While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. Audio narration by Ad-Auris. If this post was forwarded to you and you liked it, consider subscribing. It’s free. #219 Of Sins, Bets, and BluffsGood & Sin Tax on Online Games, Understanding the Foxconn-Vedanta JV Failure, and Europe Liberating Itself Off Russian Energy Supplies
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India Policy Watch #1: Yeh Paap HaiInsights on current policy issues in India— RSJIt has been a good week for sin taxes in India. First, the new Karnataka government, which had promised a host of welfare “guarantees” at the time of polls, decided that the best way to balance the budget would be to increase the excise duty on IMFL (Indian Made Foreign Liquor) by 20 per cent and on beer by 10 per cent. Before I go further, let me for a moment marvel at the beauty of the Indianism, “Indian made foreign liquor”. In a way, this magnificent non sequitur is also a product of our policy decision on liquor. But that’s a story probably for another day. For now, let’s just hope for the sake of the Karnataka government’s budget math that liquor consumption in the state is quite inelastic. Later in the week came the news from the Finance Ministry about the imposition of a GST rate of 28 per cent on the full value of transactions in online games and casinos. Prior to this move, GST was applied on the ‘platform fees’ that were charged by gaming companies to the users for providing the platform as a service. Typically, the platform fees could range from 10-20 per cent of the total value of the “game” or the “pot”. An 18 per cent GST rate on platform fees would therefore mean about 2-3 per cent GST on the total game value. This has now gone up to 28 per cent. An increase of almost 10-11 times. This means that 28 per cent GST will be levied on the total pool amount for a game, 30 per cent TDS on net winnings from the games, plus the platform has its own participation fees of 10-20 per cent. What a time to be alive as a gamer and a taxpayer! The Revenue secretary laid out the math and the logic in a press communication. From ET:
Additional ₹20,000 crores to the exchequer, plus fighting for the common man against uncommon men like gamers. And then some threats on banning the companies. There you have some watertight reasons for a policy move. What’s not to like in this for the State?! Once again, with that math of ₹20,000 crores, the revenue department is also assuming that the demand for such online games is inelastic. Separately, I can foresee tax notices being printed soon on differential taxes to online gaming companies. Well, fun times are ahead for the industry. While there wasn’t much brouhaha over the increase in excise rates in liquor in Karnataka, the GST move on the gaming industry has the industry up in arms. Maybe tipplers are lonely people who cannot mobilise themselves to protest against tax increases. The gaming industry, on the other hand, came out in unison against this bolt from the blue. Even those who find a masterstroke in every move of the current dispensation seem to be upset. They seem to have three chief grouses. First, most of them were at pains to explain how legitimate gaming companies have built their platforms in testing and rewarding real gaming skills. This is different from betting or gambling, and they want this distinction to be understood by the GST council because real games of skill in e-gaming should be applauded and encouraged. Well, all I can say is the industry hasn’t grown to anywhere around $5 billion in revenues at a staggering pace only because Indians have suddenly discovered the joys of learning gaming skills. Look at our Olympic record if you want evidence of how much we love games of skill. The ease with which many so-called gaming companies have run what are essentially gambling platforms and built huge businesses on top of it only confirms that it is difficult to monitor and regulate the distinction between a game of skills and a game of chance on online platforms where games are created every day with all kinds of surrogates to mask their gambling hearts. It is no surprise then that the government decided to do the good ol’ ‘Hanuman and Sanjeevani’ routine in bringing everything under the 28 per cent regime. I mean, why waste time on nuances? Second, there are those who lament how a high-growth industry that has considerable investor interest and that was creating new jobs is being buried under taxes. As the ET reports:
Of course, the whole math was summed by that modern sage of the Indian startup scene, Ashneer Grover, in his tweet:
Well, at least there’s no ambiguity in that tweet about this thing being a game of skills. Third, there’s the concern that this move will only drive the gaming industry offshore or, worse, underground. This is almost certain. There’s a market for gaming, and making its business model unviable won’t diminish it completely. Some of the larger and more organised platforms will increase the game value to factor in the GST and yield some margins to players to continue to remain attractive to them. But a majority of smaller players will shift offshore or morph into illegal platforms to evade GST. Raids, tax notices, and rent-seeking behaviour will follow. The government will use the usual cat-and-mouse game of tax collected at source (TCS) to plug the offshore model gap. This is the usual script that we have seen before. Of course, there are more fundamental issues that are conveniently ignored in this debate that interest me. For instance, have we actually seen sin taxes work in reducing the “sin” in society? The many years of raising taxes on liquor or cigarettes are inconclusive about its efficacy in reducing their consumption. The reduction in cigarette sales seen over the last two decades has been more on account of public awareness campaigns about the dangers of smoking, not because they have become prohibitively expensive. The other issue with most sin taxes is that they tend to be regressive. That is, they hurt those with lower incomes more who tend to have higher consumption of sin goods as a percentage of their income. I am not making a value judgment here. This is what the data shows. So, barring just