Bad Economic Zones
Indian Express, June 24, 2006
With the 25,000 acre SEZ in Haryana taking shape, and with Maharashtra
setting the pace with reforms to labour law in SEZs, India seems to be
effectively moving forward on the agenda of creating Special Economic
Zones. On one hand, an effective SEZ policy could bolster India's
growth, by making a dent on urban infrastructure and labour
reforms. It could, as a consequence, have big payoffs in terms of
employment and GDP growth. But unfortunately, at the same time, SEZs
add to a sombre picture of a second phase of a fiscal crisis. With
great difficulty, India has clawed back from a fiscal disaster over
the last six years. But early signs suggest that we could slip back to
a fiscal disaster by 2010. Proposed expenditures are large while
revenue collections could shrink.
In the first few months of forming the government, the UPA gave out a
very strong message that it believed in fiscal consolidation. Finance
Minister P. Chidambaram went ahead and implemented the Fiscal
Responsibility and Budgetary Management (FRBM) Act that had been begun
by the previous government. A signal was given to the world that
despite the support of the Left, the government was not going to run
large deficits and fiscal reform will be on track.
It had been feared that the support of the Left would make the
government take up socialist welfare measures. But reality has turned
out to be quite different. The Congress Party, and not the left, has
turned out to be the biggest enemy of the fiscal responsibility
act. Indeed, the Left's contribution is, if anything, positive. The
West Bengal Finance Minister has pushed the state VAT forward, paving
the way towards a national level GST. Despite all the talk by Left
intellectuals about financing deficits by printing money, at the end
of the day, they hvae merely supported continuing old programmes like
the PDS and subsidies for LPG, not pushing big new ones.
The Congress, on the other hand, with complete disregard to the
promises it has made on fiscal responsibility, has moved towards large
scale spending programmes such as the National Rural Employment
Guarantee Act (NREGA), pumped up the money going into Sarva Shiksha
Ahiyan (SSA), initiated the sixth pay commission, and possibly a raft
of welfare provisions including defined benefit pension for the 400
million unorganised sector workers. When implemented, these programmes
in a few years, could lead up to additional spending of well over Rs 1
lakh crore. In addition to these spending programmes, there is the
populist oil price policy which could ultimately hit the budget when
oil PSU's cannot run losses any more.
And, if that was not enough, the UPA has initiated hundreds of SEZs
all over the country, with the most generous tax concessions
imaginable. The SEZs could cost the exchequer about Rs 95,000 crore
over the next few years. This year the budgeted fiscal deficit has
been brought down to 3.7 percent of GDP. Despite the finance
commission adding to the centre's deficit by raising the share of
revenues going to the states, the FRBM was not thrown completely
off-track. The expansion of the service tax net and increase in rates,
improvement in tax administration through TIN, and direct tax reform
had a positive impact. The UPA has been lucky on GDP growth in the
past two years. High GDP and manufacturing growth has given buoyant
tax collections.
But all this is before the really big spending has started. Under the
FRBM the government has promised a fiscal deficit of no worse than 3%
by 2008-09, and that too only for the purpose of capital
expenditure. It, unfortunately, looks increasingly infeasible for the
UPA to achieve these goals. A scheme like the NREGA is completely open
ended. The government cannot say that it will only spend Rs 14,000
crore, because by the very definition of the scheme, it has promised
to spend as much as there is demand for employment. Morevoer, when
state governments are allowed to determine the minimum wage that the
centre must pay, the run on expenditure can be without limits when
states compete with each other to pay more than one another.
The most serious threat to the FRBM will come from the SEZs. Tax
exemptions are being given not only to exporters but to real estate
developers who are getting a fiscal gift from the government when
after the government acquires land cheap for them, it gives them a tax
break when they sell commercial plots and residences (not necessarily
to exporters) for a profit. Further, FRBM projections were made on the
assumption of a high tax buoyancy: An increase in GDP would lead to a
greater increase in tax collections. But now companies have incentives
to locate up new establishments only in SEZs. Not only is the
infrastructure going to be better, they are going to get tax
exemptions for profits from exports. It will not be long before
companies devise ways to show more and more income as income from SEZ
activities. With tax havens inside the country, hundreds of ways will
be found to route income such that as little as possible tax is
paid. If incremental GDP is booked in SEZs, then the basic tax
buoyancy assumptions that underlie the FRBM Task Force report will
break down. More than a hundred SEZs all over the country are a
finance minister's worse nightmare.
Advocates of SEZs look forward to SEZs featuring an immunity from the
labour law, poor tax policies and tax administration of the Indian
State. The idea is that an SEZ is a place where it becomes possible to
merely hire globally competitive Indian labour, without all the
terrible impediments thrown up by the socialist State. However, it
will be impossible for the SEZs to function without a giant new
bureaucracy springing up to plug these leakages of tax. We will have
created a new problem for the next generation of reformers to attack.
The FRBM was an act of parliament, but when the parliament itself is
merrily passing other acts which care little for the promises it made,
who will play the watchdog?
------------------------------------------------------------------------------------------------------------------------------------------------------