The OECD recently launched a scheme to combat tax avoidance and evasion related issues from both major multinational corporations and individuals. The initiative called base erosion and profit shifting ( BEPS ) plan was presented to G 20 finance ministers on the 20th of July this year on their request.
In short, the BEPS report confirms OECD’s findings that the existing international tax system is failing the rich as well as poor countries. This is more or less stating the obvious. Taking the initiative further during a recent announcement the OECD has also identified 15 policy action points that it hopes will restore trust and fairness in the system. In principle, the scheme does seem to hit the right notes especially with law and policy makers and hence it was fully endorsed by the G 20 finance ministers this month.
The OECD’s action plan on base erosion and profit shifting (BEPS) will most likely be considered by many as a step in the right direction but it does seem to be loaded with complicated ideas to help nations find ways to collect more tax revenues from major international corporations as well as individuals. And while it rightly focuses on tax treaties, tax compliance, overall tax policies among other things to fix the inefficient global tax system, parts of the scheme may not be fair for all and also falls short on addressing the real issues. For example under the planned proposal OECD recommends a multinational treaty aimed at tax avoidance but this treaty could also potentially hurt smaller countries that are using low corporate income rates to attract investments from across the world.
Also after looking at the bigger picture it will be unwise to conclude that the downward trend in tax income revenues is all simply down to deliberate tax avoidance and evasion by major corporations and individuals. But here is something interesting, according to the US government agency data for the financial year ending 2011, the US corporate tax collection was roughly around 2.4% of its GDP. And the historical data suggests that the overall corporate tax contribution has shrunk dramatically since 1950s but its not just a US problem as most OECD economies collect between 2% to 3% of their GDP in corporate income tax revenues. However, there are no clear evidence to suggest that this downward trend is all cause of corporates tax avoidance and evasion. There are serious existing policy issues related to taxation thats need to resolved and unless the lawmakers take radical measures to reform the existing tax systems even if OECD’s scheme was to be fully implemented it’s hard to project a significant rise in the overall corporate tax income revenues in terms of percentage of the GDP but we will have to wait and see.
Over the past few decades there has been a significant shift in the overall distribution of the tax burden. For example from Oct 1, 2010 to Sep 30, 2011 the US government collected $2.30 trillion in tax revenues of which 47% was individual income taxes, 36% social insurance taxes and just 8% in corporate income taxes along with 3% in excise taxes, 1% custom duties, 0.3% estate and gift taxes, and 4% in other taxes. So clearly from the overall tax distribution stand point it is evident that the US households are bearing the brunt of the tax burden. But again this is not just a US issue for example Europeans overall tax burden is estimated to be over 15% higher than Americans or Asians for that matter. And this shift in tax distribution burden has happened over decades so its not a new phenomenon and while the law and policy makers may find it easier to criticise the corporations, it is not the corporations who make or create tax policies.
The focus of the law and policymakers of G20 countries should be around finding ways to harmonise and simplify taxes across the board as most tax systems are extremely complicated and also work with major corporations to create incentives for them to make sure they pay a fair share in corporate income tax. The world has changed and will continue to change and going forward a good tax system will need to be constantly updated and forwarding looking. Any system that is seen as Tax grab and simply aimed at taking more cash out of the private economy will most likely struggle in the long run. The system needs to be redesigned to look and feel fair and this should clearly be the focus and aim of law and policy makers involved in the ongoing tax debate.
However,the recent steps taken by various governments around the world especially the European as well as the US government has been more or less front loaded with measures to increase the tax burden on the existing tax payers. And the temptation to find ways to collect more tax revenues is understandable as most governments are under severe pressure to find ways to fix their stretched fiscal position but the law and policymakers should also realise that there are already too many hidden and indirect taxes that really affect people’s standard of living.
