Supremely Erroneous Zones

SEZs, notified last Friday, are wrong — economically, politically, morally

As a person of the conservative persuasion, I am almost always on the
side of minimal government and low taxes. But I have profound objections
to Special Economic Zones (SEZs), the rules for which came into force
last Friday. My objections are economic, political and, need I say, with
the morality of its political economy.
I remember some 16 years ago, when our current finance minister, who was
then commerce minister talked about SEZs. His vision was to create
islands of entrepreneurial freedom, islands of excellent infrastructure,
islands not hobbled by the paralysing stranglehold of suffocating labour
laws, import restrictions and exchange controls. These islands would
succeed, grow and eventually transform the whole country. This vision
meant that we would be able to learn from our Chinese neighbours how to
create millions of productive jobs and, in the process, create wealth
that will lead our country out of its poverty.

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

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