Wednesday, December 31, 2014

Do airlines "fleece" passengers?

For over two decades, the Ministry of Civil Aviation has presided over the demise of many an airlines in the country. As one more airline prepares to breath its last, a series of measures are being “considered” in an effort to “do something”. Among the proposals being considered is a ridiculous proposal to cap airfares“…to prevent airlines from both over-charging passengers in spot fares while at the same time ensuring that airlines do not offer very cheap fares below the cost of operation….the ministry sources had recently indicated that there could be a cap of about Rs. 15,000 on maximum fare on any sector. The ministry sources are exploring the possibility of linking fares to the distance per km. Civil aviation minister Ashok Gajapathi Raju is currently examining the proposal which could be cleared by the ministry very soon…”. 

In fact, every time airfares go up, the myth of airlines ‘fleecing’ air passengers rears its head. What is shocking is that even the DGCA subscribes to this view. Its high time this myth about fleecing air passengers is busted.

Can the Ministry of Civil Aviation explain why - since 1991 – aviation has done so badly while every other industry in the country has prospered ?

Aviation is a difficult business
An aircraft is a complex machine. An average commercial aircraft takes 6 months to build and costs a million dollars. A popular airplane such as a Boeing 737 is made up of 6,00,000 parts while the bigger ones like Boeing 777 may have them in millions. Malfunctioning of a single part can prove fatal, as the plane flies in inhospitable conditions 30,000 feet above the earth’s surface.  Modern day planes carry ‘autopilot’ modes that use computer software to control & guide the aircraft, eliminating human errors. Aviation consumes billions of dollars in R & D expenditure, and has over the years made our flying experience safer, faster and better.

Notwithstanding some recent incidents, air travel is remarkably safe and punctual. Most flights take off and land on time, and accident rates are near zero. Boeing reports that in more than half a century of commercial flights (1959-2013), there have been less than two thousand accidents across the globe, of which only one third had fatalities. Compare this with accident statistics on road, where more than 1.1 million people have died in road accidents in India in just the last ten years (2003-2012) alone.

For all this, and the sheer speed of travel, the passengers have to pay.

The economics of aviation business
Running an airline is highly capital intensive. Aircrafts are expensive, specialized technical staff such as engineers and pilots don’t come cheap either. An inventory of spare parts needs to be kept at all times. Maintenance facilities are few and expensive. India’s aircrafts reportedly fly to places like Singapore and Abu Dhabi for maintenance. More than 50% of the operating costs of an airline are fuel costs alone. All these costs are recovered mainly from sale of tickets and booking of cargo. But in India the business is taxed heavily under the faulty notions of “taxing the rich”. A large chunk of the ticket price you pay never reaches the company and is pre-empted by the government.

Once a flight has been “scheduled”, all the costs are almost fixed. Whether the flight takes off with ten passengers or a hundred, it costs the same to the airline. In other words, the incremental cost of flying an ‘additional’ passenger is almost zero. This lends the airline industry neatly to a dynamic pricing model, where empty seats in a flight can be sold off cheap – every additional rupee directly adds to the recovery of the fixed costs. If and only after all the fixed costs are recovered can the airline turn in a profit. For any business to be sustainable, it needs to make a profit.

The myth of 'fleecing' air travelers
In the short run, supply of seats is largely fixed, as flight routes and schedules are announced in advance. It is therefore the demand for seats which drives airfares. When the demand is high, the airfares rise. Higher airfares help airlines earn revenues which compensate for low fares when the demand is low. The notion that airlines “fleece” travelers with high fares is therefore flawed and misleading. The 'fleecing' allegation is impossible to accept when most airlines are making losses. A 'fleecing' business would typically be a monopoly and make super-normal profits. If an airline demands fares which are exorbitant, travelers have an option of using some other airline, other modes of transport, or even not travelling at all. It is the traveler who decides whether she values the travel as much as the price of the ticket, and takes a decision. Also, high fares apply to a small number of seats that are sold closer to the date of flight, passengers who plan their travels well in advance can usually buy 'reasonably' priced tickets even in peak season. However, the media sensationalizes a few isolated instances of high spot fares and misleads the public. 

If there is any fleecing that occurs, it is due to the high taxes that are imposed on every aspect of the business. A huge chunk of the ticket price that the buyer pays doesn’t go to the airline. If high airfares in peak season are banned, it will impact the ability of the airlines to offer low airfares in slack season, and no one will be any wiser. 