the opportunistic move to tax people more and earn more revenues, there is limited evidence to show sin taxes work. It is just a lazy shortcut to boost revenues by taxing the already taxed some more, without the State either being more productive or curbing the so-called ‘sin’. The other question to think about is what is a ‘sin good’? It is quite clear that conventional morality plays a bigger role than the real risk to society in arriving at the definition. For instance, there is scientific evidence to suggest that sugar in all its forms is bad for the health, and given the genetic predisposition to diabetes among people from the subcontinent, a good case among those who support such taxes can be made for sugar as a ‘sin good’ that should be taxed at a high rate. But it is difficult to imagine a scenario where jalebis will be taxed at 28 per cent. Apart from GST, the government introduced a 30 per cent tax deducted at source (TDS) on net winnings for online games earlier this year. There is a conceptual issue involved in taxing gambling winnings. Betting of any type involves a few people winning, which is entirely paid for by the losses of another set of players. The intermediaries or the brokers who take the trouble to set the bet, run the odds and provide a platform do earn revenues and profits, and they are taxed like any other business enterprise. Conceptually if you see the stock market as a betting platform, you will see a certain symmetry in how profits and losses are taxed there. There is, of course, a tax on profits made from trading in stocks, but equally, there is an equal allowance available against losses made by another set of players in the same market. Similarly, if a tax is levied or withdrawn on profits from a transaction in other forms of speculative markets like property or commodity trading, a similar corresponding principle is applied to the losses made by others in the same transaction. I find it difficult to reconcile how the losses in regulated gambling aren’t allowed to be offset against winnings for the same individual if one were to follow the first principles in such matters. But that’s how the dice rolls. The government is quite confident that the industry won’t die. Instead, it will figure out a way to keep it attractive for the punters, which in turn will mean ₹20,000 crores of additional revenues. Plus, it gets to take a moral high ground in the light of multiple complaints that were being raised by families of those affected by the addiction to these platforms. And that’s good enough. That the real issue of gambling won’t be solved for society won’t matter. The State is never in the business of killing its golden goose. India Policy Watch #2: How to think about the termination of the Foxconn-Vedanta JV?Insights on issues relevant to India— Pranay KotasthaneThere's been a lot of commentary on the demise of the Foxconn-Vedanta Joint Venture over the last few days. The pessimists have found their smoking gun that India's semiconductor policy is doomed to fail, while the government has gone all out on the defensive, claiming that this failure will have no bearing on India's semiconductor plans. After grappling with the news over the past few days, here's a framework to think about this issue. I think most people are doing partial equilibrium thinking - as if getting or not getting one fab will seal India's fate in semiconductors. However, I think that's far from the truth. Importance of a fab in IndiaHaving a fab in India will not make India self-sufficient in chips. A fab in India will perhaps produce 40,000 wafer starts per month (WSPM). The top foundries produce more than a million-and-half WSPM. India's semiconductor market is far more diverse and huge for two-three fabs to handle. Nevertheless, a fab is important as it will begin a process of learning chip manufacturing. It will require a few "knowledge decades" before Indian firms can master this supply chain segment. It's like planting a seed of a Banyan tree—it will reach full maturity only decades from now. I'm reasonably confident that some other consortia might show interest over the next couple of years. But as I said, it's important to understand the purpose a fab will serve. Are Water and Electricity a Problem?No. It's ridiculous to read opinions stating that India’s problem is that it cannot provide reliable power and water, an absolute necessity for chip manufacturing plants. India operates nuclear power plants and has a reasonably successful space programme. The challenges of a trailing-edge fab are far more manageable. Once a project is identified as a national priority, Indian Union and state governments are capable of ensuring that electricity and water for that one place are top-notch. Especially since governments today are well aware of a fab's significance. Where the Government is not at FaultSome analysts have criticised the slow pace of approvals for chip manufacturing proposals. However, I think the government made the right decision in not approving proposals that didn't have reliable technology partners. The reputational and real costs would have been far higher if the projects had failed to take off after the government had approved and started capital infusion. It's great for the government to be prudent in these cases. What the Government Could Do BetterThat said, the government has three questions to answer. Firstly, none of the fab proposals have been able to find good technology partners. One reason might be that several countries are pursuing these companies, given East Asia's uncertain geopolitical environment. It's now a seller's market. Foundry companies are shopping across countries for incentives. In such a scenario, India has two options: escalate its industrial policy game or stay out of the game until the market corrects after a few months. My sense is that the government can do a lot by improving its trade, tax, and business environments to help tip the cost-benefit calculations of companies in India's favour. For example, the lack of policy consistency and high import tariffs explain why Taiwanese companies haven't shown interest in the assembly and fab stages yet. A second point for the government to consider is concentrating efforts