To tax or not to tax

INDIRECT TAXES/ OPINION

Is it justifiable to remove all tax exemptions?

Exemptions from taxation have attained a certain amount of disrepute amongst economists and fiscal analysts. Vanity bag, bindi, kumkum, writing ink "� these are a few of the favourite things which enjoyed exemption from excise duty. Innumerable hours of official time have been spent in the revenue department distinguishing between bovine fat and non-bovine fat, paper and paperboard, rubber and resin, ash and dross, prime and waste.

Exemptions create multiplicity of rates of duty leading to immense classification problems, daily hindrance in the clearance of goods, litigations and corruption. Chemicals, paper, machinery and ferrous metals are particularly replete with exemptions in the customs and excise tariff, which have made these items highly litigation prone. Loss of revenue or revenue foregone is another consideration, which should go against continuation of exemptions.

There is no proper estimate available to the public of duty forgone for such exemptions but some research institutions have tried to estimate it. Even if half of their estimate is accepted as correct, the figure is mind-boggling. If this duty foregone could be limited, the rate of tax could be reduced to a much lower level, which in its turn would encourage compliance.

The geographical exemptions are irrational and politically motivated. They have never achieved any industrialisation of any underdeveloped region. Examples of misuse of such exemption in Sikkim and North East are too well known. If a factory is established in Uttaranchal to make medicine, it does not pay excise, sale tax, and income tax. And what benefit is derived by the state? All the experts are drawn from other states; profit is taken by the company, which is elsewhere. The skilled labour is brought from other states. Only few unskilled labour get job for lower category of work.

Generally speaking the economists are not in favour of giving exemption either in a VAT regime or in regard to other indirect taxes such as customs and excise. Exemption compromises the neutrality of Value Added Tax, which is one of its well-accepted virtues. For instance, consider the exemption given to tractors in the budget of 2004-05. While the tractors don't have to pay 16 per cent excise duty, they cannot take the credit of nearly 10-12 per cent of duty paid by them on the inputs. Some of the inputs like steel have now become costlier which has increased the burden of duty on inputs. Moreover, the extra formalities necessary for getting such an exemption also increases the compliance cost of the industry. Exemption breaks the Value Added Tax chain. This goes against the principle of Cenvat and VAT. Once this principle is comprised, the path to the National Goods and Services Tax will be all the more difficult to tread upon.

Does it mean that all exemptions can be removed? Not all export-oriented exemptions can be removed since the mechanism of zero-rating the exports is by exempting the output (which are exported) and also inputs used in exports. Throughout the world exports are zero-rated. India has to do the same to remain competitive. Umpteen schemes have been devised by the Government to encourage exports in such complicated exemption mechanisms, which open the floodgate to grand misuse. The second most important exemption is for the small-scale industry. From the point of employment, potentiality of export and mass base, the small scale must be encouraged. Small-scale exemptions cannot be totally abolished. It should be limited to a turnover of Rs 2 cr and not Rs 4 cr as it is now.

So the conclusion is: (i) If we want to remove Inspector Raj, remove exemption. (ii) Exemption should be economically viable, not populist. (iii) Best tax is neutral tax. Exemption is an anti-thesis of neutrality.

The writer is former member, Central Board of Excise & Customs