GS Paper: GS3

The article highlights the issue of race among countries to offer low corporate taxes to attract global financial capital and its implications.

What factors contributed to low corporate tax

• When the Soviet Bloc collapsed in 1990, nations in east Europe were badly hit and needed capital infusion to overcome their economic woes.
• To attract global capital, they cut their tax rates sharply. This resulted in a ‘race to the bottom’.
• Global financial capital which is highly mobile has effectively used tax havens and shell companies to shift profits and capital across the globe.
• This mobility has enabled it to extract concessions from countries by making them compete with each other to match the concessions given by another — that is the ‘race to the bottom’.
• Nations in Europe were forced to cut their tax rates one after the other to not only attract capital but also to prevent capital from leaving their shores.
• Also, any country facing economic adversity can cut its tax rates to attract capital and force others to follow suit.
• India has also cut its tax rates since the 1990s.
• Most recently in 2019 the corporation tax rate was cut drastically to match those prevailing in Southeast Asia.

Implications of lower corporate tax rate

1) Shortage of resources

• The race to the bottom had global implications.
• Nations became short of resources and cut back expenditures on public services and encouraged privatisation.
• The developing countries followed suit even though private markets do not cater to the poor.
• Thus, disparities increased within nations.

2) Base Erosion and Profit Shifting

• The world experienced Base Erosion Profit Shifting (BEPS).
• Namely, companies shifted their profits to low tax jurisdictions, especially, the tax havens.
• For instance, many of the most profitable companies like Google and Facebook are accused of shifting their profits to Ireland and other tax havens and paying little tax.
• EU has levied fines on Google and Apple for such practices.
• Since all the OECD countries have suffered due to cuts in tax rates and BEPS, initiatives have been taken to check these practices.
• But they will not succeed unless there is agreement among all the countries.

3) Regressive tax structure

• Another implication of the reductions in direct tax rates has been that governments have increasingly depended on the regressive indirect taxes for revenue generation.
• Value-Added Tax and Goods and Services Tax have been increasingly used to get more revenues.
• This impacts the less well-off proportionately more and is inflationary.
• Direct taxes tend to lower the post-tax income inequality.
• The rising inequalities result in shortage of demand in the economy and to its slowing down which then requires more investment and that calls for more concessions to capital.

Call for Global minimum tax rate

• It is against this backdrop that United States Secretary of the Treasury Janet L. Yellen’s has proposed a global minimum tax rate.
• But, without global coordination, corporation tax rates cannot be raised.
• The U.S. is crucial to this coordination.
• There will also have to be cooperation among countries to tackle the lure of the tax havens by enacting suitable global policies.

Consider the question “What factors contributed to the race to bottom on the corporate taxes among the countries? What are its implications? Will the global minimum tax rate be able to deal with it?”

Conclusion

The impact of all this will be far-reaching impacting inequalities, provision of public services and reduction of flight of capital from developing countries such as India and that will impact poverty.

The article highlights the important role played by the microfinance sector in furthering financial inclusion in India and suggests measures to achieve holistic development of the sector.

Important role played by microfinance

• No other form of financial services has had the kind of far-reaching impact, in terms of fostering financial inclusion, as microcredit has.
• Access to small, collateral-free loans for economically productive purposes has helped transform the lives of millions at the bottom-of-the-pyramid—especially women.
• Over the past decade, India’s microfinance industry has grown at a compound annual growth rate of 26% to reach ₹2.36 trillion.
• It has helped 50 million economically vulnerable Indians, 99% of them women, live a life of dignity and financial independence.
• Assuming that these 50 million people who took a loan to start a small business employed at least one other person, it translates into 50 million additional jobs in the country.
• This creates a ‘network effect’ that has a social impact at scale.

Evolution of microfinance industry

• Recommendations of the Malegam Committee, which became regulations, and practices such as relying on credit bureau data to assess a borrower’s creditworthiness have helped the industry immensely.
• The vital role that microfinance plays in the last-mile delivery of financial services was acknowledged.
• Subsequently, eight out of the 10 small finance bank licences granted were also given to microfinance institutions.
• RBI has sought to undertake a comprehensive review of the sector again, after 10 years, to better align the regulatory framework with the sector’s current realities.

Steps for development of sector

• First, Entities should promote financial literacy through group meetings of borrowers.
• Second, organizations should complement their microcredit operations with social development projects and community-connect initiatives.
• Third, prospective borrowers’ indebtedness and ability to repay dues should be assessed properly.
• Fourth, loans must be given only for income-generation purposes.
• Fifth, every microfinance organization should devote time and resources for capacity building at the grassroots.
• Sixth, rather than focusing on taking over the existing debt of a borrower, or lending to her further, institutions should focus on bringing new-to-credit customers into the fold.

Consider the question “How can microcredit stimulate financial inclusion in India? Suggest the measures for the development of microfinance sector in India.”

Conclusion

There is much more that we, as a nation, collectively need to do in order to bring a vast population of unbanked and underbanked Indians into the fold of formal financial services.