Pasty Tax: The Great VAT Dilemma

British government decided to levi 20 percent VAT on cornish 'pasty' - the popular british oven baked snack. The pasty tax, as it was popularly called invited sharp criticism. The Sun newspaper ran a campaign against the government "Who VAT all the pies?". 

source: The Sun

UK entered into recession in second quater of 2012. To increase the tax inputs, UK Lord chancellor George Obsborne suggest mechanisms to bring various products and services under VAT regime in budget proposed in March. The campaigners against the change claimed the VAT system is completely in mess and shadow minister Chris Leslie said, "What a chaotic way to run a country. How on earth can you have a budget process that unravels in a day when you've got this kind of shambolic business?"

Picture Source: USA today

Out of all the taxes, the pasty tax was probably most interesting from policy perspective. The tax was scrapped for hot pasties fresh from the oven. The new tax plan will only tax those pasties which were required to be reheated during the day. Let me explain the tax through a case study:

- Roger buys a pasty from 'Greggs - a high street baker' in the morning when the pasty  is fresh out of oven - No Tax (GBP 2.50)

- Katrina buys a pasty from Greggs after some time when it comes out of oven and now it is in the process of natural cooling down or lukewarm - No Tax (GBP 2.50)

- I was not in such a hurry to eat the pasty. I buy a pasty from Greggs during the day when pasty is sitting on a hot plate or it required to be re-heated in the microwave - TAX TAX TAX (GBP 3.0)

According to the new law, the pasty which require additional effort of reheating or microwave will attract 20% VAT. The food stall owners and bakeries have welcomed the move. On the other hand, food stall which sells fried fish (they were levied VAT long time back), said system is not fair.

With the policy reversal, Gregg share rose by 9% on May 29th, 2012 (Their share took GBP 30 million beating on March 21st, 2012 when pasty tax was announced). 

Nikhil Agarwal

New Spice Trade Route: What Spain can learn from India?

In the 14^th century, Christopher Columbus commenced his voyages for India and discovered America. Perhaps is the time for Spain to rediscover a new spice trade route and learn from India.

I was recently in Valencia on a big day of street protests against spending cuts and changes to labor rights. News agencies claimed that over half a million people demonstrated across the country during the weekend. The government says that austerity measures are helping to meet deficit target as directed by the EU. On the ground zero, the realities are quite different.

In last two decades, a “Spanish fairytale” had been inspired by the American growth fueled by the vibrant housing market. From 1995 to 2011, Spanish economy on average grew by 0.65 percent per annum, reaching a historical high of 1.53 percent in 1997 and low of minus 1.60 percent in 2009. The Spanish housing market grew steadily from 1995 till 2007 before crashing down in 2008 in the midst of American crisis. The housing market shutdown created rippling effects on other Spanish industries, resulting in an unprecedentedly deep economic crunch

Dr Kiron Ravindran, Assistant Professor at the IE Business School in Madrid shared with me his experience of witnessing Spanish crisis in the past year. According to him, current unemployment rate is around 23%; shockingly, among the youth, it is over 48%. Practically every second Spanish youth is jobless with the little hope in a short term. He shared how one of his friends is filing for bankruptcy and another one has already closed his business and looking for a job.

In contrast, India’s growth story started in 1991 when then government relaxed its policies for foreign investment in support of businesses and industry. Subsequently, in 2000–2011, Indian economy grew on average by 7.45 percent annually, reaching an historical high of 11.8 percent in 2003 (with 1.6 percent low in 2002). Though India was somewhat affected by the global financial crisis of 2008, it was far from being critical. The growth slowed down to 4.98 percent in 2008, and picked up again to 9.1% in 2009.