on a fab and letting go of other competing priorities, such as display fabs. I never understood the industrial policy case for a display fab in India. Displays are not strategic. There are quite a few substitutes for Chinese display makers. Let's get chipmaking right first. Thirdly, the government needs to bring in more transparency in its approach to semiconductor fabs. The noise around the Foxconn-Vedanta fab announcement masked the fact that it was just a Memorandum of Understanding (MoU). It was projected as a big move that would make India atmanirbhar. Instead, the government needs to put out regular monthly progress reports on its semiconductor programme. This will help manage expectations. I remain hopeful that with semiconductors identified as a national priority, India will have a fab sometime in the near future. It's foolish to paint the failure of one Foxconn-Vedanta project as the downfall of India's semiconductor ambitions. Building a semiconductor ecosystem is a marathon, not a sprint. Global Policy Watch: Europe Calls Russia’s BluffInsights on global issues relevant to India— Pranay KotasthaneOpen societies and their governments deservedly get a lot of flak when they get things wrong. But when they do make the right moves, their successes often get overlooked. In contrast to closed, centralised societies where successes can be attributed to one man or “the regime”, the heroes in open societies are often too many people to keep count of or are decentralised and de-glamourised institutions plainly doing what they are meant to do. And so, their successes don’t make for the kind of spectacular narratives we see in movies. One such recent success has been Europe weaning itself off Russian oil, coal, and gas. Europeans first dug themselves a hole by closing nuclear power and coal plants domestically while simultaneously embracing energy imports from a recalcitrant strategic adversary, Russia. After Russia’s invasion of Ukraine, it was widely believed that this policy would cause Europe immense grief. It was feared that the GDP would face a double-digit contraction, unemployment would surge, and households would have to brave chilly winters without gas-powered heating. The resource-rich supplier, Russia, like the rich seth in 1970 Bollywood flicks, held all the cards, or so it seemed. And yet, Putin’s hope of using energy as a weapon bombed rather spectacularly. With their backs to the wall, European countries were able to focus their energies on reducing energy supplies from Russia within a year. In Q1 2022, 26% of its oil came from Russia. By Q1 2023, it had fallen to a mere 3.2%. Similarly, gas imports from Russia fell to 17% in a year from a high of 38% in Q1 2022. A combination of demand-side and supply-side efforts made this feat possible. The demand went down by 15% on account of closing and off-shoring power-guzzling industries and efficient power management by households. A warmer-than-usual winter also played its part. On the supply side, new sources of piped gas were tapped. Germany built a long-stalled LNG terminal at a record-breaking pace. Imports of Russian crude refined in India also helped. Old coal-fired plants were restarted, and France’s nuclear energy prowess came to the rescue, albeit late in the game. There are at least two important lessons in this European success story. Firstly, it shows the inherent resilience of large, liberal democracies. Despite a short-sighted move to increase energy dependence on Russia, European states, markets, and societies were able to self-correct quickly using disparate approaches. Alexis De Tocqueville wrote, “the federal system was created with the intention of combining the different advantages which result from the magnitude and the littleness of nations”. In Europe’s response, this jugalbandi of magnitude and littleness served well. While the decision to impose price caps on Russian oil shipments was taken at the EU level, several other demand-side adjustments and supply-side increases happened at the level of member states. France fell back on its nuclear energy sources, while Germany reactivated some of its coal plants. Not all responses had to be centralised diktats. Secondly, this case proves that the strategic impact of controlling natural resources is extremely limited. Russia failed to use energy as a weapon. On the other hand, Europe felt confident enough to impose a price cap on Russian oil shipments. A big buyer of an easily substitutable and widely available resource has a definitive strategic advantage over a big seller. For the same reason, in our previous edition, I wrote that China’s overwhelming production capacity of Gallium and Germanium shouldn’t be mistaken as foreign policy leverage. As soon as China attempts export controls, rich buyers will be able to amass domestic capacity or line up other foreign sellers at higher prices. This equation doesn’t hold if the restricted commodity is a critical knowledge product requiring decades of capability building, investment, and excellence. In that case, the supplier has the upper hand. To corrupt that oft-repeated Paul Getty quote, “If you are dependent on a critical knowledge-rich commodity on your adversary, it’s your problem. But if you are dependent on your adversary for a substitutable resource, it’s your adversary’s problem.” This lesson is particularly important for us in India, where we tend to conflate every dependence on China as a strategic vulnerability. I have argued earlier that we stand to benefit from incoming Chinese investments, chips, machines, and talent. Beyond a narrow set of core, foundational areas where Indian and Chinese interests are polar opposites, such as in defence, space, and nuclear, there’s no reason to be afraid of doing business with Chinese entities. Thirdly, State Capacity is an immense source of power. The normally sluggish Europe was able to act with amazing speed in a crisis situation because of its high state capacity. This in itself is a neglected source of power in international relations. To turn the tables on a belligerent adversary is no small achievement. HomeWorkReading and listening recommendations on public policy matters
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