Rebooting India: Realizing a Billion Aspirations (16 page)

This ‘pukka’ file, containing the e-KYC design and all correspondence with the ministry of finance, the FIU and various regulators, was by now thick enough to give an encyclopaedia a run for its money. The file turned out to be the catalyst; all the key people in the decision-making chain signed off on the design, budgets were allocated immediately and work on the implementation of e-KYC began in earnest. Say what you will about the government’s archaic file system, there is a lot of power contained in those green sheets, thanks to the merits of clear documentation, traceable decision-making and long term record-keeping.

To get a sense of the value of Aadhaar-based e-KYC in the field, we spoke with Gautam Bhardwaj, the founder of Invest India Micro Pension Services (IIMPS), a social enterprise that enables poor people to set up low-cost savings for retirement. According to him:

In early September 2014, we launched paperless and cashless enrolments for pension schemes at Tumkur district in Karnataka. Roughly 500 low-income women members of self-help groups living in remote villages in Tumkur participated in two-hour
retirement literacy group meetings over ten days. Of these, around 300 women have decided to join the micro-pension programme. Application forms for both products are digitally filled using data from each person’s e-KYC. Each form is digitally signed through a biometric authentication. Contributions are loaded onto bank-issued prepaid cards and moved into an escrow account in real time. In all this, the field experience with e-KYC is simply wonderful! It takes 3.5 minutes on average to complete the full enrolment and payment process. Forms and contributions are then electronically transferred for processing.

In fact, IIMPS found the paperless KYC and payments solution so compelling that they are pushing for wider adoption despite connectivity issues. Says Bhardwaj, ‘In some villages, we’re facing an implementation challenge on account of internet connectivity although we’ve tried internet data cards of all telecom providers. We’re trying to figure out some solution including signal boosters.’

Once the e-KYC system was created, we had to go back and make the rounds of government once again for it to receive official approval. As before, we started with the department of revenue, who themselves asked the ministry of law and justice to weigh in on whether the e-KYC solution could be considered equivalent to existing paper-based methods. Having received the legal go-ahead, the department of revenue issued an official notice accepting the use of e-KYC. The three major regulators followed suit, and banks, insurance companies and security firms started to accept the e-KYC system. Ashok Pal Singh points out, ‘The collaborative approach that resulted in the birth of e-KYC is quite rare in the government. Instead of taking a hardened position and making it a turf war, the UIDAI worked together with the department of revenue and the FIU to come up with a KYC solution that met everyone’s requirements.’

A major push for large-scale adoption of the e-KYC service came with the launch of the Pradhan Mantri Jan Dhan Yojana (PMJDY). Under the provisions of this scheme, e-KYC would be used at scale for the rapid opening of bank accounts. Banks are now insisting on
the use of Aadhaar and e-KYC before disbursing the Rs 5000 loan that has been sanctioned by the PMJDY so that one person cannot take out the same loan multiple times across different banks. Today, the UIDAI handles over 50,000 e-KYC requests daily, and that number is projected to increase exponentially in the future.

Let’s take a quick look at why the e-KYC system that we at UIDAI came up with is a win-win proposition for both service providers and customers.
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Cutting out paper cuts both costs and time; the service provider doesn’t have to manage the documents of thousands of customers, and since all records are provided instantaneously in electronic form, the time taken for document verification and data entry is reduced to zero.

As a result, Axis Bank and the like can now expand into rural and underserved areas, a proposition which would have made little financial sense before the advent of the e-KYC system. The positive impact on financial inclusion, bringing in ever more people into the formal financial sector, is an illustration of one of our core ideas—expecting organizations to participate in an initiative solely because it’s a worthy social goal isn’t likely to succeed. The minute we manage to make it an attractive business model by adding appropriate financial incentives, people are immediately willing to join in, and the whole ecosystem grows and expands in ways we ourselves might not have foreseen.

e-KYC also represents significant improvements in information security and handling, especially important in a country that doesn’t have a strong set of regulations around data privacy. Features like explicit consent, biometric verification and digital signatures make the e-KYC process robust and tamper-proof, and resistant to identity theft.

