Not a matter of law

Central excise collections from Punjab were over Rs 3,000 crore in 2001-02 and fell to less than Rs 800 crore in 2006-07. The state government thinks this is because of industrial units migrating from Punjab to neighbouring Himachal Pradesh and Uttarakhand, which were given generous tax holidays by the NDA government. Any industrial units set up in these states between 2003 and 2010 are exempt from excise duty for 10 years, get full income tax exemption for five years, and a 50 per cent income tax exemption for a further five years. Both excise and income tax are in the central government's domain, but states get affected in two ways. First, their absolute share of tax falls as the divisible tax pool reduces (because some tax-paying units shift location to become tax-free). Second, the state loses jobs, local taxes and the general demand for goods and services that industrial units generate.

That Punjab (and other states) have suffered because industrial units have shifted to places like Baddi in Himachal Pradesh and Rudrapur in Uttarakhand is probably beyond question. That does not automatically mean that these states have a case that they can take to court. For if the Centre were to be prevented from giving special benefits to any one or other category of states (special category states have always got special treatment under various formulae for financial devolution), it would hobble the Centre's ability to tackle inter-state disparities "" which is one of the basic duties of a federal government. So it is likely that the Punjab threat of legal action is designed to prevent the UPA government from extending the tax holiday given to Uttarakhand and Himachal Pradesh.

Rather than sustainability in court, the issues to be debated when looking at such area-wise concessions are fairness and efficacy. For instance, tax concessions offered to Sikkim and other hill states in the north-east resulted in low value-addition units (like final assembly plants) in heavily taxed sectors (like cigarettes) going tax shopping to the favoured states, only to desert them en masse as soon as the tax concessions were no longer available. Industrial units get located in irrational locations because of other factors too "" backward area incentives, political pressure to favour key constituencies, and the now discarded policy of steel price parity across the country. The sinner is not just the Centre; state governments too woo investment by offering free (or virtually free) land, as at Singur, and tax concessions. On the plus side, medium-term concessions can help create industrial clusters which then take on a life of their own, as has probably happened in the Pantnagar-Rudrapur belt of Uttarakhand.

The fairness argument is even harder to resolve. If difficult-to-access hill states are to be given tax concessions, should all non-coastal states claim to concessions because they incur extra transport costs on imports and exports? If so, does it not negate all arguments in favour of economic efficiency, locational advantage and international competitiveness? The best that can be said is that economic logic should be respected, and any incentives given should be no more than marginal; generous concessions tend to create extreme distortion of economic logic "" as has probably happened in the case of Himachal Pradesh and Uttarakhand.