The Hindu Business Line : Must States rely on sops?

IT IS HARD to say if the 30 months of excise and income-tax concessions for new units located in certain industrially-backward States have led to flight of any significant amount of capital from the more advanced States, as feared by the Tamil Nadu Chief Minister, Ms Jayalalithaa, in her recent letter to the Prime Minister. For, it is never going to be easy to establish that investments would not have been committed to the new locations but for the tax concessions. As for relocating investments, it is harder still as States have enough regulatory powers to stall closure and shift of manufacturing units to some other locations. Fortunately for Tamil Nadu at least, the policy does not appear to have had any adverse consequences on the flow of investments into the State as the Chief Minister herself is on record that it has been a problem of plenty.

But more than anecdotal evidence, States with more advanced industrial economies have a strong case against any special dispensation in the tax structure for units coming up in industrially-backward States. After all, it is the Centre that actively persuaded the States to eliminate local investment concessions such as capital subsidy and sales tax waivers for new units being located in their territory in the context of introduction of the Value Added Tax regime. If State-level tax concessions distort inter-State commerce, surely the same logic should prevail for concessions written into the Central tax codes as well. There is conceptual merit backed by a wealth of empirical research to suggest that such incentives, even as they confer some economic benefit to the enterprise at the micro level, impoverish the society which forgoes taxes in the near term for far-from-certain gains in the long term.

This is not to say that there is a genuine problem of lack of gainful employment or other income earning opportunities for the vast sections in these disadvantaged States. At Rs 2,187 crore Himachal Pradesh's manufacturing output in 2003-03 was a mere one-fifteenth of Tamil Nadu's; it was worse off even vis-à-vis Maharashtra and Gujarat. But, then, historically economic growth has tended to follow its own pattern with activity spreading out in contiguous areas around a core that is endowed with the right social and physical infrastructure. As the economy grows, the circle of economic activity too gets enlarged with newer areas brought under its influence, and prosperity extends to a larger section of the population. The decision of the German car-maker BMW to locate its assembly operations near Chennai does not imply that the requisite human and physical facilities do not exist elsewhere. Rather, it is in the nature of economic growth itself. This is, of course, a bit hard to digest for those accustomed to the notion of an active interventionist state that can, at will, rearrange the existing order of things. Unfortunately, the evolutionary process does not permit of any dramatic wave of a fiscal wand to secure prosperity for any section of the population that may have eluded it for long.

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