Evaluation of tax incentive policy for development of special category states in India

Abstract

Governments face unenviable challenge of bringing equity among the states in a nation. The states are endowed with a unique set of assets and liabilities. A policy chosen is aimed at neutralizing the set of unique liabilities faced by a particular state. The intention is to accelerate economic development of the state. In India, the hilly states of Jammu and Kashmir, Himachal Pradesh, Uttarakhand, Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim and Tripura (collectively referred to as G11 states) have been accorded a special category status. Union government exempted the businesses set up in these states from income tax and excise duty and state governments gave them interest subsidy, transport subsidy and capital investment subsidy. The objective behind this policy was to develop these states economically. Accordingly, tax incentives and subsidies of Rs. 160000 crore, during a period of ten years from FY 2004-05 to FY 2013-14, were given to the businesses set up in these G11 states. The aim of this paper is to evaluate whether these states have developed as a results of this policy. When the policy was formulated by the Government of India, its evaluation was not thought of. Therefore, neither the economic indicators nor their quantification is available for evaluation. Hence, the major challenge is to decide the indicators. Even after this decision, the problem is to decide the benchmark values against which the achievements are to be compared. In this paper, the development is measured on six indicators namely: (a) Per Capita Net State Domestic Product at 2004-05 constant prices (PCNSDP) (b) Per Capita Manufacturing Sector State Domestic Product at 2004-05 constant prices (PCMSDP) (c) Per capita employment in private sector (d) Per capita number of industrial units set up (e) Per capita investment in the industrial units set up and (f) Human Development Index (HDI). Data was collected and analyzed on this parameters. The performance of G11 states (Treatment group) is compared with the remaining 17 states, called as G17 and it constitutes control group for evaluation. It is found that only Himachal Pradesh, Uttarakhand and Sikkim have partially developed as a result of this policy. Even this development has taken place only in pockets. For example, in Himachal Pradesh the entire industrial activity is concentrated in and around Baddi in Solan district and in Uttarakhand, the industrial development is centered in Haridwar and Pantnagar. This policy is a total failure in the seven states of the Northeast (Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura).In addition to the problem of distributive development, the policy suffers from other problems also. To get full benefit of excise exemption, the businesses have to complete only the last stage of production (for example: packaging) in G11 states. Similarly, the income tax exemption is on profits and businesses are tempted to divert profit of other unit, to the units in G11 states. As a result, the units in G11 states are low investment and low employment units. Most of the high investment, is in hydro-electric power generation and cement production. Since, these investments are location specific, the tax incentives are wasted on them. As a policy recommendation, this paper suggests that the government should stop tax incentives immediately. It should collect taxes from these states and use it on infrastructure development, specially on those projects demanded by the states. Further, the central government and state government should frame a policy to improve governance and taxes collected should be used to fund this policy