And also while higher taxes or finding new ways to increase tax revenues from the existing pool of tax payers in order to pay down the debt may seem as an easier option there needs to be a realisation that the current deficits weren’t caused by corporate and individual tax evasion and avoidance. The law and policymakers do need to realise that there is a lot more to an economy than taxes, and there are no perfect economic or tax systems and probably never will be but without growth most countries will continue to struggle. Also continuing to tap more from the existing pool without enlarging it or cutting down on the overall expenses to a sustainable level is a high risk plan so the G 20 finance ministers will do well to keep their focus on finding ways to take collective measures to boost the global growth in order to generate more income.
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In the past few weeks the markets have come to a realization that the developed world is struggling to generate growth and going forward the global growth projections put out by multilateral institutions including of the International Monetary Fund ( IMF ) and the World Bank paints gloomy picture. The growth outlook has been downgraded to a lower level from previous estimates. To counter the downturn in the economy the policy makers and the central bankers have been trying out various ideas to keep the economy growing. One of the widely used though unconventional monetary policy tool to stimulate growth has been to print more money through quantitative easing (QE) program by the central bankers. Although through their quantitative easing (QE) program the central bankers were able to provide critical support to the market it has had a limited affect on generating growth so far. And one could also argue that monetary policy tools on their own are not going to be enough to create growth.
Going forward the policy makers in the government will have to take the baton from the tiring hands of the monetary policy makers and have the courage to take bold decisions that goes beyond party politics and is right for the economy. The people on the streets especially those in the U.S. and Europe as well as the markets are increasingly losing faith in their political leaders’ ability to fix the CRISIS. And it is probably the right time for the politicians to stand up and deliver. In a recent speech delivered by the president of United States to joint session of the congress Mr. Obama proposed tax credit to the SMEs under Obama’s American Jobs act plan as one of his own initiatives to encourage SMEs to hire more and create jobs. He also proposed common sense based regulations to remove the regulatory burden on the SMEs. Although these are steps in the right direction but the tax credits and the removal of unnecessary regulatory burden on the companies won’t do much on their own to create the level of jobs growth that US economy needs. Besides the tax credits and regulatory reforms the SMEs also need to have an easy access to capital at very reasonable and flexible terms. The government will also need to energise the supply and demand side. Consumers’ confidence is going to be one of the key factors in turning the economy around and the government will need to work closely and tirelessly with all the parties to bring the confidence and positivity back in the system.
It is important to point out that a CRISIS born in a globalised world will need a global effort to fully overcome it. Although it is unwise to expect the developing world especially the BRIC nations to bailout European states it is in the best interest of both the developing and the developed world to work together closely on finding a long term sustainable solution.
In the aftermath of the CRISIS high street banks especially those in Europe and the United States have so far failed to support the SMEs and in fact most banks have reduced their lending to the sector significantly while increasing the cost of capital at which they will lend to the SME sector companies. Banks as one of the beneficiary of the quantitative easing program have not passed on the cash to the real economy and they are still struggling with their risk management strategy so to expect them to do more to support the economy and the SMEs sector is probably unrealistic at least for now.
The small and medium size enterprises ( SMEs ) are an important integral part and the supporting pillar of any economy. Generally the sector tends to lead a country’s new and fast growing industries. Some of the success stories of developing world today including of Korea, Taiwan among others has been built on the dynamism of the SME sector. Also due to its inherent structure the labour intensity is generally higher in the SME sector companies hence the sector is usually the largest employer in a country. For example over the last two decades the SMEs sector has accounted for around 65% of new jobs created in the U.S. and overall it accounts for about half of non-farm U.S. employment and within Europe the SMEs sector employs around 68 million people which in percentage terms translate to around 72% of the workforce in the non-primary private sector.
