Tax Professionals’ role in the economic turmoil

Friends,

I am deeply honoured to be invited here in this National Tax Conference being held at Varanasi. I am particularly very happy that it is under the Presidentship of Shri Bharat Ji Agrawal, Senior Advocate of Allahabad High Court, who was my senior in the legal profession when I was a lawyer in the Allahabad High Court.

The topic which we are discussing today is extremely important.

A terrible worldwide recession is sweeping all over the globe, playing havoc with the lives of millions of people. Everyday news comes of job cuts, decline in consumer spending and the downward trend of the stock market. All sorts of explanations and cures are being given for this catastrophe, most of them superficial.

Some say that the recession is due to greed. Some blame the sub prime mortgages, others blame the monetary policy, or the interest rates, etc. To my mind these are superficial explanations, and one has to go deeper to find the real cause.

An economic recession is a feature of an industrial, not agrarian economy. In agrarian economies, too, there were catastrophes, but these were due to natural calamities like drought, epidemics, etc. An economic recession is a feature peculiar to industrial economies.

There have been recessions every eight or ten years ever since the Industrial Revolution of the 18th Century. These, however, were followed shortly thereafter by recoveries. But there has been one Great Depression which lasted from 1929 to 1939, and was ended only by the Second World War (in which 50 million lives were lost) which generated the massive demand for armaments, supplies to armies and war affected civilian populations, and capital for reconstruction. This Great Depression caused havoc in large parts of the globe, particularly in the developed countries.

We are now witnessing a Second Great Depression, and its sweep is wider than that of the Depression of 1929, because while the latter affected mainly America and Europe, the former is affecting the whole world.

What is the cause of such economic recession or depression?

The principal cause of an economic recession (or depression) is lack of sales, which in turn is due to lack of purchasing power in the masses. There are other causes also, but these are only incidental, and not the main cause.

A large part of the world’s population is so poor that it hardly has any purchasing power. Even in the developed countries there are many poor people.

Apart from the above, as the industrial economy develops, in the process the industries tend to become larger and larger and more and more capital intensive. This generates unemployment.

Suppose a manufacturer had 500 workers working in his plant. With the advance of technology he may get a new machinery which requires only 100 workers to produce the same amount of goods which he was producing earlier. This means 400 workers will become unemployed. Even if 100 of these 400 workers can get jobs elsewhere this still leaves 300 workers unemployed. When we enlarge our scene (because the same process is inevitable in most industries) we find large scale unemployment is being generated everywhere.

Now the worker, apart from being a producer, is also a consumer. Of course a worker in a steel factory does not consume steel. But he and his family consume food, clothes, shoes and various other articles. When he becomes unemployed his purchasing power becomes drastically reduced. And when .unemployment is generated on a large scale, the market correspondingly contracts on a large scale. Hence, while production increases sales decrease, and this leads to a recession. Thus we see that the very dynamics of an unregulated industrial economy is that by the very inevitable process of its growth it keeps destroying its market.

The goods produced have to be sold. But how can they be sold when people have lost their purchasing power (due to widespread unemployment)?

Mass production has to be accompanied by mass consumption. By taking purchasing power out of the hands of mass consumers the industrialists deny to themselves the effective demand for their products that would justify reinvestment of their capital accumulation in new plants (which would also provide employment). Thus while the productive capacity keeps rising (due to the reason given above) the demand keeps contracting, until the system self-destructs.

Before the Great Depression of 1929 high level of employment was generated by high level of debt in the form of mortgage debts (for housing etc.), loans to buy cars and other consumer goods, brokers loans (for buying shares, etc.). The same thing happened in recent times. But this cannot continue endlessly. A time comes when people cannot repay their debts (due to unemployment or cut in real wages). Then debtors curtail their consumption, which reduces demand, and the producing units have to close down or drastically cut production.

In modern economies, most businesses require loans for their normal operations. Banks normally retain a small fraction of their deposits (5% or less) and give the rest as loans to borrowers. When the banking sector does not work properly (because of defaults by loanees) businesses do not easily get loans, and consequently they have to curtail their production and lay off workers. As they curtail production they require less raw materials and other supplies. Hence their suppliers have to reduce their output and lay off their workers.

If manufacturers cannot sell they cannot generate enough revenue to repay their loans. The business goes bankrupt and the bank finds in its hand non performing assets. Hence banks want to lend less. This becomes a vicious cycle.

Depositors get scared because some banks have collapsed due to the non-performing assets. Hence they start withdrawing their money, and more banks collapse.

The economic recession is thus caused by the reduction of purchasing power in the masses which is due to the very dynamics of unregulated growth. The productive capacity has been enhanced enormously, but the vast majority of people are too poor to buy.

The problem, therefore, is not how to increase production, but how to increase the purchasing power of the masses. Production can be increased several times because there are tens of thousands of engineers, technicians, etc., and there are immense reserves of raw materials in India. But the goods produced have to be sold, and how can they be sold when the people are poor or unemployed, and thus have very little purchasing power?

