Concept of inverted duty structure in Customs is a myth

The discussion on inverted duty structure has once again assumed importance because in the Budget 2018-19 there is a mention in the Annexure-VI to Part B of the Budget Speech that certain duties on some medical devices have been reduced from 2.5% to nil which is because of the need to correct inversion in the rate of duty. So the issue that we are now discussing here is whether there is any validity in the concept of inverted duty structure, or it is a myth.

The concept means that the rate of duty on raw materials and intermediates (input) must be necessarily lower than the duty on output. This assumption that there is a clear cut distinction between input and output is itself wrong. It can be true only for a particular commodity under some conditions but not in general. In the macro economic sense there is no such distinction between input and output. For what is an output in one industry is an input in another industry. Steel sheets are output in the steel industry but inputs in the machinery industry which manufacture pipes and machinery. All the chemicals are finished products in chemical industry and raw material in other industries. Arvind Virmani submitted a report in the year 2001 with this conclusion.

However, input and output are clearly distinguishable in the case of a particular industry. It is the owners of these particular industries such as those who own tyre industry or toy industry or machinery industry who argue for protection of duty on their input in relation to their output. But if it is granted individual industry wise then there will be a cross purpose. For example, if the duty on textile is reduced because it is an input for toy industry, then the duty on the input in the textile industry will have to be further reduced and so on. What one does not take into account is that machinery is also an input. If the duty on textile (as a input) is reduced then even the duty on machinery will have to be reduced further because machinery is also the input for making textile. There will be a chain reaction. It will lead to an impractical situation and finally the revenue collection will fall so heavily that the Budget maker will have to give up such an idea of reducing duty on input compared to output.

Finally, what is important is not just the nominal rate of protection but the Effective Rate of Protection (ERP). An economist or industrialist can point out that if the duty on the output is lower than the duty on inputs, then the effective protection is lower than the nominal duty rate. But the reply to this point is that the effective rate of protection is determined not merely by the nominal rate of duty but by the value addition. With a substantial value addition, the effective rate of protection will most likely be positive.

And it is not exactly the rate of duty but the actual amount of duty necessary to produce an item which is important. For example, at one point of time, the rate of central excise duty on ball point pen (output) was 10%. The central excise duty on ink was 15%. When the manufacturer claimed that ink rate should be brought down to below 10%, it was calculated that the actual duty amount on the ink to make one ball point pen comes only to 50 paise. If a 10% reduction is given, then the difference would come to only 5 paise which is immaterial because the ball point pen sells for at least Rs10/-.

So the conclusion is that the logic of inverted duty structure is not correct. What is more relevant is the Effective Rate of Protection. Rate of customs duty is a potent instrument of economic dirigisme. So tying it down to a dogma that the rate of duty on input should be lower than that of output will be a biggest mistake when the difference between input and output itself is non-existent and when effective rate of protection and many other considerations are much more relevant.

The writer is member, Central Board of Excise & Customs (retired)

Email: smukher2000@yahoo.com