Are Tax Sops for Businesses Justified?

Tax concessions must be subjected to the same level of scrutiny as other expenditure programmes. Will Arun Jaitley oblige?

 Will finance minister Arun Jaitley announce a slew of tax concessions for certain manufacturing sector industries on February 28 to boost the Make in India programme, as news reports suggest he might?

If he does, it will lead to the resurfacing of that old debate – are tax sops for businesses justified when subsidies for the poor are being pruned; aren’t tax concessions subsidies in another form?

Sundry tax concessions, waivers/holidays and other sops totalled Rs 5.6 lakh crore in 2012-13 (the last year for which firm figures are available). At Rs 2.4 lakh crore, subsidies on food, petroleum and fertiliser totalled were less than half this figure.

But the debate is an artificial one. The discourse about trimming the subsidy bill is not about denying subsidies to the poor. It is about proper targeting of subsidies. It is about reducing the inefficiency-driven cost of delivering them. It is about income support instead of price distortions.

It is also pointless to pit tax concessions and subsidies against each other, a narrative the left[*] initiated but which has got main-streamed.

The criticism about tax concessions mainly relate to those given to the corporate sector and not those on personal income tax. In any case, they account for less than 10 per cent of revenue foregone (the term given to exemptions).

Tax sops serve a purpose, just as subsidies do. They are given in the hope that they will spur economic activity. There are area-specific concessions for companies setting up units in backward areas or north-eastern and hill states. There are sector-specific concessions to give a fillip to investment in particular industries. Such sops usually take the form of exemptions from corporate income tax, whose share in revenue foregone has ranged between 11 per cent and 18 per cent since 2004-05 (the year from which revenue foregone started to be tracked).

Similar considerations drive excise and customs duty exemptions (whose share of revenue foregone averages 80 per cent); in addition, they can bring down the prices of goods and spur demand. This was the rationale behind excise duty concessions to the capital goods, consumer durables and automobile sectors in the wake of the 2008-09 recession and that is why the concession was extended twice before being withdrawn from 31 December 2014. That is also why items of mass consumption priced below a certain threshold also get excise duty exemptions.

That, however, does not mean that these sops are great budgetary policy or that they should escape scrutiny.

It is not just the left-leaning academics and politicians who liken tax concessions to subsidies; public finance experts also do. D. K. Srivastava, chief policy advisor at Ernst & Young and former member of the Twelfth Finance Commission, insists that tax sops are really implicit subsidies given to potential tax payers. In fact, the idea of treating tax concessions as an expenditure (that’s why they are also called tax expenditures) was first mooted by an assistant secretary of the United States Treasury Stanley Surrey who, in 1967, started compiling what he termed “government spending for favored activities or groups, effected through the tax system rather than through direct grants, loans, or other forms of government assistance”.

Explicit subsidies, Srivastava notes, have a budgeted limit; but when a subsidy is built into a tax, the amount is never discussed simply because it is not known. If this amount can be quantified, he believes, then there will be some attempt to look at what value it is yielding. But that is not the case.

Indeed, it has been ten years now that tax expenditure figures have been published in the budget, but there has been no serious effort to study whether they have served the purpose for which they were given. Have the north-eastern states seen a lot of industries being set up? Deduction of profits of cooperative societies and deduction of profits of industrial undertakings derived from housing projects account for the largest amounts of revenue foregone under corporate income tax. Does anyone know how these have helped?

The Tax Research Unit of the finance ministry has got the National Institute of Public Finance and Policy (NIPFP) to do some studies but there has been little apart from this. The tax concessions given to the special economic zones (SEZ) have come under close scrutiny but only because the SEZ policy itself has faced a lot of criticism.

But for such assessments to be done, it is necessary to define very clearly what a tax concession was supposed to deliver at the outset, says NIPFP professor R. Kavita Rao, one of the authors of a 2005 paper on the subject that prompted the publishing of the revenue foregone statement. Unfortunately, this is not done. And when questions about the utility of a tax concession are asked, they spark off conflict between the administrative ministry and the finance ministry’s department of revenue. In the case of the SEZs, the commerce ministry has been pretty aggressive in countering any suggestion by the department of revenue that the SEZs are not giving enough bang for each revenue foregone buck.

Indeed, there is a worry that tax concessions can be misused. A World Bank publication, Tax Expenditures – Shedding Light on Government Spending through the Tax System points out that tax expenditures could lead to what it called fiscal opportunism unless they are exposed to adequate scrutiny. Rao feels the sops for SEZs has only given every exporter an excuse to migrate to them.

There is a growing feeling that the negative effects of tax sops outweigh their positive points. The World Bank publication points out “that tax expenditures tend to slowly erode the tax base, reduce the effective tax rate, and ultimately weaken government fiscal balance”.

Tax concessions should be the last option for boosting economic activity and should be kept to the minimum, says Srivastava, a view that the World Bank, International Monetary Fund and the Organisation for Economic Cooperation and Development all hold. In the case of area-specific sops, it might be far better for the government to provide direct expenditure support to make the area industry-friendly. This will be a far more transparent and monitorable support. Sector-specific concessions can be substituted by identifying policy and other issues constraining a sector and addressing those. Both Srivastava and Rao say these are more long-term and sustainable ways of helping a sector.

But tax concessions are preferred, says Rao, because it is money in the pocket, while there’s a lot of running around required to avail other kinds of support. Srivastava suggests reducing the overall tax burden on all sectors; not only would this be more beneficial to the economy, it will also end lobbying by specific industries.

Fortunately, there seems to be some realisation of the need to temper tax sops. Though the amounts involved have more than trebled between 2004-05 and 2012-13, the concessions are declining in terms of percentage of total taxes as well as GDP since 2009-10 (see table). Some of the area-specific concessions have been withdrawn. (The amounts that still figure in the revenue foregone statement relate to concessions given earlier.)

It will be ten years from the time that the revenue foregone statement started to be tracked and published in the budget document. Now is as good a time as any other to subject tax concessions to the same level of scrutiny as other expenditure programmes.

Foregoing Revenue