Even though the SMEs are seen as an important part of an economy and play a very crucial role in jobs creation in general the sector is not serviced well by banks today. The banks who mostly play the role of an underwriter of loans or suppliers of credit to an enterprise are limited in their abilities to offer a flexible funding solution to the sector and provide the right support to the SMEs due to a number of reasons, including banks being very cautious in their lending approach, uncertainty about the future and the changing market conditions, a changing mandate from their shareholders and the board, lack of commitment to the sector as well as the lack of the supporting secondary market infrastructure that will encourage and allow the banks to make good PRIMARY loans to the SME sector and be able to refinance in the secondary market if and when required. Financing SMEs do pose real challenges for the banks especially in the current environment where they are continuously feeling the pressure on their balance sheet and struggling to keep their heads above water. Also it is important to point out that while there is an immediate need to address the lack of capital availability to the SMEs it is important that the solution is sustainable and will add value in the long term.
The idea behind the new SME bank or the SME financing vehicle will be to work closely and directly with the sector as well as other banks, credit guarantee agencies, regional development agencies, usiness associations among others to provide direct and right funding solutions to the SMEs and also help in developing the secondary market infrastructure that will allow existing banks and lenders extending loans to SME sector companies to refinance their loan books.
Most Small and Medium Size enterprises require a flexible funding solution that is right for their business and will support them fully and won’t be called back or withdrawn living their business in limbo like an overdraft facility or credit line due to changes in the market conditions or a change in the strategy of the bank. SMEs like any other sector of the economy will prefer certainty and also a ring fencing of their funding commitments from the banks so they can make business decisions.
The inception & operational strategy of the proposed SME Bank
- The Central banks and the governments could create a SME Bank or SME Financing Vehicle in partnership with financial institutions including of development banks, private investors and other investors with focus on SMEs or similar investment asset class.
- The investment strategy and the role to be played by the SME Bank should be multifaceted and flexible to allow it to meet a range of capital requirements coming out of the SMEs. A single funding solution or investment strategy may not provide the right support to the sector.
- The SME bank should also be able to work with traditional and nontraditional lenders to SMEs including of high street banks.
- The SME bank should also provide a third party service to others and help other banks manage and monitor their existing SME loan books better and get paid a fee for its services.
- Buy off the existing loans from the balance sheet of the banks enabling them to refinance their loan book and use the new money to extend more loans.
- Also act as a guarantor to the SME sector companies that are looking to secure funding or provide performance bonds to their counterparties/clients if and when required.
- Be able to securitise SME loans under special tax free investment provisions for a limited period to attract investors into the asset class.
- Provide advisory and consultancy services to SMEs and work intimately with the sector.
Proposed Shareholders/Participants of the SME Bank (or the SME financing Vehicle)
The government or the central banks, development agencies, multilateral institutions, local banks, credit guarantee agencies, private investors and financial institutions among others
Proposed Capitalisation and Guarantees
A part of the capital commitment to the SMEs bank could come from the Central banks using the government bonds purchased through their QE program and the remaining from its prospective shareholders. The capitalization of the bank should be based on the real funding requirement of the sector and should be sufficient to service good SMEs.
Benefits of the SMEs Bank
The SMEs bank will play a very important role with huge benefits to the SMEs sector companies, high street banks, lenders focused on SMEs, credit guarantee agencies as well as development banks and other market players. It will also act as an additional pillar supporting the market in the long run and will be a good value ADD going forward.
The local banks, credit guarantee agencies and other lenders or service providers to the SMEs by working closely with the SMEs Bank will be able to take a preemptive action on any loans or services extended to the SMEs that has a possibility of becoming a non performing loan. Also banks could easily offload good and performing loans to the SMEs Bank (or the SME financing Vehicle). While the SME Bank will do direct primary loans and investments to the SMEs sector companies it also will also help develop the secondary market for SMEs loans underwritten by the local banks and other lenders. It could also play the role of the credit guarantee agency to the SMEs sector.
Exit strategy for the shareholders
The shareholders could EXIT if and when required through an IPO in few years time when the markets are going to be much calmer.
The SMEs bank will energize the sector by providing a critical support to the SMEs with a range of financing solutions and will also add significant value to the existing system on a long term basis. It is an idea that needs to be seriously explored by the policy makers.
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