On the death bed - again
The aviation sector in India was first opened up in the early 1990s, but most airlines which came up at that time have failed to survive. A second lot that came up in the early 2000s with the entry of low-cost pioneer Air Deccan has done no better.  The main contributor to poor mortality of India’s aviation sector is the regulator itself. The sector has been “…choking on high taxes, poor regulation and bad airports…”, to quote Capt. Gopinath. The DGCA seems to have taken upon itself the mandate to regulate airfares. The Narendra Modi government has come to power on a platform of 'good governance'. The PM has often espoused the cause of 'minimum government, maximum governance' and claims to have a business friendly image. That such a government can even think of regulating airfares sends a shiver down my spine. 

(See also "Our airfares are too low" on what are "high" and "low airfares)

Sunday, December 21, 2014

The misleading debate on bringing back Black Money

Imagine this.

Journalists & cameramen have assembled in large numbers at the Delhi’s Indira Gandhi International Airport, eagerly awaiting the arrival of an incoming Air India flight. The flight arrives, and a triumphant Arun Jaitley, India’s Finance Minister steps out of the aircraft, flanked by top Finance Ministry officials. He is carrying two large suitcases in his hands. For a moment, he puts the suitcases down and waves to the waiting media. Everyone knows what’s in those bags. The reporters just cannot wait to ask him some questions. The moment has arrived. Yoga guru Baba Ramdev is among the first to issue a congratulatory tweet to the NDA government. Prime Minister Narendra Modi proudly proclaims that his government has completed an electoral promise made to the nation. The black money stashed abroad by unscrupulous Indians in Swiss banks has finally been brought back!

If this is your visualization of the moment when India is going to get back its promised “black money” from Swiss banks, this write-up is going to disappoint you. But the media coverage of the black money issue has been so wanting in depth, and so mired in meaningless sensationalism, that the aam aadmi may be forgiven for thinking something similar is going to happen one day. The manna from Switzerland is bound to arrive. After all, wasn’t it part of the “Achche Din” package?

In this article, I put in perspective a few thoughts on this much debated topic which seem sorely missing from the mainstream discourse.

The color of “Black Money”

I have found most discussion on the black money issue, such as this or this or this or this center around tax evasion. Businessmen make profits on which they do not pay tax, the money is secretly moved to some bank in Switzerland. This money needs to be brought back as the country is losing out on tax revenue. This is the standard narrative of black money that is dished out to the aam aadmi

However, this is far from the truth. Tax evasion is only a part of the problem.

Proceeds of crime

A large part of the money stashed abroad illegally is, what is termed in banking parlance as “proceeds of crime”. It owes its origin to criminal activities like corruption, misappropriation of government funds, fraud, cheating, or activities of underworld gangs, drug mafias and terrorists. The entire wealth accumulated though criminal activities is illegal and liable for confiscation. The account owners are liable for criminal prosecution. Here, the question of tax assessment, payment of penalties or even amnesty (as suggested by some), does not crop up at all. Simply speaking, if I steal Rs.100 from you and hide it under the carpet, the problem is not that I have not paid Rs.30 of tax, the problem is that I have stolen Rs.100. No government in its right senses can regularize this wealth on payment of tax.

Most discourse on black money conveniently skips this angle.

Under-invoicing of exports and over-invoicing of imports is a standard mode of laundering money abroad

Where is the money?

A common misconception that people seem to have is that the money is lying in some (Swiss, mostly) bank account. But is it there really? Do you really believe that someone stashing millions of dollars of stolen money would keep it in a bank account for years together for everyone to see? 

Obviously, the money has already been used up – to buy villas and yachts and Ferraris, to invest in Hedge Funds or Private Equity, to buy Soccer Clubs or Formula One teams, to purchase hotels, farmland or commercial property, to invest in shares or pay back loans! Even the returns generated from these would have been further used in payment of dividend, for business or further investments. It is nearly impossible to “bring back” the money the way most people seem to think about it.

Most of the government’s efforts on this issue has centered on enabling sharing of information with foreign governments or banks involved. Even if that is accomplished, all that a bank can share is a statement of account, many of them in benaami names or shell companies. The statement would contain inflows & outflows, but actually getting the money back is a different ball game altogether. In this era of electronic transfer, when money can be moved from one corner of the world to another in a matter of seconds, we can never get anything in a foreign bank to confiscate. No government, following its “due procedure” can ever move faster than the account holder himself and ‘catch’ the money in a foreign bank before it moves out.

Black money once “created”, is simply impossible to “bring back”, at least in the manner in which it is being made out to be. Its better the people face this reality and temper their expectations, no matter how noble the intentions of the authorities may be.

