Rationalise Customs duty

Besides removing exemptions, overall simplification is necessary

In the 2021 Union Budget earlier this year, Union Finance Minister Nirmala Sitharaman announced that hundreds of exemptions in Customs duty were to be reviewed over the course of the year. Ms Sitharaman added that a new structure for Customs duty would be put in place by October. This was in addition to some tweaking of Customs duty done during the Budget, which she justified as helping certain sectors being targeted by the government, such as mobile phone manufacturing and auto parts. It has now been reported that the Union finance ministry has begun the process of reviewing 523 different Customs duty exemptions that had been notified in five batches — the first one being dated as long ago as February 1999.

There is nothing wrong with reviewing and updating exemptions to tax rules. It is unclear, however, if this exercise is being conducted with clear and coherent aims in mind. It appears that there are different objectives at work — closing loopholes, import substitution, and revenue generation. The problem is that multiple objectives can make for bad policy. They can conflict with each other at times, or cause policymakers to choose suboptimal solutions. In any case, the fear is that the government has of late prioritised revenue generation and import substitution over other, more growth-oriented, objectives. The focus on exemptions appears to be guided by the government’s priority in achieving such policy goals. The effort, instead, should be broader: Towards a rationalisation of the entire Customs duty structure.

India’s Customs requirements are today excessively labyrinthine, with multiple tariff slabs. There are almost 20 different rates, ranging from nil to 150 per cent. As a consequence, considerable effort is diverted by Indian companies with exposure to the outside world — whether directly or through competitors — into the lobbying process. Finance ministers in the recent past have not been able to resist playing with the Customs rates — the 2021 Budget was no exception to this rule. Such tweaking is a relic of socialist-era India, when it had the powers to make or destroy companies. With every further disruption of the Customs code, India takes a step that brings it closer to those dark times.

What is needed in a tax code, including for Customs duties, are transparency, simplicity, and stability. The Indian Customs structure does not satisfy these requirements in the least. In fact, the removal of exemptions purely because they are exemptions, but without a clear prior explanation, only creates instability and turns off investors. Low and stable tariff rates allow companies to correctly evaluate their value added and profits, and this predictability is itself crucial to whether India can become part of the global supply chains that now dominate world trade. An eventual increase in tariffs for products embedded in such a global supply chain hurts Indian exports. The greatest priority as world trade recovers from the pandemic must be to ensure that India emerges from this troubled period with increased competitiveness. Unplanned increases in tariffs at this stage will almost certainly hinder that effort. The government can proceed with its efforts to remove exemptions. But it must be located within a larger effort to clean up and modernise the Customs structure overall.