Jul 21, 2014

Revenue forgone or Industry forgone?

In the book 'an uncertain glory', Jean Dreze and Amartya Sen (p. 90) write this:
'The pernicious role of regressive subsidies applies not only to those that are visibly and explicitly given, such as subsidies on diesel or fertiliser, but also to implicit subsidies, notably those arising from what the Finance Ministry calls 'revenue forgone' - tax revenue that could have been collected, but was forgone on account of various exemptions and incentives. Some of these are justified, but many others are nothing more than disguised handouts to powerful lobbies, especially corporate lobbies'
So far so good. Then they go on to say,
' ...the subsidies include more than Rs 57000 crores of custom duties forgone on 'diamonds and gold' alone...'
and question such subsidies that can't be justified in an economy struggling with basic needs in terms of food security, health, sanitation and education.

In a later chapter, (pp. 271-272), Dreze and Sen return to this number and juxtapose it against the debate about the bill of Rs 27000 crore on food subsidy that might follow the National food security Act. They wonder as to why there is so much debate about this 27000 crore when no one questions the 57000 crore being lavished as tax exemption on rich jewellers and the associated lobby.

To be fair, Sen and Dreze acknowledge that the figure of 57000 crore might be an overestimate as '...those imports would probably decline if a duty were to be imposed, and also since some of the imports may be used for re-export after work on them for making jewellery...'

Before proceeding further, let me update the numbers. The revenue forgone data is published with the annual union budget as annexure 12. The latest figure given for revenue forgone on account of diamond and gold is around 47000 crore (2013-14). This is a sharp decrease from last year's figure of around 62000 crore rupees (2012-13). The figure quoted by Sen/Dreze is for the year 2011-12. Sen/Dreze narrate the incident as to how the Govt had to roll back a hike in excise duty on gem and jewellery sector amid protests whereas a similar attention is not bestowed on food sector. They conclude that '...the biases in public attention and protest clearly have serious consequences...'

That conclusion is tinted in welfare economics, and is premature. 

In any case, there are multiple problems with both the data that is put out in this form, and the way it is interpreted. 

Let's take the revenue forgone statement. There are two types of exemptions that we are talking about here. One is the exemption in the import duty due to various notifications, and another is the tax nullification schemes on export products in order to keep the products internationally competitive. 

When a rough precious stone is imported into the country for polishing and re-export, it is exempt from import duty. The logic is simple. Any duty on export product will add to the final cost of export product, making it increasingly uncompetitive in international markets. Most of the countries nullify the domestic taxes on export products, including nullifying any import duties, if levied. 
Imports for re-exports in India are usually duty exempted through schemes such as replenishment schemes or advance license schemes run by the DGFT. Thanks to such schemes, India today has the biggest polishing industry in the world, cornering almost 95% share in this sector. It is highly employment intensive, employing around a million people directly. 

The other type of exemptions arise due to notifications that exempt additional customs duty/countervailing duties. Levying duties on diamonds or gold beyond a certain point is counterproductive in terms of increase of smuggling of such goods. The govt. can rise the customs duty upto a level where smuggling premium equals the customs duty. The customs duty is safely around 10% on gold for example, as of now, which seems reasonable. Beyond this, it gives diminishing returns. The purpose of countervailing duty is to negate the effect of domestic excise duties on local firms, thus giving a level playing field for local firms against cheap imports. In case of gems and jewellery, most of it enjoy nil excise duty, thus leaving no scope to impose an unjustified countervailing duty on imports. 

Finally, the value addition in polishing sector is hardly 10%. This number is the bottom edge of margin at which any industry can survive. Any attempt to levy a duty on import of stones would kill the polishing industry which survives entirely on exports of imported content. This would also lead to great loss of employment.

Revenue forgone statement, unfortunately uses a lame formula that takes into account the above mentioned types of exemptions. It makes it appear like some handout subsidy, which is not the case. 

The entire gems and jewellery export industry exists solely due to such revenue forgone. Rather, there would be no revenue to tax if it is taxed. 

Someone needs to tell this to those who prepare the revenue forgone statement.  And Sen/Dreze need to stop using such statements to prove their point. Their points on welfare are well taken without such shoddy comparisons.