The Hindu Business Line : `Sin' tax: Damned if you do, damned if you don't

SHOULD cigarette smoking be banned because it is injurious to health? Must we close down liquor shops because alcohol, if consumed in excess, is deleterious to our physical constitution? Should we spend less on petrol and petro-products given the high global prices and pressure on our forex resources? Should we discourage the purchase of automobiles given that still 25-40 per cent of the population lives below the poverty line?

These questions may sound like issues raised in a moral science class or a beginner's economics textbook.

But for the government these are difficult questions to answer, considering that reducing consumption of cigarettes, alcohol, petrol consumption and automobiles means a financial compromise — a revenue trade-off in the form of excise collections.

Excise collections account for 33 per cent of the government revenue. The ability of the government to achieve such targets depends on the performance of the economy, in particular, that of the industry.

The curious aspect of these collections is that over 55 per cent of the collections comes from three industries — tobacco products and beverages (T&B), petro-products and automobiles.

Table 1 gives the share of these three industries in excise collections.

The share of these three industries has been rising over the years. The collections depend on production, which in turn depends on demand (sales).

In the financial years 2001 and 2002, when production was either low or declining in the auto-segment, excise collections from this sector fell, affecting the overall excise income.

Excise duties have been rationalised by the government over the years with the introduction of fixed slabs and extension of MODVAT.

It is interesting to see how the effective excise rates have moved — the net position.

Table 2 gives the overall average rate of excise for these industries.

Two contrasting pictures emerge. First, that though the government changed the excise structures regularly, the net effective incidence has come down only marginally over the years.

While the T&B industry has actually seen a rise in its excise rate, the auto industry has seen a fall; on petro-products, however, the excise rate has remained fairly stable.

Much thought has gone into the announcement of nominal rates by the government.

Lowering nominal rates further would mean a loss of revenue, especially on T&B and petro-products.

The so-called `sin tax' is necessary to fill the coffers; any actual decrease in their consumption will cause fiscal turbulence.

In fact, the T&B industry accounts for just over one per cent of the net sales of the manufacturing sector, it contributes to 9-10 per cent of excise collections — the highest rate in the industry.

It also means that people do not mind paying a tax of over 70 per cent of the value of the product. The scene with petro-products is different.

It accounts for around one-third of the sales of the manufacturing sector and accounts for around 36 per cent of excise collections. The average effective rate has remained more or less constant.

This shows that the adjustments in the final price and in the excise rates have been made so as to be revenue neutral.

But with the average rate being just about the same as that on the entire sector, sustained rise in consumption is essential to keep up the revenue flows.

The auto sector's share in excise is higher than that in sales. The excise rates have been coming down, as a result of duty rationalisation.

But consumption here is dependent on extraneous factors such as income distribution; it is the higher income groups that enter this industry as consumers.

The government has to hope that the rich become richer so that they can afford more expensive vehicles. Likewise, the poor have to become less poor, and while a transition has been taking place the movement has been slow with the preference being for second- hands rather than new cars when income levels rise.

The basic message is that in an economy like India's there is need for conspicuous consumption to ensure that the government is able to meet its revenue targets.

This is so as the tax system is already skewed against goods where demand is relatively inelastic.

(The author is Chief Economist, NCDEX Limited.)

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