More Export, less Taxes

Much of the economic reforms so far have been half-baked, but in one area our economic structure has truly been transformed. Exports, which used to be only 5 per cent of gross national product (GNP) in the 1980s, have now risen to 10 percent of GNP.That is a major achievement. In the absence of any rupee depreciation, most of us thought inflation would erode export growth. Instead, exports have shot up by 27 per cent in the April-June quarter, on top of increases of 20 per cent arid 18 per cent in the last two years. Clearly liberalisation has tapped deep, unsuspected sources of productivity, which have more than offset the effect of inflation.

Welcome though this structural transformation is, I suspect it is having an unexpected, unwelcome side-effect. Export activity escapes taxation. No income-tax is paid by exporters. No excise duty is levied on export production. And no customs duly is levied on inputs for export production. And since exports as a proportion of GNP have doubled, a rising chunk of economic activity no longer pays any lax at all. This is surely one reason why the share of Central taxes in GNP has fallen steadily from 8.1 percent, before the reforms, to 7.1 in the latent budget.

Ever since coming to power, Mr. Manmohan Singh has talked bravely of fiscal reforms. But the fact remains that the revenue deficit-difference between tax revenue and current spending-has doubled from Rs 17,585 crore in 1990-91 to an estimated Rs 35,823 crore in 1995-96. One reason is that Mr Singh has funked cutting expenditure, notably on subsidies and staff. The other reason is that taxes as a percentage of GNP have fallen.

Till now, critics have claimed that the tax/GNP ratio has fallen because Mr Singh has cut tax rates, especially for the rich. However, a closer look shows that despite tax in GNP has risen form 1 percent to 1.3 percent, and of corporate tax from 1 percent to 1.5 percent. In these cases, improved tax administration and compliance have more that offset the effect of lower rates, and of export exemptions.

The real problem is that the share of import duty in GNP has fallen form 3.9 percent to 2.8 percent, and of excise duty from 4.6 percent to 4.1 percent. Initially, it was thought that this was due to slow industrial growth in the first three years of reforms, with a consequent slow growth of imports. But industrial growth shot up by 8.4 percent and imports by 21.7 percent in 1994-95,yet the share of excise duty in GNP rose from just 4 percent to 4.1 percent and the budget estimates for 1995-96 suggests no further improvement either. The boom in production and imports has not led to a matching boom in revenue.

This has puzzled many observers. Some think this is. a consequence of excessive duty cuts. However, it seems to me that the real reason lies elsewhere, in the growing export-orientation of the economy. Since export activity escapes taxation of any kind, export buoyancy will lead in the short run to a deceleration of revenue. The very factor that reduces the foreign debt problem worsens the internal debt problem.

In the longer run, I believe this will be a very favorable development. Growing exports represent activity which would simply not have taken place in the pre-reform era. Maybe such activity escapes taxation directly, but ft will spur other domestic activity which swells tax revenue. Owners of export industries may not pay additional income-tax, but if they spend their extra income on liquor, hotels or anything else, that will translate into revenue. The additional labour force in export industries, will pay taxes on both income and consumption. So will suppliers of local goods to export industries. Except for diamonds, there are strong linkages between export industries and the rest of the economy.

These should assert themselves with a lag. In that case, the shrinkage of revenue caused by export-orientation will be temporary. But we cannot be certain. Optimists (like commerce minister P Chidambar-am) believe exports should continue to grow by 20 per cent in dollar terms for a long time to come. In that case, the share of exports in GNP may rise to 15 per cent, greatly increasing the slice of the economy that yields no tax revenue.

On the other hand, optimists will argue, most of the task of cutting tax rates has already been accomplished, and cuts in future years will be far more modest. Some tax rates, like income-tax or import duty on capital goods, may not be cut at all. So revenue should become more responsive to economic growth.

Maybe so, maybe not. But in the long run, it seems to me, we will have to start taxing export income at some stage. In the past, we have discriminated against exports in so many ways, like overvalued exemption has proved an invaluable important compensatory device. But we need to move to a regime where this discrimination against exports disappears totally. After we do this, we can once again tax exporters with a clear conscience, and without depressing export growth.

What do you think?