For India to be truly competitive, customs rates have to come down to zero
Why does China have a high rate of growth of manufactured imports while India lags far behind? Until now the explanation has been mainly labour laws, infrastructure and FDI regulations. The Kelkar report suggests that an important factor in China’s favour is its tax system. Globally, most export-oriented production takes place using global production chains. A toy may be be made in Brazil, sent to India to get painted, and then re-exported to Japan. In India, raw materials, the unpainted toy, worth Rs 100 might turn into finished goods of Rs 110 — since painting only adds 10 per cent value to the toy. On this small base, if a 1 per cent octroi of Rs 1.10 is slapped on the value of the toy, then it looms large as 11 per cent of the Indian firm’s genuine business. In contrast, a Chinese firm doesn’t have to pay such a tax.
To handle this correctly, exporters should be refunded the indirect tax that is embedded in their goods. This fits well with VAT. Under a VAT regime, Kelkar has recommended the simultaneous removal of all cascading taxes like octroi, and sales tax.
So, every exporter would add up the VAT payment that is shown on invoices of raw material purchases. He would get a full refund for all these payments when export takes place. The 10 pc tax on the painting of the toy would first be put on the value-ad of Rs 10 and so would only be Rs 1. When exported, the exporter would get a refund for the tax paid.
But there is still the question of customs embedded in inputs that is paid by exporters. While there is a concept of duty drawback to refund customs for exporters, it only applies to direct imports. Duty drawback can not reach all the affected firms.
Kelkar has recommended a shift to three customs rates of 5, 8 and 10 pc. Hopefully, this means that unlike in the present regime, the peak rate of 10 per cent will be a genuine one. Even so, this is inadequate: for India to be fully integrated into the global production chain, customs rates have to be down to zero.
China, which collects only 3 pc of its total revenues from customs offers a striking contrast to India, which collects 10 pc (after CVD). By the early 1990s, China had fully put into place the modern architecture that is now proposed in the Kelkar report. We propose to start next year. Better late than never.