Transactions are easy to store and trace, making audits far simpler. And finally, the e-KYC platform provided by Aadhaar is open to all service providers, both government and private, to use in any transaction that requires identity verification, whether it’s in obtaining an LPG connection or determining eligibility for a bank loan. e-KYC is also
designed to answer the needs of a highly mobile society. Digitizing the KYC process provides an easy method of identity verification irrespective of a person’s physical location.

For those of us who already possess two or three forms of ID and have easy access to banking facilities, the use of Aadhaar as a KYC document might make life a little simpler. But for the majority of Indians without bank accounts, Aadhaar-based e-KYC enables them to enter the formal financial sector on the strength of a number and a fingerprint. It is a validation of our efforts that the PMJDY, aimed at eradicating India’s ‘financial untouchability’,
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accepts Aadhaar numbers as being sufficient proof for KYC. By providing an open, Aadhaar-based KYC platform, we hope to revolutionize the way customers and businesses interact, whether in the public or private sector.

Opening up the formal financial sector to all Indian citizens is merely the first transformation that the e-KYC process can bring about. Ultimately, the power of e-KYC lies in the fact that it can be used for any conceivable application requiring an identity, an address, or both, to be verified. Cross-checking your biometrics might be all it takes for you to enter an airport or board a train. The same data could also be enough for you to buy a SIM card, operate a vehicle or cast your vote. We can expect a whole host of new business models to spring up around the e-KYC ecosystem, using the idea of an electronic identity to develop services and products that are also completely digital. e-KYC is the first step towards building a digital identity for every Indian, and to move towards the vision of India as a completely paperless society.

Taxes are what we pay for civilized society.

—Oliver Wendell Holmes, 1927

IT’S A MISTY WINTER morning in Khanauri, a state border checkpoint in Punjab, and Lakshman Singh is getting restless. The thirty-eight-year-old is driving a truck laden with chemicals, and has been waiting here for six hours to pass through the checkpoint. Why the delay? Singh complains, ‘They say they have not received the information from the previous check-post about the passage of my truck. That’s not my fault.’ Nearby, Dinesh Kumar, who is ferrying a load of yarn from Gujarat to a blanket factory in Punjab, has to fend off anxious calls from factory managers asking where he has reached, and whether he is stuck. Around Singh and Kumar, drivers stand in long lines, waiting to receive an official go-ahead while their assistants huddle around fires and brew up tea to stay warm and stave off boredom.
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A similar story unfolds at the Walayar checkpoint, on the border between Kerala and Tamil Nadu.
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Trucks routinely get stuck here for four to five days awaiting clearance; textile entrepreneur D. Bala Sundaram, who runs a business with an annual turnover of Rs 9 billion, is so fed up of the delays that he no longer sends his trucks
to the nearby international container terminal in Cochin. Instead, it’s more efficient for him to send his trucks hundreds of kilometres in the opposite direction to the smaller port of Tuticorin, from where the cargo will head to Colombo, Sri Lanka, and thence around the world. Even though this diversion drives up his freight costs by 20 per cent, Balaji says the trade-off is worth it. ‘We can give our clients an exact date when the cargo will reach its destination. With the Cochin port, we simply cannot be sure when or whether our cargo will reach the port itself.’