How big is the problem

There is no doubt that the extent of the problem is humungous and needs to be tackled on a war footing. For example, illicit capital flowing out of India over a 10-year period from 2003 to 2012 has been estimated to be higher than the country's total income tax collection during the period itself. While everyone agrees that the menace needs to be curbed, solutions are difficult to come by. Combating the problem requires negotiating a complex maze of financial regulations and international diplomacy. Though Switzerland has received the most media attention, it is not the only “tax haven” where such funds are being siphoned off, there are several others. (For example, Tax Justice Network lists out 73 such jurisdictions).

In 2007, evidence of deposits of more than US $ 8 billion surfaced in the UBS Zurich accounts of Hassan Ali Khan alone. The inaction of the Manmohan “Sin” Government in cases such as these led to the landmark Supreme Court order in July 2011 forming a Special Investigation Team (SIT) to investigate and bring back black money. The SIT was formed immediately after Narendra Modi government took charge in May 2014.

The landmark Supreme Court order forming the SIT came in a case filed by Ram Jethmalani & Others

The SIT on black money

The Terms of Reference of the SIT (available here) are wide and far-reaching. The SIT is charged with the responsibility and duty to investigate and prosecute all instances of stashing of unaccounted money in foreign bank accounts, investigate and prosecute activities which are the source of such money and to prepare an action plan for the future. The SIT is headed by former Supreme Court judges and has heads of virtually all national investigating agencies such as IB, RAW, CBI, ED, DRI, NCB, FIU etc as its members. It reports directly to the Supreme Court. All organs of the Central and all State governments, such as agencies, departments, constitutional bodies etc have been ordered to co-operate with the SIT. The SIT is also empowered to re-open past cases where investigations have been completed and charge-sheets filed.

Effectively, the issue of black money stashed abroad is now outside executive control and owned by the SIT. It is the SIT that has to deliver concrete results, not just in terms of giving recommendations for the future (which is the easy part) to pre-empt generation & stashing away of money, but actually getting back what has been lost and prosecuting those involved. The SIT report is awaited. But it is pertinent to note that even the ToR of the SIT or the Supreme Court order which led to its formation (available here) does not specifically charge it with "bringing back" the siphoned off money.

What can be done

Clearly, the fight against black money needs dramatic solutions and out-of-the-box thinking. Suggestions such as banking transaction taxes, annulment of high value notes, stringent regulations and even amnesty schemes have been suggested from time to time. While each of them have their own merits and demerits, the one I have found the most actionable has come from “super spy” Ajit Doval, presently the India's National Security Advisor. In a blog post in 2011, Doval writes:

"...India must pass a penal law declaring itself as the sole owner and beneficiary of all Indian monies, assets and bank accounts held abroad by or the dependents of Indian nationals without due declarations to the Indian authorities. On the strength of such a law, the Government of India can ask world governments and foreign banks to recognize Indian government as the beneficiary of undeclared wealth and freeze the accounts till owners of the wealth are able to prove that they had acquired it by fair means and from legally valid sources....

...Government of India should register an omnibus criminal case against suspected unidentified persons who have been indulging in criminal activities and unauthorizedly transferring money to tax havens abroad.  This would enable the Government to get assistance of foreign police and investigating agencies for gathering evidence and information. It will empower the government to approach different banks abroad, as also the concerned governments, for information regarding the money trail as they pertain to criminal cases..."

In other words, we should "nationalize" all such assets lying outside India and put the onus on their owners to prove that the assets are legitimate. 

When it comes to recovering what has already been plundered, only such drastic solutions can give some decent results. Even then, we can only hope to recover only a part of the stolen wealth, nothing more can be expected.

The economic solution

Enforcement and policing is never a sound and harmonious solution. For that, the problem has to be pre-empted.

Tax rates have to be kept as low as possible, so that tax avoidance ceases to be profitable. This means the government keeps its expenses as low. The government should withdraw from economic activities, restricting itself to the bare minimum such as maintenance of law & order and running the judicial system. This reduces the scope for bribery and crony capitalism. In India, much illicit wealth has been generated from bribes paid to twist policies or government decisions. Scope for discretionary decision making aids corruption.

Global economies are slowing, and profitable investment opportunities are shrinking abroad. India is among the fastest growing economies in the world today. If business climate in India is improved, incentive to retain money abroad reduces. This again calls for dismantling bureaucratic controls, improving the rule of law and installing a quick and efficient grievance redressal system.

Despite all this, a few black sheep will still exist. For them heavy penalty should await. Investigations should be fast, and justice delivery certain. Police and judicial reforms therefore should be on top of the government's agenda.

If all this is done, the problem of “black money stashed abroad” can be mitigated. But for now, the suitcases Mr. Jaitley would be carrying are likely to be largely empty.