Supremely Erroneous Zones

Thanks to our vam-panthic friends (who at the risk of repetition seem to behave as if they are the agents of Chinese capitalists who want to prevent Indian businesses from succeeding on the world stage), the move to have more employment-friendly labour laws has been jettisoned. SEZs will doubtless create an environment where our residual import and exchange controls do not operate. They might create better physical infrastructure than our crumbling cities. Without reformed labour laws, these may not add up to much. But we Indians are like that only. And that’s about what we can do.

Suddenly, from an unexpected direction a new “sop” is added on to SEZs. Firms operating in SEZs are expecting to get prolonged income tax holidays. This I submit is a profound mistake. There is no economic, or for that matter social, logic to suggest that value added in the export market is superior to that in the domestic market. Exports do not justify an income tax rebate. In the distant past, when we were starved of foreign exchange (due to other distorting economic signals), we decided to give exports a special break. To the extent that this is a state commitment, it is in order to let it run its course, which is at the most for the next couple of years. But to now create a new set of “upper caste” tax-exempt businesses in the SEZs is totally without justification.

Tax rates should be low, stable and predictable for all economic actors. To create another pampered, subsidised rich people’s enclave is fiscally not prudent and defeats the very basis of economic reform. We are now encouraging people to “play games”, set up new units on paper, transfer tax-paying businesses into these tax havens, open up businesses which have no economic logic except that of tax management and so on. The great peninsula of India will be dotted with Cayman Islands, Bahamas and Monacos. The totally unwarranted and misconceived waiver of excise duties in Himachal and Uttaranchal (a gift of the NDA government) has lead to numerous units “shifting” their production to these states and has cost the exchequer a bomb. An unfortunate side effect has been the considerable harm caused by chemical and other polluting units getting located in these ecologically fragile, beautiful states!

The real estate magnates who are “developing” the SEZs are quite openly selling them as tax havens, no more, no less. And the tragedy is that no business can afford to walk away. Any management that does not try to leverage these emerging tax havens would be committing a folly in strictly selfish business terms. And once several large companies acquire stakes in these fiscal giveaways, they will acquire a life of their own. They will lobby to keep them and keep extending them. All of this at the cost of the country’s public finances. It is important that this be cut off at the pass before it acquires an unstoppable momentum.

And now for the “moral” issues involved. I do not want to sound sanctimonious….but clearly if wage-earners can pay income taxes, if domestic businesses can pay income taxes, I see no reason why the businesses located in SEZs should be exempt. After all income taxes would arise only if they made profits. It is going to become increasingly difficult to hold the moral high ground and demand good infrastructure if businesses keep seeking tax-exemptions rather than pay their fair share. In a poor country, this insensitive behaviour is even less acceptable. The argument that the government in all probability will waste the money it collects in taxes is a specious one. On that basis, anyone who sells medicines in Bareilly or bicycles in Sholapur or TV sets in Madurai should also not pay taxes — why should only the exporting denizens of SEZs get away?

The political economy issues are even more staggering. In 1789, the ancien regime collapsed in France precisely because the rich aristocrats refused to pay taxes; George III lost the thirteen colonies for reasons of perceived fiscal injustice. We certainly don’t need the return of the capricious estate duty and 97 per cent “Krishnamachari” income tax rates. But we also do not need a regressive tax regime that works as a reverse Robin Hood.

Net-net, SEZs are not what they were meant to be or could have been if we had allowed labour law reform (as originally intended and as practiced by the communists of China). If we want to go ahead with SEZs with some benefits in the form of tariff relief and better infrastructure, and hope the labour law reform will eventually follow, then so be it. There is a second order sub-optimality to this and it is in line with our finance minister’s original vision.

But to make the SEZs a source of fiscal loss by stealth and for the benefit of profitable businesses (they have to be, in order to benefit from income tax-exemption) is completely unjustified. It will send needlessly distorting signals through the economy. It will erode our public finances and will create islands of subsidy that will become permanent sores (like the LPG subsidy) which we will find difficult to escape from.

The writer is chairman and CEO, Mphasis. Write to him at jerryrao@expressindia.com