India’s roads account for two-thirds of its freight traffic, but only 40 per cent of travel time is spent actually driving. The rest is lost to waiting at border checkpoints, paying taxes—there are eleven different categories that apply to road transport alone—and dealing with the local authorities.
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According to the World Bank, these delays mean that the logistical costs of manufacturing in India are two to three times higher than international benchmarks; cutting wait times by half would decrease the logistics costs by 30–40 per cent, making India’s manufacturing sector more competitive globally.
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It’s not just the manufacturing sector that has to contend with the complexity of India’s tax laws—it applies to all taxpayers in the country. When it comes to taxation, for example, the relationship between the people and the tax authorities assumes an adversarial tone, extending even to government-produced adverts on the radio warning you that for every high-value purchase or investment you make, the taxman is watching. During his election campaign, Prime Minister Narendra Modi used the phrase ‘tax terrorism’ to describe the relationship between tax officials and the public, saying, ‘You cannot treat every citizen like a thief. Some serious thought is required and financial experts must see how taxes can be simplified.’
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The finance ministry was also expected to issue a directive to the tax authorities to avoid ‘harassment of taxpayers, whether they are individuals or companies’.
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In the view of Bharat Goenka, co-founder of Tally Solutions, a provider of business accounting software used by hundreds of thousands of businesses and small merchants, and someone who is deeply engaged
with India’s taxation systems, ‘The government always works on the principle that their job is to make the law, and the citizen’s job is to follow the law. The process of ensuring that the citizen is capable of following the law is not anyone’s problem. Following the law comes through the concept of enforcement rather than the citizen’s convenience.’

Taxes are the price we pay for living in a civilized society—they pay for our military and police forces to keep us safe, they pay for our roads, our schools, electricity, water—in effect, every public good that our nation provides its citizens. But when they are not implemented well, they hurt both our economy and our people. We need a taxation system that has a set of transparent, clearly understood rules, making compliance easy and evasion difficult. In our opinion, it is technology-based reform that will deliver on these twin goals.

By any measure, the town of Baddi in Himachal Pradesh ranks as an economic success story; boasting of over 2000 factories, Baddi generates an annual turnover of Rs 600 billion, acting as an economic engine for the entire state.
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And yet, by the rules of the open market, Baddi is a terrible candidate for a manufacturing hub—there is no rail transport to the nearest major city, Chandigarh, and local truck unions have enforced a monopoly that makes road transport an expensive proposition.

Then how did Baddi manage to become a manufacturing powerhouse? The answer lies in the fact that the centre doled out massive tax exemptions to factories set up there, including five years of exemption from income tax and ten years of exemption from central excise taxes. These ‘tax holidays’ have now come to an end, leaving the authorities worried. Newer companies have little incentive to adopt Baddi as a base, and existing companies might choose to scale down operations, resulting in a massive hit to the economy of both the town and the state. When the basic rules of setting up a manufacturing plant, such as easy access to transportation, are bypassed in favour of
tax considerations, it is an indication that tax policies are not in sync with market forces, producing gross distortions as a result.

A combination of political and economic factors have seen India’s manufacturing sector stuck in a long-term holding pattern, its contribution to India’s GDP hovering around the 15 per cent mark for decades; that number is over 20 per cent for countries like China, Indonesia and South Korea which have outstripped us to become global manufacturing hubs. Part of the problem is India’s skewed markets; Nandan described them in
Imagining India
as ‘splintered’ and ‘fragmented’, a legacy of blinkered economic policy decisions that continue to hobble growth and development.

The current state of Indian markets can perhaps be described as ‘quasi-open’; capital and labour move freely across the country, while goods and some services do not. Services like banking and telecommunications already benefit from a common market; they can be set up anywhere in the country and sell their products to people without difficulty. On the other hand, our manufacturing sector is heavily driven by the local tax structure and tax breaks, which take priority over such factors as labour, transport and economics—an unsound and economically inefficient way in which to operate.

The idea of combining India’s splintered and fragmented markets into a single unified common market is not new. Simply put, a common market allows goods and services to be manufactured where it makes economic sense, for them to be sold where the market demands, and for free, unrestricted movement of these goods and services across the entire country. Tax regimes should support this vision, with a simplified taxation system that abolishes the traffic-choked checkpoints at state borders. In a common market with a well-designed tax regime, tax considerations will no longer distort business decisions.

