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Should tax exemptions be scrapped?
March 08, 2006
With the new SEZ policy in place, tax sops can only rise - the issue is whether these result in higher investment and jobs, or more corruption.
O P Garg, President, Federation of Indian Export Organisations
The issue of revenue foregone has to be viewed in the context of policy objectives such as increasing saving or investment
The figure of revenue foregone, amounting to Rs 158,661 crore (Rs 159\86.61 billion) in 2004-05, assumes considerable importance in view of the fact that this is 1.25 times the fiscal deficit estimate for that year, and about twice the revenue deficit estimate.
Let's first analyse the issue of revenue forgone on exports. Every country follows the policy of exporting goods and not taxes. Therefore, export goods are relieved of the incidence of taxes and duties through remission or exemption of duty on the inputs used in the product exported.
Though this should have declined with import duties coming down, exports have been growing by about 20 per cent a year in the past three years. With the introduction of special economic zones, this will rise more. But this has to be seen as an engine of growth and an instrument to provide partial relief to infrastructure disabilities.
Increased exports and development of SEZs as an effective remedy for infrastructure bottlenecks are creating more employment opportunities. The ministry of commerce has also carried out a study that links export growth to employment opportunities.
Similarly, much of the revenue forgone under excise is in respect of concessions given to the small scale industry and this has balanced the inherent disadvantages faced by the small manufacturer, while competing with large scale industry or imports.
The revenue forgone has also been given to meet some of the stated policy objective such as encouraging investments as well as savings. If the saving rate in the country has gone up to 29 per cent and investment to 30 per cent, we can fairly presume that these initiatives have served the intended purpose.
The concession given on account of development of infrastructure, which has recently been extended up to 2009-2010, should not raise any eyebrows considering the pathetic state of infrastructure that requires massive investment. We are investing 2 per cent of our GDP on infrastructure, while China is investing 19 per cent of the same on infrastructure. Considering China's GDP to be about five times that of India's, China is investing an amount equal to our GDP on infrastructure itself!
However, there cannot be two opinions that we need to target the exemptions so that they serve the intended purpose. There have been cases where the exemptions have not reached the target beneficiaries or the stated objective of the policy.
I am happy that the statement of revenue forgone has dispelled the impressions that exporters are a pampered lot who enjoy various concessions from the government. The only benefit enjoyed by the exporters are reimbursement of the taxes and duties paid by them that is often not neutralised to the full extent.
S Mukhopadhyay, Former Member, Central Board of Direct Taxes
Exemptions create multiplicity of rates which results in huge classification issues, and this delays clearances and also leads to corruption
Vanity bag, bindi, kumkum, writing ink - these are a few of the favourite things that enjoyed exemption from excise duty. Populism, thy name is exemption!
I have spent a lifetime in the revenue department distinguishing between bovine fat and non-bovine fat, paper and paper board, rubber and resin, ash and dross, prime and waste. I have fought the hardest of court cases on these non-issues just because the rates of duty were different, often due to exemptions.
Exemptions create multiplicity of rates of duty leading to immense classification problems, hindrance in the clearance of goods, litigations and corruption. Chemicals, paper, machinery and ferrous metals are particularly replete with exemptions in the customs and excise tariff, which have made these items litigation prone.
Though there is no proper estimate available as to the amount of duty forgone for such exemptions, some research institutions have tried to estimate it. Even if half of their estimate is accepted as correct, the figure is mind-boggling. If this duty forgone could be limited, the rate of tax could be reduced to a much lower level, which in turn, would encourage compliance.
Geographical exemptions have never achieved any industrialisation of any underdeveloped region. Examples of misuse of such exemption in Sikkim and the north-east are well known. If a factory is established in Uttaranchal to make medicine, it does not pay excise, sale tax, and income tax. And what benefit is derived by the state? All the experts are drawn from other states; profit is taken by the company, which is located elsewhere. Skilled labour is brought from other states. Unskilled labour gets to do low-category work.
Does it mean that all exemptions can be removed? Not really. Export-oriented exemptions cannot be removed because the mechanism of zero-rating the exports is by exempting the output (that are exported) and also inputs used in exports. Throughout the world, exports are zero-rated and India has to do the same to remain competitive. But our export-oriented exemptions have gone far beyond simple zero-rating.
Umpteen schemes have been deviced to encourage exports in such complicated exemption mechanisms, which open the floodgates to misuse. The second most important exemption is for the small-scale industry. From the point of employment, potentiality of export and mass base, small scale industry must be encouraged. An extreme view that the small-scale exemption should be abolished is not the answer. But it should be limited to a turnover of Rs 2 crore (Rs 20 million) and not Rs 4 crore (Rs 40 million), as it is now.
To conclude, (i) If you want to remove Inspector Raj, remove exemption. (ii) Exemption should be economically viable, not populist. (iii) Best tax is neutral. Exemption is an anti-thesis of neutrality.
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