India’s growth story is linked to several factors:

•  Rise in the industrial and agricultural productivity
•  Growth of the middle class – from 8% the total population in 1980 to 22% of in 2010
•  Investments to education are paying big dividends. From a meager 17% literacy levels in 1950, India has achieved 75% literacy in 2012!
• Investments to high-tech and capital intensive industries
•  Market led economic model where entrepreneur is in the center
• Vibrant market space for private and public companies. India boasts over 100 private companies with the market capitalization of at least USD 100 billion
• One of the largest R & D hub for multinationals in Asia
• Largest English speaking workforce in the world

In our opinion, Spain could learn from India on the two key factors – Education and Service industry:

1.     Capacity building and skill development: Continuing education and skill building is one of the key drivers for economic growth. Indian education system is the world’s second largest after the United States. India produces annually almost a million engineering graduates. The government announced a 24% hike for education in its 2011budget. According to some reports, there are significant challenges about the employability potential of the graduates due to the lack of new-age business and technical skills. To overcome these challenges, private education providers are helping to prepare graduates to be ‘industry ready’. Indian national government has had ‘let-go’ the education from the individual states, allowing private education providers to compete in the free market. In contrast, although Spain spends a decent amount on education (approximately 4.5% of GDP), over 80% of the Spanish education system is under the government control, providing little scope for the innovation. Spanish education system could involve more private initiative, thus creating new opportunities that ensure competitive advantage for their graduates when it comes to the industry‑ready skills and employability.

2.     Development of the near-shore capabilities: Cost of operations and wages in Spain are somewhat lower than for its EU counterparts. Spain can take advantage of such cost arbitrage by developing near-shore service capabilities, for example by collaborating with the Indian outsourcing companies. Indian ITC companies are always on the look up for suitable partners, especially as it relates to the hosting of their near shore centers. Indian companies that tried to setup their operations in Hungary, Ireland and Poland have had little success due to the lack of local support and, especially, well trained and dedicated labor. Spain’s economy can leap forward by providing skilled resources to setup near shore centers of industrial and service excellence.

A road to the economic prosperity is tough, long and sometimes bumpy. The Indians have learnt the hard way what the Europeans might have forgotten, that the prosperity mainly comes from encouraging the private initiative, rather than by raising regulatory barriers. Perhaps now it is the time for Spain to re‑discover the “spice trade route” to the intellectual riches of the South Asia.

About the Author:

Nikhil Agarwal is President and senior partner of Cambridge Global Partners (CGP), an international consulting firm.

Their profile is available at: http://www.cgpworldwide.com/team/nikhil-agarwal

Sustainable Transparency using ICT

As an international issue, transparency came to prominence after World War I in the post-war negotiations. It took considerable time for many nations to pursue transparency. In the mid-1980s, only 11 nations had freedom of information laws, but by the end of 2004, 59 nations. Transparency and the right to access government information are now internationally regarded as essential to democratic participation, trust in government, prevention of corruption, informed decision-making, accuracy of government information, and provision of information to the public, companies, and journalists, among other essential functions in society.

Government transparency generally occurs through one of four primary channels (Piotrowski, 2007):

1. proactive dissemination by the government;
2. release of requested materials by the government;
3. public meetings; and
4. leaks from whistleblowers.

Traditionally, there are three types of anti-corruption approaches (Shim & Eom, 2009):

1)   Administrative reform. Administrative reforms are the most commonly used approaches, primarily through the enhancement of the quality of government bureaucracies to ensure that a watchdog agency or structure exists to officially monitor government behavior. Another common element of administrative reform is the creation of merit based hiring and promotion for government positions, which feature formalized rules of conduct, accountability, and responsibility, sometimes learned from corporate approaches.

2)   Law enforcement. Law enforcement approaches often compliment administrative reforms to ensure that an appropriate system for punishing corruption is in place. While administrative reform lowers opportunities to take bribes, law enforcement greatly increases the potential costs and punishments for taking bribes.

3)   Social change. The social change approach is based in the idea of reform through social empowerment of citizens by allowing them to participate in institutional reform movements and by cultivating a civil, law-based society as a long-term deterrent to corruption. By changing cultural attitudes that have been accepting of corruption, citizens can ultimately protect themselves from corruption.