Tax reform is only one step towards building a common market. It must be accompanied by reform in several other sectors as well: farmers should be able to sell their produce freely in any market in the country; land reform and better land titling systems should create a countrywide market for land; and a common national grid should allow for easy transfer of surplus electricity between producers and consumers so
that all parts of the country can have a robust electricity infrastructure capable of supporting manufacturing units. In this chapter, we focus on the issue of tax reforms, specifically the Goods and Services Tax; in the next chapter, we will examine the potential of an electronic toll system to allow for the smooth flow of goods nationwide. These reforms are essential if India is to overcome its abysmal performance in the manufacturing sector so far, and rise up to assume its rightful place in the global market.

A major step in untangling India’s tax laws came with the introduction of the Value Added Tax (VAT) in 2005. But, as Bharat Goenka tells us, ‘Simply announcing a government scheme without corresponding education on the ground will not lead to enthusiastic adoption.’ And so his company spent ‘an obscene amount of money promoting VAT’, conducting workshops and melas all over the country for small businessmen explaining what VAT was and how it worked. Goenka says, ‘We didn’t sell a lot of our software but we ended up meeting almost 300,000 merchants across the country. Our workshops were so popular that even the tax authorities started participating.’ Within a year of VAT being rolled out, he recalls, ‘There was a palpable shift towards adopting VAT. Earlier, there was no linkage between purchases and sales—VAT created that linkage. The shift we sensed in our own customer interactions was not because VAT made it more convenient for people to pay their taxes, but because the linkage made it harder for people to avoid paying tax.’

Prior to VAT, what we had was a cascading tax system—every time goods were sold through the manufacturing chain, a sales tax was levied on the total value. As the accompanying diagram illustrates, taxes added up at each stage, and attempts to avoid this ballooning tax bill created distorted incentives for manufacturers. T. Koshy, a former executive director at the National Securities Depository Limited, who has worked extensively in the field of taxation, gives us an example. ‘The cascading tax system incentivizes vertical integration so that the
same firm tries to carry out as many of the intermediate manufacturing steps as possible in order to pay less tax.’ In our example, that would mean one firm controlling the entire manufacturing and supply chain, all the way from making yarn to selling the finished shirt in a retail store. Koshy adds, ‘In the cascading system, one item can have two different prices depending on whether it was manufactured by one large firm or many small firms. This price difference is solely due to taxation, and this sort of distortion is what the VAT system was designed to eliminate.’

How does VAT manage to eliminate these distortions? Just like the cascading tax system, VAT too is applicable at every stage of the manufacturing process. The critical difference is that it is not applied to the total value of the goods; rather, it is applied only to the value added at each stage of production. Equally important, the system is set up to be self-policing; the taxes from every stage feed into the next, and if one link in the chain fails—one manufacturer does not file taxes correctly, for example—the entire chain collapses. Since it applies only to the value added by each manufacturer and not to the total value, VAT also encourages specialization, rather than the kind of vertical integration that arose in the earlier cascading tax regime. Increasing the levels of transparency and making it harder to game the system result in increased revenue collection and a lesser burden of oversight upon the tax authorities. Koshy adds, ‘VAT is a truer measure of economic growth than creating artificial incentives through tax holidays and exemptions.’

The creation and implementation of the VAT system was a Herculean task; as Nandan wrote in
Imagining India
, it was ‘a convoluted and contested reform that started in 1997 and was negotiated every inch of the way. It involved two central governments, all the state governments with their many, divided loyalties, several enterprising bureaucrats and a couple of holdout states who resisted the reform well into 2007. All in all, it is a tale of a few good men negotiating and manoeuvring the reform for the better part of a decade, through the labyrinth of the government and its bureaucracy.’

The idea of VAT met with strong resistance from state-level
governments who feared the centre would now appropriate their revenue and tax collection powers, leaving them beholden to the centre and unable to function independently. Every state had to be convinced and brought on board before this new taxation system could be implemented. P. Chidambaram, the finance minister at the time, offered to compensate states for any losses incurred once the VAT system was in place. He assured the states that if they achieved anything less than 17.5 per cent in tax growth, the Government of India would make up the difference, creating a safety net for states who were otherwise reluctant to sign up for VAT implementation.