Friday, May 8, 2009

Obama's 'Taxing' Proposals

On Monday (4th May, 2009), the United States President, Barrack Obama announced the proposed implementation of another one of his election promises, targeted towards improving the domestic economic climate, and freeing up financial resources for investment in areas of pressing importance. The proposal is to withdraw the scheme of deferred tax for foreign income, currently in place in the U.S. Under this system, an American company earning income abroad does not pay tax in the U.S. until the income in brought into the country. This makes it possible for a company to avoid U.S. taxation by ensuring that the money earned is kept outside the country by investing it in expansion and new projects outside the U.S. This was widely seen as incentivising the outsourcing of jobs, since investments abroad were a way of avoiding the domestic tax regime. In a move purportedly directed towards disincentivizing outsourcing, the proposal seeks to remove this deferred regime, and tax the income earned by companies registered in the U.S., even if it is not actually brought into the country.

Reactions to this move are mixed, with experts and analysts taking diametrically opposite views, as to the advisability and implications of the move. To begin with, there are the archetypal ‘free market v. regulation’ debates, revolving around theoretical issues of whether such governmental intervention to regulate the market is advisable. But leaving those academic debates aside, there are significantly different stances being taken as to the effects of this move.

There is a large body of opinions, especially those in places like Bangalore, viewing this move with anxiety. This anxiety is based on the justified apprehension that the such disincentivization of foreign investment will further worsen the spill-over effects of the global financial crisis. Post-crisis, the volume of work, and resulting revenue, for the back-offices of MNCs has already taken a beating, and the implementation of this proposal is feared as having taken things from bad to worse. However, this ominous view has been countered by many, at several levels.

First, the most prominent argument used seems to be that while this proposal will reduce profit margins for American companies, it still doesn’t negate the economic advantage of outsourcing. Thus, it is argued that the economic benefit gained from outsourcing a said activity will continue to outstrip the increased tax burden, thus not really affecting the process of outsourcing.

Secondly, and connected to the point made above is the argument, also made by members of the Confederation of Indian Industry, that the proposal will do no better than to affect the competitiveness of American companies, since it is not sufficient to render foreign investment imprudent. This gives an opportunity to many organisations, heretofore managing low-end operations, to move up the ladder in terms of involvement in IT services. This view is being adopted by many Indian companies like WIPRO, having the capabilities of making this transition.

Finally, specific to India, is the practical reality that the difference is taxation levels will be insignificant. Income of American companies earned in India was subject to the Indian tax regime. The rate of tax sought to be imposed by the U.S. is only marginally higher than that imposed in India. Thus, even on economic grounds, the move is unlikely to act as much of a deterrent to investment into India. This is different from the case of other countries, which got investment due to their favourable tax structures. It is these so-called ‘tax havens’ that stand to lose more than countries like India.

Thus, purely on economic grounds, predictions of immediate slowdown resulting from the proposal seem a tad premature. However, what is definitely a cause for concern is the attitude that this move may be taken to signify, and the possible implications of the increasing acceptability of ‘protectionist’ measures in world trade. Some, including NASSCOM, have argued that the move is not about outsourcing, but a domestic tax measure. Some have even argued that the move is a reaction to the impression (based on the reaction to the banking crisis) that the administration, though Democrat in name, is actually suspiciously right-leaning. Thus, the use of the ‘protectionist’ tag is dismissed as a purely political move to dilute the this impression.

If these political reasons are to be accepted, and if the economic implications in this one instance are examined, it may make a case against viewing this proposal with alarm. However, having said that, the spill-over effects of the move, in terms of moulding the acceptability of such measures from other countries, may not paint that rosy a picture.

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