Why are customs inspectors so corrupt? Because India’s high tariffs induce bribes. And India’s bewildering variety of tariff rates for different items (and even for the same item depending on its end use) encourages corruption by manipulating import classifications.
The resulting hassles and legal disputes impose costs and delays, hitting our international competitiveness. High tariffs make India a high- cost economy that penalises exporters. The system rewards the corrupt, the manipulative and inefficient. Arvind Virmani has just submitted a Customs Tariff Reform Report exposing the false logic underlying the existing system. He proposes moving over three years to a flat import tariff of 20 per cent, with no exemptions. He adds that there is case for a higher tax on selected consumer goods.
India has cut import tariffs from a peak of 150 per cent in 1991 to 35 per cent for most items, and some industrialists claim that further cuts will kill them. But Virmani shows that India is still highly protectionist. Its average weighted tariff (29.5 per cent) in 1999 was the third highest in the world. Lower rates prevail in neighbouring Sri Lanka (22.5 per cent), Bangladesh (22 per cent), Nepal (18 per cent) and China (15.7 per cent). This encourages smuggling. It also frustrates attempts to promote free trade within SAARC: Customs differentials lead to quarrels and disruptions.
Tariffs in south-east Asia range from 17.3 per cent in Vietnam to zero in Singapore. Why is south-east Asia, with less protection, much more competitive than India? Because a tax on imports is, unwittingly, a tax on exports.
High duties curb imports, and so reduce the trade gap. This causes the rupee to rise, hitting exporters. Thus import taxes end up taxing exports through the exchange rate. A better way to encourage producers is devaluation, which benefits exporters and importers equally. High tariffs tend to benefit the least competitive producers, while penalising exporters, the most competitive.
Industrialists seek a low tariff on raw materials, intermediate rates for intermediate goods, and high rates for complete manufactures. This, supposedly, will discourage semi-finished manufacturing and encourage sophisticated production. Not so. In computers, the final computer assembly is low-tech while intermediate steps like silicon wafers and microprocessors are high-tech. The intermediate step of bulk drug production is far more high-tech that the next step of formulation into tablets or the final step of packaging.
Duty differentials unwittingly reward industries that add the least value. Consider a tariff of 5 per cent on raw materials and 20 per cent on finished products. That may appear to provide 15 per cent protection for industries. Not so. Oil refineries add only 15 per cent to the value of crude oil, and will therefore get effective protection of 100 per cent of value addition. By contrast, an engineering industry that adds 100 per cent to raw material value will get effective protection of only 15 per cent. The least value addition will get the most protection.
Machinery has high value added. But it is also an input for the low-tech industries like textiles. So costly, protected machinery unwittingly makes textiles uncompetitive, a classic case of negative protection.
This is why Dr Virmani proposes a flat tax. It does not discriminate between imports. It does not encourage illusory value addition. It eliminates negative protection. It eliminates customs manipulation and corruption.
Chile has long imposed a flat import duty of 11 per cent and prospered. It is the most efficient and least corrupt country in Latin America.
India’s tariff schedule is replete with exceptions and exemptions. These represent a triumph of lobbying over rationality. Most outrageous are multiple rates of duty for the same item, depending on its end-use. If stainless steel has a high tariff if used in cutlery and a lower one if used in machinery, imports supposedly for machinery will end up as cutlery.
Multiple end-use rates have largely been eliminated from the excise duties. Virmani urges their elimination from the customs list too. Some people urge a higher tax rate for consumer goods, like wheat or cars. They argue that consumer goods are not inputs into the production of something else, and so will not create negative protection or a high-cost economy.
But even consumer goods are often inputs into other goods. Wheat is a consumer good, but is also an input for noodles, bread and restaurants. Cars and air conditioners are consumer goods for individuals, but are also capital goods for companies. The distinction between inputs and final consumption goods is fuzzy. Nevertheless, a case can be made for a higher import tariff for selected consumer goods, where distortions and negative protection are likely to be limited. The case becomes stronger when the government urges need revenue to plug its fiscal deficit.
Virmani has not dealt sufficiently with the heavy subsidisation of certain items, especially agricultural goods, by many countries. So, the international price of these items does not represent efficiency. It represents dumping financed by subsidies, and can kill even efficient Indian producers. Besides, agriculture is a sensitive area. Even a modest fall in prices can push many people below the poverty line, and global prices are notoriously volatile. Some price stabilisation mechanism is required opening up to agricultural imports with flat rate. This could be a floating tariff to minimise price fluctuations. Only when global trade in agriculture is liberalised and de-subsidised will a flat tax make sense for agriculture.
That still leaves a strong case for the coming budget to formalise the Virmani Report recommendations. Yashwant Sinha should cut the maximum import tariff from the current 35 per cent to 30 per cent next year, 25 per cent the year after, and 20 per cent by 2004-05.
Simultaneously he should end exemptions and anomalies and move towards a uniform tax, raising low rates even while lowering high ones. That will draw screams of protest from the inefficient and corrupt. But it will benefit the efficient and honest.
