Devangshu Datta: Where the victim benefits!

VIEWPOINT

A government is an entity with the power to collect taxes. This does not mean it has to levy taxes. The task for a decent government is to induce the populace to be productive, generate savings, and make useful investments with those savings. This is akin to feeding and milking a cow in such fashion as to get more milk and less moo, if one may paraphrase Lord Vetinari.

Taxation is not optimal. Most people dislike paying taxes. The exceptions are liars or statistical freaks. Any government that finds a less painful way to unlocking household savings is likely to be popular.

Low tax levels and an environment that encourages high productivity lead to more milk and much less moo. Free ports such as Singapore, Panama and Macau work on that principle. Most low-tax regimes are prosperous""is this a chicken-egg situation?

Anyhow, offering decent infrastructure, high public safety, etc. and allowing people to keep most of their income works. Alternative revenue streams can also be created through options like casino tourism. Monaco is the showcase for the low-tax, casino-driven model but there are several examples.

Instead of low taxes, Scandinavia and the EU offer riffs on the welfare state. This works on delayed gratification. An employed EU citizen pays high taxes. An unemployed citizen gets a dole. EU-dwellers are guaranteed good free healthcare, free education, etc. And, retirees get lavish pensions""the taxes come back for those who live long enough.

But the European model is a demographic Ponzi scheme; it works only if the number of those employed exceeds the number of retirees. Italy is already on the wrong side of that hill and many EU nations will get there within a decade.

These concepts don't transplant easily to India. Gambling is "immoral". Zero tax may not work for the same reasons high taxes don't. People evade high taxes because the Sarkar lacks the power to either enforce compliance or provide the quid pro quo of a benign environment. Zero tax would hobble the already limited capacity to improve the environment.

So, other routes to tapping household savings must be found. One cunning strategy has been service tax""this has dramatically improved public finances but it would be difficult to push up rates much further.

An alternative is the increasingly popular ULIP (Unit-linked insurance plan). ULIPs now constitute perhaps 70 per cent of new insurance premiums. That meant over Rs 40,000 crore last fiscal and it is growing quicker than bank deposits and investments in equity mutual funds.

ULIPs are psychologically seductive. They seem to offer a combination of safety as well as delayed gratification. The premiums give insurers huge sums in long-term float. This is ideal for long-gestation, high-risk, high-payoff plays. ULIPs already provide a backbone to equity markets. Their influence is likely to grow.

These flexible instruments can be structured in many ways. So much so, it's impossible to judge the return to a given ULIP-holder from an NAV statement. The long-term record of a ULIP is likely to be comparable to the best equity funds, so long-term investors would have no cause for complaint.

The problem is mis-selling. Investors buy ULIPs because they want insurance and actually, ULIPs are inefficient in terms of insurance cover. Most holders have no clue about commission structure and allocation ratio.

If they did, they would feel cheated. In the early stages, ULIP commissions are massive. It is in the interests of the seller to structure a ULIP so as to generate the most commission. Many agents suggest churning at the three-year mark when the investor is at the worst stage of the ULIP cycle.

This presents a peculiar moral conundrum. People take ULIPs for the wrong reasons. Insurers push them for the wrong reasons. If people understood these instruments, they would shy away. If the commission structure changed, insurers would stop pushing them.

Yet, a passive investor may get excellent returns from a ULIP. And the flow of long-term ULIP funding helps build a stronger economy. This is a rare example of a con-job where the victim actually benefits!