Will Sin Tax be the way going forward?

By Larissa Fernand |  07-05-20 | 

In case you frown upon those who drink alcohol or view it as a social menace, here is a pragmatic take on that ethical stance. Your state government is extremely dependent on it for revenue.

This news report looks at data published by the Reserve Bank of India, and puts the excise duty on the sale of alcohol at Rs 1.75 lakh crore, on a national level. A study by Indian Ratings & Research (Ind-Ra), a Fitch group firm, revealed that the share of alcohol is more than 20% for five states, 15-20% for seven states, and 10-15% for three states. (Alcohol is prohibited in Gujarat, Bihar, Nagaland, Mizoram, Manipur, and the union territory of Lakshadweep.)

When the Goods and Service Tax, or GST, was enforced, state governments lobbied hard to keep liquor, petrol and diesel out of its ambit. The reason being that it would be easier for them to boost revenue collections should the need arise.

This came in handy in 2018, when the Kerala government raised excise duty on liquor to finance humanitarian work after severe floods ravaged the state.

That situation has risen again. As states see a sharp erosion in tax collections, thanks to the lockdown due to the pandemic, they are all clamouring to open up alcohol shops. Not only that, some are slapping on a corona cess too, or jacking up the price of alcohol substantially.

As consumers cry foul, ethical purists talk about “sin stocks” and “sin tax”.

What on earth is that?

A sin stock screener would automatically eliminate certain companies – tobacco, alcohol, casinos, adult entertainment, and weapons manufacturing are the common ones.

It is hugely subjective. Some individuals may consider beef eating a taboo, others may put pork in that category, while some vegetarians may consider all meat consumption as cruel. The same can be said for alcohol. In fact, some believe aerated drinks must also fall in this category, though many would throw bricks at them for saying so.

Taking the argument one step further, the sin tax is justified simply because the commodity is a sin stock.

By definition, these are goods or services whose consumption is considered unhealthy, degrading, or socially undesirable due to the perceived negative effects. And, if left to market forces and behaviour, would usually be over-consumed. The sin tax helps keep the public in check and adds to the government’s kitty.

According to the report presented by the committee in the 38th GST Council meeting, the government received several suggestions to increase GST revenues. The notable ones include having a two-rate structure with 10% and 20% slabs, and special higher tax on sin and luxury goods and services.

According to Bloomberg, GST compensation cess, a central government tax on select sin goods may see a rate increase. The revenue collected from this cess— (Rs 95,081 crore in FY19) —is paid by the centre to the states to compensate for revenue lost due to the implementation of GST. It would do so for five years starting 2017-18, when GST was rolled out. (Since alcohol comes under the state, the GST compensation cess is on items such as pan masala, cigarettes, coal, aerated water and motor vehicles).

I am a believer in ESG investing, which is a holistic approach to ethical investing. But simply relying on exclusion principles to arrive at a sin stock, is something I do not personally subscribe to.

Having said that, I reached out to D Muthukrishnan after his recent tweets on sin stocks grabbed my attention. Being an investor in the ITC stock, yet never having smoked a cigarette in his life, I was curious about there being any dichotomy in his mind regarding this.

True to his style, he was extremely matter-of-fact and nonchalant about it: “If I take a moral stance, I will not be able to invest in any FMCG company. Being a pure vegetarian, I would not be able to own leather shoes or a leather bag, let alone invest in a company that manufactures it.”

So then what is his true north? “As long as the company is in a legitimate business and has been a consistent wealth creator, I would consider it,” he says.

Excellent point.

In case you thought virtue was a free lunch, Cliff Asness of AQR tells us not to get fooled that easily. If the virtuous are not going to own these stocks, you better reward the sinner for doing so. And so don’t be surprised at a higher than expected return with dividends.

That is a very entertaining jibe, but I like what Lawrence Hamtil of Fortune Financial Advisors has to say on the subject.

He cautions investors that all sin stocks are not created equal and expected performance may not necessarily be evenly distributed across the spectrum of those industries.

"A lot of these stocks - like tobacco and defense - tend to exhibit a high degree of profitability, consistency in their earnings streams, and wide moat practices, so they're relatively insulated from new competition. The sin stock anomaly notwithstanding, these stocks exhibit quality and low volatility. Casino stocks, on the other hand, are high volatility and very cyclical. And historically, have been one of the "sin" sectors that have underperformed over time, relative to their peers in that universe.”

Let me end with a quote that a fund manager in the U.S. said years ago: "If you wrapped these stocks in white paper and couldn't tell what they were, people would love them".

Just because the morality may repulse you, don’t assume the return will.

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