ICTs offer countries a new approach to creating transparency and promoting anti-corruption. ICTs can reduce corruption by promoting good governance, strengthening reform-oriented initiatives, reducing potential for corrupt behaviors, enhancing relationships between government employees and citizens, allowing for citizen tracking of activities, and by monitoring and controlling behaviors of government employees.

To successfully reduce corruption, however, ICT-enabled initiatives generally must move from increasing information access to ensuring rules are transparent and applied to building abilities to track the decisions and actions of government employees. Taxes and government contracts are areas where e-government has been seen as a clear and successful solution to corruption problems in many nations, including such examples as:

•       India: putting rural property records online has greatly increased the speed at which the records are accessed and updated, while simultaneously removing opportunities for local officials to accept bribes as had previously been rampant. The Bhoomi electronic land record system in Karnataka, India, was estimated to have saved 7 million farmers 1.32 million working days in waiting time and Rs. 806 million in bribes to local officials in its first several years. Before the system, the average land transfer required Rs. 100 in bribes, while the electronic system requires a fee of Rs. 2.

•       United States: has creating sites that allow access to the data of government expenditures, for stimulus dollars (www.recovery.gov), general funds (www.usaspending.gov), and information
technology funds (www.IT.usaspending.gov) sites, which are intended to promote public monitoring of government spending for faster identification and elimination of wasteful projects.

•       Chile: the ChileCompra e-procurement system has been used to allow government officials and citizens to compare the costs of bids to and services purchased by the government. The system saves approximately $150 million US annually by preventing price fixing or inflation by corrupt officials and contractors. In addition to reducing corruption, this system expanded the number of small businesses that could participate in the government bidding process.

•       Greece: Beginning October 1st 2010, all Ministries are obliged to upload their decisions on the Internet, through the «Cl@rity» program. Cl@rity is one of the major transparency initiatives of the Ministry of the Interior, Decentralization and e-Government. Henceforth, the decisions of the public entities can not be implemented if they are not uploaded on the Clarity websites, each document is digitally singed and assigned a transaction unique number automatically by the system.

The question is to create sustainable practices for transparency. Key factors that may influence the extent to which ICTs can create a permanent culture of transparency include:

•       ICT access. The wider access to ICTs in a society, the greater connections between different parts of a society. More social interconnectedness means greater ability of members of the society to work together to promote social benefits like transparency.

•       Trust. Research has shown that the provision of greater access to government information and increased transparency through the use of ICTs increases trust among citizens.

•       Empowerment. As detailed above, using ICTs to increase citizen engagement makes the citizens empowered to participate in openness initiatives and to promote cultural support for transparency.

•       Social capital. The social networks and affiliations within a society that can collaborate to promote social good – known as social capital - benefit from increased access to information through ICTs.

•       Bureaucratic acceptance of transparency. Any ICT-enabled transparency initiatives will be far more likely to have a broad cultural impact if they are embraced and actively used within the government bureaucracy. Further, this acceptance must be demonstrated to citizens.

Comments welcome.


Nikhil Agarwal
nikhil.agarwal at cgpworldwide.com


acknowledgement: Thanks to Michalis Tolkas at University of Edinburgh for his inputs.

Risk Pooling

Risk Pooling is linking the uncertainty of individuals into a calculable risk for large groups.

Let us try to understand it with an example: There could be chances of widespread dengue fever in Pune during monsoons. As per the health department estimates, out of every 1,00,000 people in the Hinjewadi area of Pune, only 1,000 may contact dengue.

The health department has following information:

• An event but which might occur in future – Dengue
• Population size which can get affected – 1,00,000
• Calculable risk – 1000 (1% of population)
• Legal risk

This information can help us in making a risk pool. Assume the cost to be Rs 500 per illness, then insurance company can insure 1,00,000 members of the group against the Dengue fever, (500* 1000 = Rs 500,000/total population) or you can say Rs 5 per person. By agreeing to pay the cost of each sick person in exchange of the Rs 5 payment (Premium), the insurance company has effectively pooled the risk of the group.

