President Obama's tax proposals
 

The Obama tax proposals: no cause for India to panic

Roopen Roy

 

On campaign I used to talk about the outrage of a building in the Cayman Islands that had over 12000 business-businesses claim this building as their headquarters. And I’ve said before, either this is the largest building in the world or the largest tax scam in the world.”

 

President Barack Obama, May 4th Speech.

 

President Barack Obama’s tax reform proposals should not cause any panic in India. They are primarily designed to plug loopholes in the US international tax regime. It is proposed to limit US deductions for expenses related to unrepatriated foreign-source income, modify the foreign tax credit rules, crack down on abuses of offshore tax havens by individuals and beef up Internal  Revenue Service international tax enforcement efforts. Together, the overall impact of the proposals would be an increase of approximately  9% in the US tax burden for corporations with foreign-source income. If approved by Congress and passed into law in its present form, the provisions will become effective in 2011 and raise some $210 billion over 10 years.

  The media and some members of the IT industry have plucked the following sentence to create the proverbial storm in a tea cup:”And it’s a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.” If he had said Beijing or Bermuda instead of Bangalore my friends in Nasscom  Pramod Bhasin and Som Mittal would have been happier. But what do you expect a US President to do in the midst of a deep recession with record domestic job losses? Make a stirring speech on the benefits of  free market ? The job losses this time are not limited to  the manufacturing sector involving blue collar workers. Many executives in the financial and services sectors are seriously affected. To them, Bangalore is a symbol of how digitization has enabled the electronic mobility of the global workforce.  Hence, the political rhetoric.

Honestly, however, the tax proposals (and they are only proposals at this stage) were not designed to hurt India’s IT outsourcing industry. The business case for off-shoring to India is sound and built on robust foundations. These fundamentals are unlikely to be dented by the proposed changes in US tax laws. Even after this speech, Nasscom and McKinsey have put out estimates that by 2011 our global exports in IT will cross $ 60 billion.  The growth engine of the IT industry is hardly likely to sputter and stop. The Nassom-Mckinsey Report projects our IT exports to be $225 billion by 2020.

Let us examine why India is today a leader in the IT off-shoring industry. Is it because India offers the most  friendly fiscal regime to the US MNCs? It is certainly not a tax haven. The second question: why is outsourcing not taking off in “no-tax” countries? The main ingredient of the secret sauce is not low tax rates.  It is not even the cost arbitrage. Even though that is how the game began. The answer lies is in the experience, quality and availability of expertise and talent in India at a great price. The sentiment is best summarized in the quip:”Went for cost, stayed for quality.”

Many of my American friends have repeatedly asked me one question: when will the India cost advantage peter out? During the last decade, compensation costs in the IT outsourcing industry have shown a steady rise. The hourly rates have not increased in lockstep , yet the profits of the IT companies have recorded a rise. How do we explain this paradox? There are several factors in play. Firstly, the cost model of our IT outsourcing industry is not invariably driven by efforts measured in person/hours. The better companies have created templates and libraries of components that are re-usable. When they execute projects repeatedly in a specific industry or function, they can collapse the elapsed time and efforts through replication capabilities. Second, the individual whose compensation has increased is not performing the same task year after year. He is replaced by a new person often fresh from the campus. Thirdly, as companies grow, they harvest the economies of scale and broaden the base of their staff pyramids. Fourthly, the use of new tools and cumulative experience continuously enhances productivity. And last, though not the least, Indian companies are rising up the food chain offering  entirely new sets of values.  80% of the incremental revenue growth through 2020 will come from new businesses and new customers.

There is another fundamental that will favour India.USA is a country which has built its fortunes and competitiveness by creating an ambience that is a magnate for talent .They have also leveraged digitization to construct a business model that makes global talent electronically fungible. President Obama is unlikely to strike at the root of America’s ability to compete. It is not in his own country’s interest to deny its businesses from dipping into the global talent pool and sharpen its competitive edge. I sign off by quoting what President Obama said in the same speech,” Now, understand, one of the strengths of our economy is the global reach of our business. And I want to see our companies remain the most competitive in the world.”

 

Roopen Roy in the Managing Director of Deloitte Consulting in India. Views expressed in this article are personal.