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Fiscal Industrial Incentives Schemes of the Government of Madhya Pradesh: Costs and Benefits

Publication date

Jan, 1999

Details

Report submitted to the Government of Madhya Pradesh.

Authors

Indira Rajaraman, Hiranya Mukhopadhyay and Namita Bhatia

Abstract

Madhya Pradesh, like other states, has sought to promote industrial development by offering three types of fiscal incentives: capital investment subsidies; interest subsidies; and exemption/deferment from sales tax. These concessions have imposed heavy costs on the state exchequer; the revenues foregone from such tax concessions alone could fund at least a dozen new growth centres each year (at Rs. 35 crore per growth centre). In a scenario where different types of industrial incentives are superimposed on each other, the overall impact on investment is additive. The disentangling of the incremental impact of each has been attempted in two ways, using a database on investment in large and medium industry in the state. Both econometric exercises show that tax concessions failed to play an investment promoting role. The landmark multilateral agreement reached between chief ministers of states on 16 November, 1999, to remove sales tax concessions with effect from 1 January, 2000, is thus directly in line with the findings of this study. A further date for introduction of VAT has been set at 1 April, 2001; a full-fledged VAT operated on the tax credit method is, with very few exceptions, incompatible with giving new units a differential tax advantage: The econometric results for the capital subsidy are more ambiguous. The slowing of the growth rate of real investment after 1988 cannot be ascribed solely to the replacement that year of the central government subsidy, which was available to large and medium industrial units, by the state subsidy scheme which (with some minor exceptions) was not available to large and medium units. There was also a sharp concurrent decline in power availability. Given the overwhelming importance of infrastructure in attracting industry into a state, the first best option is the redirection of fiscal resources from capital subsidies towards infrastructure provision (the November agreement between states does not include capital subsidies in its ambit). If this first-best alternative is not acceptable, it should be possible to redefine the base to include fixed investment in infrastructure alone. Alternatively, or in addition, the capital subsidy could be confined to a set of labor-intensive thrust industries.

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