Impact of tax structure on different sectors of the economy (with specific reference to the impact of tax incentives on the services sector)

Abstract

This study seeks to understand the relationship between various tax incentives provided by the Government of India to the services sector and the impact that these incentives have had on the actual development of the sector. The services sector in India has boomed since 1990, now accounting for well over 50% of India’s GDP. A few sub-sectors such as business services (including IT), banking, telecommunications services and hotels and restaurants have grown much faster than the other sub-sectors. Several factors have been attributed for their growth, one among them being tax incentives provided to them. The objective behind providing these incentives has been to develop these sectors in addition to attracting foreign direct investment, and ensuring balanced regional development. Three ‘fast-growing’ sectors, namely computer software and services, telecommunication services and hotels have been selected for analysis. It appears that these tax incentives are closely associated with growth in the computer software sector. However, there does not seem to be substantial evidence to prove that tax incentives have been instrumental in the development of the other two sectors. A cost-benefit analysis of tax holidays provided to the software sector reveals that holidays might not be the most appropriate method of incentivising growth in that sector. Methods such as accelerated depreciation should be adopted instead, since the revenues foregone in this alternative are much lesser. The Government should carefully evaluate the costs associated with providing tax incentives to the services sector and employ the right mix of tax incentives to boost investment in this sector. Though these incentives provide an initial impetus for attracting investment, other factors such as a latent pool of talent in the country available at a low cost might be more responsible for sustaining the growth of services in India