Should some industries get tax breaks that others don’t? In general, no. The finance ministry has come out with proposals, for public discussion, to abolish several existing tax breaks. This is a building block of the Budget promise of finance minister Arun Jaitley to cut the corporate tax rate within four years from the current 30% to 25%. This aims at matching corporate tax rates in most Asian competitors, removing India’s current disadvantage of high taxation.
Jaitley said in his Budget speech that India had so many exemptions and exceptions that the average tax rate paid by companies was not the supposed 30% but 23%, and some paid only the minimum alternative tax rate of less than 20%. Many exemptions were irrational, benefited a few favoured industries with good political connections, violated economic fairness, and deprived the exchequer of huge revenues. So, he said, to maintain revenues while cutting the corporate tax rate, he would also have to abolish many exemptions.
The government has now come out with a proposed list of exemptions to be axed. Naturally, those facing the axe are screaming blue murder, saying they will be wiped out without tax breaks. They don’t explain how so many other industries manage without the same breaks. Their claims to being exceptional are typically inflated or bogus. Too many useless, unmerited tax breaks have been given in the past, and Jaitley should be congratulated on wanting to clean the Augean stables.
Back in 1991, left intellectuals and protectionist businessmen both shrieked that opening up the economy to foreign goods and investment would kill Indian industry. In fact, Indian industries not only held their own but themselves became major multinationals. Tata emerged as the biggest private sector employer in the UK. Indian industry needs the pressure of competition to shape up, not tax breaks and concessions.
The finance ministry proposes to end all tax breaks linked to profits, investment or specific areas. No longer will industries get tax breaks for locating in a favoured region. Some tax breaks like accelerated depreciation, linked to the amount invested, favored capital-intensive industries over labour intensive ones, terrible priorities in a country needing new jobs. Weighted deductions, which gave tax breaks for favoured types of spending (like R&D in pharmaceuticals), are also on the list for axing.
The new proposal represents a welcome wholesale junking of exemptions. Cherry-picking only some of these would have been an invitation to charges of favouritism and cronyism. Wholesale junking also moves the tax code towards simplicity and transparency, two desperately needed goals.
Some states will groan at losing tax breaks. But any state that provides good investment conditions will always attract investment. Those that don’t, should suffer the consequences. We need competition between the states to provide good infrastructure, rapid clearances, and a bribe-free climate. Investment will follow.
Some tax breaks already have a date of expiry, and those will be, quite rightly, honoured. Where no sunset date exists, the tax breaks will expire on March 31, 2017. This sunset date will apply to concessions for infrastructure, special economic zones, and oil production.
Many industrialists will complain that the new proposals go too far. Every government, including neighbouring ones in Asia, gives tax breaks to sectors and activities which it regards as having high priority. Doesn’t India have priorities, too?
This rhetorical question will resonate with politicians. Yes, they will want to give some sectors high priority and offer these tax breaks. To some extent, this is inescapable in a democracy. But it can open up Pandora’s Box of endless demands, cronyism and complexity. Almost every industry and region can find one reason or other to demand a tax break.
If, indeed, exceptions are to be made, the guiding principle must be the same driving India towards a 25% corporate tax. Tax exemptions, like the corporate tax rate itself, should as far as possible mirror exemptions given by our competitors. Rather than listen to domestic lobbies with fat pockets or political clout, we need an expert committee to objectively identify tax breaks in competing countries that affect our exporters, and so need to be matched. Tax breaks for R&D in pharma are possible candidates for such matching. This will be a crony-free, corruption-free way of identifying a limited number of exemptions clearly linked to international competitiveness, without opening up the floodgates to a zillion demands from cronies.
There is also the matter of timing. If most tax breaks are to go by March 2017, the corporate tax rate should also be cut to 25% by that deadline. If the tax cut will come only by 2019, as Jaitley hinted in his Budget speech, the removal of tax breaks may need similar phasing.