Chocolate and Gold Coins

Wednesday, March 02, 2005

Strange Taxes and Rent-Seeking in India

Amit Varma, that most excellent blogger from India, found an interesting commentary from the India Express about rent-seeking by industrialists in India. Gautam Chikermane writes of these rent-seekers:

Death is the only way — this thinking, this attitude, this whole approach has to die. Come budget time and for decades now, we have been seeing one private interest group after another approach the finance ministry with its list of demands — demands that help that industry become more profitable, either at the cost of another industry or consumers. For decades, the finance ministry has been accepting, rejecting, modifying these demands.

A little later on in the article, you get an idea why industrialists in India are such avid rent-seekers. The government chooses to raise revenue from a rather bizarre collection of commodities. He gives the examples of naptha imports for the petrochemical industry and synthetic fibers imports for the textile industry. In general, the article gives the impression that India tries to raise a sizable amount of revenue on intermediate goods, and specifically imported intermediate goods. The motive for rent seeking in such an environment is very strong.

Mr. Chikermane recognizes that rent-seeking behavior is damaging, but he blames the industrialists for being greedy and the government for listening to them:

[W]here does “national interest” fit into an argument that demands lowering of duties? What do any number of “lakh workers” have to do with a sector being freed from price control? Why lean on consumers when it is clear that either way they will lose (an adverse price impact will be a pass-through and a favourable one pocketed)? And while the organised industry seeks concessions, individuals are unable to look beyond deductions, exemptions, [and] rebates.

What Mr. Chikermane fails to understand is that a poor choice of things to tax can lead to serious problems in the economy. Most, perhaps all, economists would agree that taxing intermediate goods is a very poor choice of things to tax. You raise very little revenue but you put an industry in turmoil. In the worst case, you merely put the firms out of business and raise no revenue at all.

Faced with devastating taxes of this sort, renk-seeking becomes a very profitable enterprise. The talent of the industrial class is spent in persuading the finance minister instead of improving technology and doing business. Also, these taxes produce rent-seekers in pairs: one who is hurt by the tax and one who is protected by it. These antagonists fight a classic zero-sum game in their attempts to persuade the finance minister.

Why would India choose such inefficient taxes as these arbitrary taxes on particular intermediate goods? Mr. Chikermane indicates part of the motive. Raising the taxes paid directly on individuals would be unpopular with consumers. If all taxes are equal, let the industrialists pay them, and then the consumers won’t have to bother with them. The problem is, not all taxes are created equal. Taxing intermediate goods creates an enormous excess burden on society, and contributes to poverty.

Mr. Chikermane ends his article with an appeal to the government:

Exactly thirteen years ago, in February 1992, Manmohan Singh presented a budget that unleashed the creative energies of Indian business. P. Chidambaram can take this one step further by changing the theme of Budget 2005 to “wealth creation for the individual” and unleashing that far greater, far widespread, far reaching potential.

I would agree with that sentiment and would hope the current Prime Minister Manmohan Singh would be wise enough to see the destructiveness of these intermediate goods taxes. He should shift the taxes off of industry and onto consumers. It might not be popular with consumers, but just imagine what India could do if its industry were to be unleashed!

Here is another article via Amit Varma that suggests India should scrap the current taxes system and got to a Value Added Tax (VAT) which is essential a national sales tax.

Here is a link to a blog (MadMad) via Amit Varma that rails against possibly the stupidest tax I’ve every heard. Imagine a tax of 20 cents on withdrawals of cash of $200 but no tax on withdrawals of $100. How much tax do you raise? You inconvenience a lot of people though. Apparently there is such a tax in India.


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