View: Finally, government is getting out of 30 years of socialist hangover

Like most large institutions, governments are creatures of habit. Certain policy principles get embedded in the DNA of policymakers that make reform difficult. A path dependency sets in. One such principle is maximising revenue for the government. Another is favouring or incentivising MSMEs. Prima facie, while there may be nothing objectionable in either of these principles, they have caused great harm to India’s competitiveness and growth prospects. Over the last few months, there is firm evidence that Narendra Modi’s government is ready to walk a new path.

The aim of revenue maximisation is a natural outcome of a political economy that has consistently leaned towards welfare or redistributionist measures. In a country where the per capita income is still just $2,000, there are a lot of people and plenty of causes which justifiably require support from the government. The inability of successive governments to broaden the tax base sufficiently has meant that a small group of productive individuals and firms has been the permanent target of a squeeze.

Unsurprisingly, when presented with steep targets, revenue officials look for opportunities to tax. Sometimes, interventions can be relatively benign (on macroeconomic outcomes), like imposing small surcharges on the richest personal income brackets. At other times, interventions can threaten to derail the country’s growth story, like in the case of the infamous Retrospective Tax Amendment (on Vodafone) or the treatment meted out to the telecom industry, say, by applying the concept of adjusted gross revenue (AGR) to non-telecom revenues.

By repealing the retrospective tax amendment and offering relief to telecom companies via a moratorium charges due, redefining AGR and rationalising spectrum user charges, GoI has finally signalled that it will not try and extract revenue at any cost, and that it is willing to reverse previous policy decisions to achieve this.

In doing so, it is coming around to the view that the best way to improve revenue collection is to increase GDP, rather than to squeeze taxpayers. This logic should now be extended across the board. Early in its tenure, this government did the right thing to auction natural resources rather than give them out on a discretionary basis. But the goal of transparency should not be mixed with revenue maximisation. If the latter becomes the primary motive, there is a temptation to create an artificial scarcity by auctioning only a small amount of, say, spectrum, coal or iron ore. That raises the cost of doing business and destroys competitiveness, since crucial inputs become very expensive.

Auctions can be perfectly well-designed without the motive of revenue maximisation for the government. Similarly, in petroleum products, there must be a limit to which GoI can raise revenue, because costly fuels will ultimately impact competitiveness and growth through multiple channels.

The second principle — to do good for MSMEs — is also logical in a political economy that has always been suspicious of ‘Big Business’ and romanticised small business. For many decades, there have been tax benefits and other government support available for MSMEs. All that those policies have achieved is creating an ecosystem where Indian firms do not have the scale to integrate into regional or global value chains.

Scale is important because global firms place big orders and need suppliers who can fulfil those. It is also important for cost-competitiveness. Scale is necessary if India wants to have a global footprint of Indian firms. And all evidence suggests that large firms provide the highest quality jobs, whereas MSMEs provide informal or semiformal employment.

GoI’s production-linked incentive (PLI) scheme that targets 13 sectors and promises a total package of almost Rs 2 lakh crore over five years is the first government scheme that actually gives government funds to firms to become larger. That it is explicitly linked to incremental production and has a limited time period makes it one of the most focused and effective government interventions in terms of achieving desired outcome.

GoI has indicated its intent to use similar incentives in strategically important sectors like semi-conductors and display fabs. Sensibly, the PLI scheme has been introduced without abolishing the incentives for MSMEs. The redefinition of MSMEs is, indeed, a progressive step. It will encourage firms to become larger than their current size. Of course, every business starts ‘small’. But the incentive structure must facilitate at least some of them to become giants.

One of the shortcomings of the India reform process of the last 30 years has been the inability of the government apparatus to get rid of its socialist hangover. Finally, it may have begun to happen. After all, even Air India is private now.