Economic storm in a coffee cup

VG Siddhartha’s purported letter to the Cafe Coffee Day board of directors makes two points that indicate that the state of the Indian economy is not very good at present

Cafe Coffee Day (CCD) founder VG Siddhartha’s tragic end has come as a rude shock to his legion of admirers. The genuine outpouring of emotional testimonials and grief shows the extent to which the brand he helped create has touched the lives of many. In the absence of detailed information in the public domain, it would be unfair to make any comment except to pray that his family gets the strength to bear the loss.

However, as a public policy analyst, there are two interesting facts in his letter to the board of directors floating on the social media (assuming it is genuine) that made me sit back and reflect.

The first is his lament that he failed to create a profitable business despite the years of hard work. What does it say about the macroeconomic situation we are in?

Spendings on coffee and such beverages in an outlet like CCD is an example of discretionary expenditure. It is the kind of thing you indulge in when you have some money to spare. Conversely, when income comes under strain, typically such expenses are the first to be slashed.

When economic hardships beckon, you’d first slash your expenditure on a CCD outing much before you admit your child to a budget school or slash medical expenses. In short, CCD is in a business that is the proverbial canary in the mine. If it is passing through turbulent phase, the broader economy cannot be doing well.

Second, he has blamed his woes on the high handed tactics of the Income Tax (IT) department. IT department in turn has rebutted the charges. Leaving out the specifics of the case, it is evident that the sentiment he expressed is widespread and pervasive. There are multiple reasons for this.

First, recently there has been a controversy about the estimation of GDP growth rates. Without wading into the controversy, it can be said that GDP growth rate in recent years has stopped being correlated with many macroeconomic variables like corporate topline and bottomline figures.

This is important because tax collection targets are determined using the nominal GDP growth figures, assuming a certain tax-to-GDP ratio. If tax targets are exaggerated, either due to measurement issues or due to structural changes in the buoyancy, the taxmen will have the incentive to adopt strong arm tactics.

Second, starting from 2009, there have been multiple changes in the Income Tax Act which are loaded against businessmen and entrepreneurs. Such ad hoc amendments are driven by casual empiricism and done with the sole objective of revenue maximisation, without any consideration of how they will affect the viability of different sectors.

One concrete example may help. Take real estate. Before 2009, on real estate transactions, state governments used to levy stamp duty and the Centre used to impose capital gains tax. However, the finance bill 2009 came up with an ingenious way of double taxing such transactions.

According to the amendment in section 56 (2) of the IT Act, if the sales value of any immovable property is less than the stamp duty value of such property, the difference between the two values is deemed ‘gift’ to the buyer and added in her income, being taxed at the highest tax rate applicable.

Why is this problematic? For one, it is double taxation. You are taxing both buyer and seller for the same transaction under different heads. Second, the arithmetic is problematic. You’re valuing the same property differently for computing tax liabilities for different persons. No wonder the construction sector, possibly the biggest employer of blue collar workers besides agriculture, is in turmoil under such a bizarre tax regime.

This provision was not a problem earlier as the circle rates used to calculate stamp duty value used to be quite conservative and real estate prices were booming. However, in recent years, the state governments have raised circle rates aggressively and the real estate prices have crashed due to liquidity crunch, ensuring that in many places this provision has become effective.

Similar issues abound in the treatment of share transfers (so called angel tax). Yet another issue relates to retrospective taxation. According to an amendment done in 2017, the tax authorities have the power to reopen cases upto the last ten years. One doesn’t have to be an economist to understand the uncertainty and chaos this will create. Firms have perpetual existence, people handling the operations don’t. They keep changing. Memories are lost; records are lost. Justifying each and every transaction with documentation a decade later is not fun.

The bottomline is that in the last decade, the idea of a stable, predictable tax regime has been given up. What we have is an annual tinkering exercise that is driven more by revenue considerations than by the canons of prudential taxation.

Tax policy is a subset of the broader economic policy whose main objective is the maximisation of economic activities, employment and welfare. When tax policy is used merely as a revenue maximisation exercise, tragedies like the one involving VG Siddhartha can not be ruled out.

(Avinash M Tripathi is Associate Research Fellow (Economics) at Takshashila Institution)

(The views expressed above are the author’s own. They do not necessarily reflect the views of DH)