In other words, a risk pool is one of the forms of risk management mostly practiced by insurance companies. Under this system, insurance companies also come together to form a pool, which can provide protection to insurance companies against catastrophic risks such as floods, earthquakes etc. The term is also used to describe the pooling of similar risks that underlies the concept of insurance. While risk pooling is necessary for insurance to work, not all risks can be effectively pooled. In particular, it is difficult to pool dissimilar risks in a voluntary insurance market, unless there is a subsidy available to encourage participation.

In US, health insurance risk pools are special programs created by state legislatures to provide a safety net for the "medically uninsurable" population. These are people who have been denied health insurance coverage because of a pre-existing health condition, or who can only access private coverage that is restricted or has extremely high rates. 


Do write to me if you wish to discuss other cases of Risk Pooling.


Ruchi Agarwal
ruchi.agarwal (at) cpgworldwide.com 

Who is the Carrier of Risk - Insurance Companies or Common Man?

From last 10 years, I am witness of motor third party liability insurance pity condition in India.

Motor third party liability insurance is mandatory under section 166 of the Motor Vehicle Act 1988 in India. Since the act was passed, every insurance company has to compulsorily accept the third party liability insurance. Very soon, it becomes the biggest roadblocks in the progress of Indian insurance companies’ profits. The reasons were huge claims especially in case commercial vehicles motor liability, long tailed in nature – generally takes 7- 8 years to settle, unpredictable awards made by the courts,  no limits placed by Motor vehicle act on the awards and as a whole the motor third party liability became riskier and capital intensive for the insurers day by day.

The issues were exaggerated in the year 2005 when regulatory bodies started receiving denial from the insurance companies to insure commercial vehicle for third party insurance. In April, 2007, regulators came up with the solution to the problem and introduce Indian Motor Third Party Insurance Pool (IMTPIP) for the commercial vehicle. Afterwards, the pool member insurers have started accepted commercial motor liability Insurance but it did not end their problems. In the next 3 years, the pool generated Rs 673 crore losses especially in commercial liability claims which were showing the losses of  470 crore in  the year 2008-09 increased almost 4 times from last year claims. It was clear evident from past data and with the current premium; the pool will become unsustainable in near future.

The recent committee report by IRDA on third liability pool gave solution to the critical issues of insurers. The insurance companies will now be able to decline the risk under the commercial motor liability in case it does not fit under their underwriting criteria or they are not capable of underwrite the risk. The denial of the risk will not end the insurance company responsibility, the same insurance company will act as policy servicing underwriter for GIC who will accept the risk in such cases. GIC (General Insurance Corporation), who is the only reinsurance company in India, will directly underwrite such risk through its separate website. A nodal officer will be invited from each insurance company to handle and give proposal number in each such case. In all the cases whether insurance company accept the risk or decline the risk, the dream to cover 100% motor vehicle insurance can become true. Now the white elephant of the Indian insurance industry has got some other way to fund the expenses. 

Are you really convinced that it is the solution of the problem? Atleast I am not !!

 The major lapse here is in the root cause analysis, whether the problem lies -

·      In settlement of claims

·      Non-issuance of the policy

·      High claim ratio of motor industry

·      Bad emergency management services in the country

·      Long claim settlement time taken by judiciary body

As per the WHO, India has the highest road accidents in the world. 

 

Image credits:  (http://www.dw-world.de/dw/article/0,,5519345,00.html).

There are 24 life and non-life insurance companies in India (as per IRDA data 2011).  If all insurance companies in India join hands together and make a common pool or NGO for Emergency Medical Services (EMS) rather than motor third party claims, I think the country, common man as well motor third party insurance industry all will be better served.

Comments are invited.

Ruchi Agarwal,

MBA, FIII, ACII