Since the 2008 Global Financial crisis there has been a cheap and superabundant availability of capital for investment. According to Bain’s Macro Trends Group, today, global financial capital is nearly 10 times the value of the global output of all goods and services. This trend will continue due to growing financial markets in emerging economies such as India and China, that are accounting for more than 40% of the increase in global financial assets. Data suggests that they will continue to fuel growth in financial capital well beyond 2030. Hence, large enterprises can readily obtain the capital they need to buy new equipment, fund new products, enter new markets, and even acquire new businesses. Therefore, the skillful allocation of financial capital is no longer a sustained competitive advantage.
This has affected evolving business models and strategies of the 21st century, as seen in multinational companies such as Google, Amazon, Facebook and Apple – they build to a huge scale using enormous amounts of capital, shifting their focus from creating customers who will pay for a good or service to ‘buying’ the loyalty of millions of non-paying customers before figuring out how to capitalise on the service/make money from the franchise.
For example, Indian based company, Reliance Jio SIM adopted a simple yet expensive acquisition cost, providing unlimited free voice calls to any other network, no roaming charge and internet surfing, music, movies and other programs free of cost. Once the customer had subscribed to the network and had started using the same, the next step was to retain him or make him comfortable with Jio’s features and services by extending the duration of these free services. The revenue-earning stage came last; customers now familiar with product, are loyal users and want to pay for the services as well.
Publicly-listed companies like electric carmaker Tesla, music streaming firm Spotify and ride-hailing firm Uber make billions of losses and poor return on investments, yet they continue to be funded. The rapid growth of the tech sector is the main reason why investors are willing to put their money into unprofitable companies, since many shareholders value growth and tend to be more comfortable even if firms aren’t making huge margins. They are willing to sacrifice near term profitability in exchange for maximising growth.
The fallout of adopting such a strategy from the point of view of the economy is that companies having access to endless/cheap capital can drive out all competition creating a near-monopoly market. Indian businesses call this unhealthy market practice ‘capital dumping’, using subsidised capital from profitable markets abroad to gain market share at the expense of Indian rivals. This dubious strategy has affected local competitors, for example Ola and Flipkart against global competitors Uber and Amazon respectively.
Another concern that arises with the adoption of such a strategy, is the excessive substitution of labour with capital as a factor of production. Readily available capital is fuelling large investments in automation and technology, which will surely create some jobs somewhere, but in the short-term it polarises jobs i.e., the demand will be for very high skills, or very average skills, with middle-skilled jobs being phased out which will cause a huge social blowback.
Lastly, firms contribute very little towards taxes since they make losses for years on end. This results in multi-million tax concessions to big businesses. Given how big capital increases its economic clout, we need to review our taxation systems.
Some suggestions given by the IMF include multinationals having a permanent establishment in other countries must pay a minimum amount to their host countries, as the cost of doing business, even if they are making a loss. Corporations benefit from roads, bridges and ports that are served by various government ministries; these companies should pay for these services regardless of whether they make a profit or not. The cost of consuming government services should be treated as no different from various other operational costs such as rent, employee compensation or utility bill.
Secondly, a higher rate of withholding tax on cross-border payments must be levied. When a non-resident receives a payment that is chargeable to tax, the paying person should withhold the tax. If the payer does not withhold applicable taxes, the expenses will not be deductible when computing the payer’s income. Additionally, the resident payer can be subject to interest, penalty and recovery provisions for failure to deduct taxes.
Another suggestion is that companies can be asked to pay 2-3% as taxes on gross revenues rather than net profits. Such a tax would badly hit small and medium enterprises that face structural impediments, because of which the government is trying to assist them; however, this dilemma can be overcome by setting a relatively high threshold of, say, Rs 100 crore of annual revenue for the application of this tax. This idea has been tested in India; operators of private airports (GMR, GVK) pay a certain percentage of their gross revenues to the Airports Authority of India (AAI), however this is yet to be introduced in other sectors.
Lastly, inheritance tax should make a come-back on both the financial side as well as real assets. This is also essential to bridge the gap in a nation of inequalities. The government can make exemptions in case of lower inheritance amounts by placing a threshold of say Rs 25 cr and overall gentle rates say 10% to encourage compliance.
Countries want to make sure that corporations bear a fair part of the overall tax burden, but they also want to attract investment, jobs and innovation which is why these reforms have not been introduced yet. Countries must weigh the pros of collecting greater tax against the cons of driving away foreign investment. India’s market size is so enormous that only small or niche players will be discouraged, and the big boys will invest even if India levies a modest amount of additional tax.
By Mahima Munjal
Grade 12 student, The Shri Ram School Aravali, Gurgaon
This piece was written under our Writing Mentorship Program – June 2019.