments, which in turn will generate jobs, revenue and new opportunities.

But the only issue is: Can India follow the path shown by countries such as Mauritius, or merely wallow in resentment against a country half the size of its largest State for having stolen its thunder?

(The author is a freelance writer and can be contacted at jayanthiiyengar1@yahoo.com)

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