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The why of tax incentives

At the height of the 2014 election campaign the Congress party as also the Aam Aadmi Party (AAP) levelled sharp criticism against the government of Gujarat extending huge tax concessions to industrial leaders like Gautam Adani. Like Dhirubhai Ambani, Adani built a huge empire, focusing on infrastructure. A major criticism of Chief Minister Modi was his offering land at very low prices. Gautam Adani responded through a few television interviews that it was nothing unusual. He pointed to several other state governments offering him even more attractive prices for land, to set up projects in their states.

Across the world states offer various incentives to attract investments. These range from low price for land and liberal tax incentives. In the US, for instance, several states including Houston, New Hampshire and Florida, do not levy sales tax. This is offered as an incentive for attracting industries to these states.

 

Ford Motor India Plant

This has been practised widely in several industrially developed states in India as well. In the 1990s, the AIADMK government headed by J Jayalalithaa attracted large investments by DuPont and Ford Motor Company to set up their factories in Tamil Nadu.

States also vied with each other in extending other concessions of various sorts. Tamil Nadu, for instance, offered Ford Motor Co. the funding of sales tax for 14 years at no interest. That meant all the sales tax revenues that were payable to the state for 14 years could be accumulated and used for capital and other expenditure. This meant, in several cases garnering, much larger funds than the monies invested on the plant and machinery at the starting point. Hyundai Motor Company and other later entrants also made full use of such practices.

Such large projects brought with them large employment not just in the main plant but also in dozens of component manufacturers’ in the services sector and in triggering more such investments in mega projects. Automobile companies that have set up shop this way have developed Tamil Nadu as a hub for production of specific brands of cars, especially in the smaller capacities, for export including to developed countries. Last year Hyundai is estimated to have exported 200,000 cars, Nissan accounted for a similar large volume of exports. Ford is estimated to target an export of around 100,000 cars and the list continues. Could these remarkable changes, especially the image of the state as a hub for production of automobiles of high quality and technology and the transfer of vital management practices have happened, but for the liberal incentives offered in the initial stage?

Of course, there is the valid criticism that states indulge in  fierce bottomless competition to attract investments  through a war of incentives. There is the criticism that the incentives offered do not match with the results. But this question can always be debated in any business and policy decisions as certain element of risk of failure is inherent in these. But overall, such incentives have worked well. Maharashtra in initial years built its vast industrial base on such active advocacy. Haryana followed suit soon and even Noida in UP offers such incentives in a big way. Tamil Nadu, Karnataka and Andhra Pradesh did this subsequently and today this has become a well-established trend.

As mentioned earlier, this is a global practice. Look, for instance, the shifting of automobile production from Detroit which held sway over this industry for several decades in the 20th century, making downtown Detroit a ghost town today.

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