Recent weeks have seen considerable debate on the cost and efficacy of special economic zones. The protagonists argue that this is the panacea for the ills - particularly the poor state of infrastructure and high transaction costs - involved in the bureaucratic procedures and clearances.
However, the dissenters contend that this is merely a means of providing tax shelter to the favoured. Concerns have also been expressed on the displacement associated with land acquisition and adverse consequences on uneven development. The evaluation of economic spin-offs of the SEZs and its welfare cost need to be debated further.
The SEZ strategy seeks to reduce the transaction costs and enhance the competitiveness of exports by simplifying procedures and giving fiscal concessions. The former set of measures includes the creation of world-class infrastructure, ensuring single-window clearances, simplifying regulations, streamlining procedures, requiring documentation with emphasis on self-certification, dispensing with the need for bank guarantees and facilitating sub-contracting with foreign participants.
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The fiscal concessions include full exemption from income tax for the SEZ units for five years and 50 per cent concession for the next five years and exemption from customs and excise duty from all imported inputs to SEZ developers as well as units located in them. They are not required to pay even the minimum alternate tax.
The Board of Approvals has already given its nod to 150 SEZs and another 240 applications are pending before it. Of the approved, 85 are in the IT and IT-enabled services, 14 are in pharmaceutical and biotechnology, nine are in textiles and apparels and 10 are multi-product SEZs.
Multi-product SEZs are required to have a minimum size of 1,000 hectares but the size restriction in the case of gems and jewellery, information technology and bio-technology could be as low as 10 hectares.
They are required to earmark only 25 per cent of the land in the SEZs for industrial purposes and the rest could be developed into residential and commercial complexes.
The Union commerce ministry, which is spearheading the movement for more SEZs, claims that there will be an additional investment of Rs 100,000 crore (Rs 1,000 billion), mainly through the foreign direct investment route, and it will create 500,000 additional jobs.
Will it materialise? Indeed, the inflow of FDI depends on a variety of factors including policy on FDI itself, besides stable policy environment, infrastructure, labour laws and the system to protect property rights.
Surely, the policy will make investment diversion from non-SEZ areas to SEZ areas attractive and to the extent that relocation cost is lower than the tax benefits, there will be investment diversion. History is replete with instances where fiscal incentives have led to significant revenue losses and investment diversion rather than creation (Anwar Shah, Fiscal Incentives for Investment and Innovation, OUP, 1995).
In fact, such tax preferences make the tax system complex and open up avenues for evasion and avoidance. So we will perhaps see a massive relocation of manufacturers and exporters and significant erosion of direct and indirect tax bases in the years to come.
Some of the companies have historically paid low effective rates of tax by way of MAT and they will avoid even this. For the IT and IT-enabled companies, this comes as an additional bonanza. They will continue to live in the wonder world of the tax haven.
The policy on SEZs sounds like a candid admission by the government of not just its failure but also incapacity to create an enabling environment. Is it that we require procedural streamlining only for units located in the SEZs? Should we forget about providing power, water, ports and airports for units located outside these enclaves? What sin have those worthy entrepreneurs located outside these enclaves committed, who, despite odds, have continued to export but are not eligible for tax benefits?
Indeed, the discussion on the cost of SEZs should shift from the narrow considerations of revenue loss to the larger issue of welfare loss to the community. A major source of welfare loss is confiscation of land and displacement of people and shifting of productive land away from agriculture.
Definitive estimates of the land to be acquired and people to be displaced are not available but some estimate that over a million people may be displaced. In fact, the recent experience of Kalinganagar in Orissa typifies the likely scenario.
The land was acquired from the tribals at Rs 30,000 per acre by the state government and sold to Tata Steel at Rs 335,000 per acre.
As the developers of SEZs are required to use only 25 per cent as bonded factory zone, the rest could be used to develop commercial and residential complexes, clubs and other recreational facilities. Whether or not SEZs will attract FDI and enhance exports, it will certainly provide a boost to development and transactions in housing and commercial properties.
Thus, it may not surprise us if the SEZs take up massive investments and speculation in real estate and housing as the main activity and investment in manufacturing and exports may actually become subsidiary.
Indeed, the advantage of a federation is the large common market. The creation of several tariff zones within the country does not help efficiency in resource allocation. Even when there are additional investments, the location of units may not ensure forward and backward linkages to the extent desired.
Furthermore, most of the SEZs are located in relatively advanced states and this adds to regional disparities.
There are other welfare implications of revenue loss as well. There is horizontal inequity between the exporters located inside and outside the SEZs. Vertical equity is violated with continued exemption to IT and IT-enabled units, which can get the SEZ status even with 10 hectares of land.
The massive relocation of units to SEZs involves cost and loss of efficiency. Given the compulsions of coalition politics and continued infatuation with large plan sizes, the massive loss of revenue may force the finance ministry to raise revenues in inefficient ways.
At a time when the need of the hour is to broaden the base, reduce the rates and levy simple and transparent taxes, creating complexities will only add to the administrative burden and will create a larger scope for evasion and avoidance of the taxes.
The author is director, NIPFP