You have to hand it to India's politicians. The SEZ (special economic zones) controversy was primarily about the huge tax losses that would occur, but Congress Party President Sonia Gandhi converted into one on using farmers' land even though there is little evidence of fertile farmland being taken up for SEZs.
So now that "protect the farmers" has become the rallying cry, this will be the touchstone for judging whether SEZs are good for the economy or not, not the tax losses this will cause or the distortion between non-SEZ and SEZ players.
Prime Minister Dr Manmohan Singh, who, by now, finds no problem in being an economist one day and a politician the other, told state governments that they should look at their fiscal situation before offering tax sops to industrialists.
Yet, the same gentleman chose not to intercede on behalf of Finance Minister P Chidambaram when the latter cautioned about the huge tax losses that would occur if the SEZ policy was allowed to go through. At that point, Singh gave the impression that Minister of Commerce and Industry Kamal Nath's maths was the more appropriate one, that the increased economic activity as a result of the SEZs would more than make up for the taxes lost on them.
In the early days of the SEZ policy, the finance ministry had estimated the tax losses could be around Rs 100,000 crore (Rs 1,000 billion) till 2009-10, around Rs 57,000 crore (Rs 570 billion) on account of direct taxes as exporters would once again get tax-free status under the SEZ and the rest on account of the customs/excise that would be lost on the capital goods used in the SEZ.
The ministry of commerce's consultants, however, turned this around and, to his discredit, Chidambaram chose not to counter it--perhaps since he saw the mood was hostile, who knows?
First, they took the Rs 57,000 crore tax loss figure, and said this represented a profit of Rs 228,000 crore (Rs 2,280 billion) -- assuming effective tax rates are around 25 per cent -- and a turnover of Rs 11,40,000 crore (Rs 11,400 billion) -- assuming a profitability of 20 per cent.
Based on a tax-GDP ratio of 12 per cent, the commerce ministry calculated this additional economic activity would lead to Rs 136,800 crore (Rs 1,368 billion) of taxes. Voila, Chidambaram's case was destroyed since this extra tax was higher than the tax lost!
The consultants even picked holes in Chidambaram's calculations--the Rs 57,000 crore of direct tax losses, they said, should have actually been Rs 22,900 crore (Rs 229 billion) since export profits are tax-free till March 2009--they're wrong on this, though to explain the calculations would take a lot more space and rigour than this column allows.
There are two problems with the ministry of commerce's maths. One, Chidambaram's calculations did not take into account software exports, which are currently tax-free but will lose this status in 2009-10. If, however, they move to SEZs, as is widely expected, they'll become tax-free all over again. If the incremental exports take place from SEZs, this will hike 2009-10 direct losses by around Rs 15,000 crore (Rs 150 billion). Nor did the calculation take into account the profits of the developers of SEZs and the tax lost on this.
The larger problem, however, is that it is no one's contention that the turnover generated out of the SEZs (the Rs 11,40,000 crore the commerce ministry's talking of) will not lead to taxes--that is, while the unit in the SEZ will enjoy a tax benefit, the salaries it pays its employees and the inputs it buys from other units outside the SEZ will be taxed.
The real issue is of the additionality of investments. If the investment that is being given SEZ status was going to come in anyway, then the taxes lost on the SEZ are important.
If, however, the investment is coming into the country comes in only because of the SEZ tax breaks (that is, this would have gone to Shenzen otherwise), then the tax losses don't matter as much since, to use the commerce ministry's argument, the additional taxes are greater than the tax losses.
This is where the fudge takes place. While the commerce ministry gives examples of such merchant exporters who've come in only due to the tax breaks, the bulk of the SEZ proposals is from investors who would have set up their businesses anyway.
With the IT/ITeS industry growing at over 30 per cent annually, surely Infosys will set up new facilities even if there are no tax breaks? If the global textiles market is booming, surely exporters would set up textile units even if they had to pay taxes on their profits?
But why talk of theoretical cases, the best example of this is the Posco steel plant in Orissa, which has just been given the approval to classify itself as an SEZ. Posco is a project that was coming into the country anyway; it was a project where the only things the promoters wanted were land to set up their plant and a captive iron ore mine--the captive mine increases profitability hugely.
Yet, when the SEZ scheme got unfurled, Posco decided there was no harm if it also got some additional tax benefits, and so applied for SEZ status. If Posco doesn't get the captive mine or the land it requires, however, it will still leave the project, regardless of the tax breaks--you can ask its management.
But that doesn't really matter in the Sonia-Manmohan scheme of things. There is no fertile land being taken over by Posco, and the 450 families that are getting displaced are being promised decent compensation under Orissa's new rehabilitation policies, so no farmer will be shortchanged. Long live Posco!
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