Energising excise

One of the striking features of this year's Budget is the relatively pessimistic expectations it has for growth in the collection of central excise revenues. These are budgeted to grow at a mere 6.3 per cent, as opposed to over 28 per cent for corporate income taxes, 50 per cent for service taxes and 20 per cent for customs duties, despite the reduction in tariff rates. Excise duties, the largest source of central revenues, contribute about 30 per cent of the total central tax kitty. There is a very simple way to benchmark their performance. Being a value added tax (VAT) on industrial production, the base comprises the nominal industrial GDP, which in the current year will grow at around 13 per cent. The growth rate may come down a bit next year, but certainly not to 6 per cent. The excise pessimism is all the more remarkable in the light of specific references in the Budget speech to the source of the problem and the articulation of some proposals to address it.

The source of the problem, as is well-known by now, is the pervasiveness of exemptions. These apply on the basis of a number of factors; the nature of the product itself, the scale of production, the technology used and the production location are the main criteria for exemption. Exemptions obviously provide enormous arbitrage opportunity and it is worth the producer's time and effort to create a logistic framework that allows him to maximise his benefits from them, simultaneously depriving the government of revenues by (of course) fully legitimate means.

This situation is particularly ironic because the great virtue of a value added tax, or VAT, is the incentive it creates for voluntary compliance. Any producer who is already paying taxes has a strong incentive to deal only with suppliers who are also paying taxes because, otherwise, he cannot avail himself of the offset. Theoretically, VAT should have expanded the tax net and provided a counterweight to the convergence to the single, low rate prescribed by the reform blueprint. However, it is clear from the experience over the last several years that the power of exemptions has neutralised the positive incentives of VAT and diluted both the impact of reform and the ability to move towards the ideal state of a single rate with no exemptions.

Given the compulsions of the fiscal responsibility law, the finance minister cannot afford to let things continue as they are. Accelerating excise collections to match the growth rate of its base is critical to meeting the fiscal targets without flogging other sources, which do not have similar loopholes to escape through. He needs to build on the intentions articulated in the Budget speech and plug the leakages as soon as possible. While the narrowing of eligibility criteria will perhaps have to phased in over subsequent Budgets, a strong and unambiguous signal needs to be sent to businessmen as soon as possible that they should start preparing for an exemption-less world. At least future investment decisions should not be governed by the economics of exemptions; a cut-off date can be decided on, and the sooner the better. For existing units, a phased reduction in entitlements is perhaps the only feasible way. VAT offsets will mitigate some of the cost of re-entry into the net.