The problem is also not how to increase demand. The demand is there, but people do not have the money for purchasing goods. In India, for instance, 70% people live on incomes of Rs. 20 per day. This is not sufficient for even buying necessities, like foods or medicines, what to say of durable consumer goods like motor cars, refrigerators, computers, air conditioners and other goods.

The solution to the economic crisis is by raising the purchasing power of the masses. How this is to be done requires a great deal of thinking and discussion, and all serious thinkers must now address this main problem facing our country, and indeed the whole world.

To my mind one of the methods of resolving the economic recession is to reduce taxes drastically.

The purpose of imposing taxes is to generate revenue for the State so that it can perform its functions, which in the modern world include social and economic welfare of the people, apart from maintaining law and order.

As already stated above, the economic recession is due to lack of sales, and that in turn is due to lack of purchasing power of the people. If taxes are reduced drastically the prices of goods will go down drastically, and thereby people can buy more goods. In other words by reducing taxes we will be increasing the purchasing power of the people, and that will be a very important step for resolving the crisis of recession.

No doubt taxes are required by the Government as revenue for its various functions.

However, in my opinion the revenue should not exceed what is genuinely required by the Government. As everyone knows, at present there is a lot of waste of the public funds by various authorities due to mismanagement, corruption, etc., because of which the government expenditure becomes grossly inflated. Hence it is necessary to stop wastage of public funds, which means stamping out corruption with an iron hand, and stopping mismanagement and wasteful expenditures. This calls for strict accountancy of the public funds and a strong vigilance over such funds by the public, which includes the professionals like you all.

As regards the chartered accountants, they must be strict in accounting and not be mere hirelings of certain businessmen, as was seen in the Satyam case in India or the Enron case in USA. Strict accountancy is absolutely essential if our country is to progress, and hence our accountants should be men of honour and refuse to do wrong things merely because they can earn some money thereby.

In a country like India with immense poverty and disparity of income the current taxation rates seem inequitable and unjust. The maximum tax rate of 30% for all income over Rs. 5 lakhs needs to be reviewed, and a more realistic sliding scale of income introduced for those who are in higher income groups. It is absurd that income tax rate for a person making Rs. 5 lakhs or Rs. 100 crores per year is the same. On top of this, those who play in the financial markets such as stocks, commodities or derivative markets are not required to pay any taxes whatsoever on long-term (12 months) capital gains or dividends, making the Indian financial market perhaps the most tax free market in the world. Even for short-term gains, unique tax exemption vehicles via Mauritius etc. have been ingeniously evolved to completely avoid payment of taxes. It is rules and regulations like this, specially crafted for the rich and affluent, that are increasing tremendously the disparities of income in India. As responsible accountants and experts you must bring such matters to public attention and do what is best for the country.

The situation in India today is that while we have recently increased the number of billionaires in our country, the poor have become poorer and even the middle class is finding it difficult to make two ends meet because of rising prices. This is a dangerous trend and if continued is going to lead to widespread social turmoil and social unrest. It is totally unfair to the vast masses of our people and it will not be tolerated very long.

Society owes subsistence to all its citizens either in procuring work for them on a reasonable wage, or in ensuring a livelihood to those who are unable to work.

As stated by the great French thinker Rousseau in his book “Discourse on Inequality”:

“Nothing can be farther from the law of nature, however we define it, then that …, a handful of people be gorged with luxuries while the starving multitude lacks the necessities of life.”

In the State of Maharashtra lakhs of farmers have committed suicide and are still committing suicide while in the same State one industrialist is said to have built a forty storey building for his residence. This state of affairs cannot continue much longer.

Unfortunately, most people are silent about this terrible plight of our people because those who should be speaking out e.g. the public leaders, government officials, the media, etc. are mostly beneficiaries of the present system, and hence do not want to disturb it. It is time now that the patriotic intellectuals speak out on these issues. Apart from the above, tax professionals, being intellectuals, must study economic theory and read the books of economists like Adam Smith, Ricardo, Marx, Keynes, etc. or at least some commentaries on them. This will enable them to better understand the present economic crisis, so that they can propose proper measures to alleviate the same. At present, unfortunately, tax and accountancy professionals have no idea of economic theory.

Hence the task of the tax professionals is to study and explain all this to the public, and if possible, enter public life in various ways so that the economic crisis can be resolved. The tax professionals can contribute a lot for changing the economic scenario of the country. We have to go by the realities of the situation and not make imaginary proposals. The two days Conference shall be discussing various important subjects, both on direct and indirect taxes, and I hope they will consider the suggestions made above.

I wish the Conference a grand success.

[Reproduced with permission from the Paper presented at AIFTP’s Two Day National Tax Conference held on 7th and 8th March, 2009 at Varanasi]