INDIAN PUBLIC FINANCE TERMPAPER: CUSTOMS DUTIES Ashish Bharadwaj, M.Sc. Economics II, MSE (Nov 2007)

The central government has four major taxes: personal income tax, corporation tax, central excise duties and customs duties. In our analysis, we will confine ourselves to customs duties only. The customs duty in India consists of ‘basic’ tariff, the additional duty of customs (AD), and special excise duty (SAD). The additional duty is the counterpart of excise duties paid by domestic manufacturers i.e. countervailing duty (CVD). The special additional duty has been introduced to serve as the counterpart of state sales taxes on domestically produced goods. Since the customs duty is collected under the three sub-heads (basic, AD and SAD), its custom duty collection rate should be obtained by dividing total collections under the three heads by the total value of imports during the year. Some commodities like alcohol have a ‘basic’ rate higher than the ‘peak’ rate. During the reform years, the “peak” rate has come down from 150 % in 1991-92 to 40 % in 1997-98. The “peak” rate was reduced to 35% in 2001-02 and 30% in 2002-03. The reduction in the peak duty rates has continued. The 2005-06 Budget reduced the peak duty rate to 15% for non-agricultural products. The average tariff rate has therefore declined over the 1990s. As a result the customs duty collection rate has declined from about 47% in 1998-99, and to 21% in 2000-01. The average customs tariffs rates still remain among the highest in the world1. 1. Revenue Performance of Customs and Excise Duty relative to GDP

Excise and Customs revenue as % of GDP

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1950

-51

1952

-53

1954

-55

1956

-57

1958

-59

1960

-61

1962

-63

1964

-65

1966

-67

1968

-69

1970

-71

1972

-73

1974

-75

1976

-77

1978

-79

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

Year

Rev

enue

(as

% G

DP)

Excise revenue as % of GDP Customs revenue as % of GDP

1 Srivastava, D.K., “Issues in Indian Public Finance”(2005), New Delhi

1

The profile of the share of the customs duties shows more of an inverted U-shape, similar to Union excise duties, although these started at a level much higher than excise duties. In 1950-51, the customs duties accounted for nearly 1.6% of GDP, which was the highest among all major central taxes. (Table 1, Appendix A) These were overtaken by excise duties in 1957-58. Following a slightly volatile pattern, these reached a peak of 3.9% in 1986-87, after which they started declining. By 2001-02, these had reached a level, relative to GDP, of 1.8%, which is compared to its level in the mid sixties. Thus, customs duty, which was the highest contributor, is fast becoming the lowest contributor now. 2. Relative Shares of Major Central Taxes in Centre's Gross Tax Revenues

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1950

-51

1952

-53

1954

-55

1956

-57

1958

-59

1960

-61

1962

-63

1964

-65

1966

-67

1968

-69

1970

-71

1972

-73

1974

-75

1976

-77

1978

-79

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

Year

Shar

e in

%

Income Tax Corporation Tax Excise Duty Customs Duty The chart highlights the inverted U-shape of the curve representing the share of Union excise duties, which can be contrasted with the more U-shape type of curve of the customs duties until the beginning of the nineties. What is also clearly observable is that the four taxes are tending to come close to each other in terms of their shares in the centre’s gross revenue receipts. (Table 2, Appendix A) 3. Customs Duties: Annual Buoyancy Tax buoyancy is measured as % change in tax revenue over a given period by % change in tax base, which is generally taken to be GDP, over the same period. While the contribution that a tax makes to overall collection of tax revenues is an important consideration, another important feature of the tax sources is their volatility. To examine this, we look at the yearly growth rates. Customs duties are more noticeable for their negative growth in more recent years. (Table 3, Appendix A)

2

Annual Customs Duty Buoyancy

-10.00

-5.00

0.00

5.00

10.00

15.00

1951

-52

1953

-54

1955

-56

1957

-58

1959

-60

1961

-62

1963

-64

1965

-66

1967

-68

1969

-70

1971

-72

1973

-74

1975

-76

1977

-78

1979

-80

1981

-82

1983

-84

1985

-86

1987

-88

1989

-90

1991

-92

1993

-94

1995

-96

1997

-98

1999

-00

2001

-02

Year

Buo

yanc

y

32.28.28.5

1010.1

11

13.9

20.5

17.110.9

8.8

8.7

7.120

22.2

16.8

0 5 10 15 20 25 30 35

Custom Tariff Rate

India

Turkey

S.Africa

Chile

Mexico

Argentina

Russia

Egypt

Thailand

Indonesia

Taiwan

S.Korea

Malaysia

Sri Lanka

Bangladesh

China

Cou

ntry

Comparison of custom rate among countries

3

EMPIRICAL STUDY I Testing for Cointegration between the following

a) Customs Revenues and Other Central Tax Revenues such as Personal Income Tax, Corporation Tax and Total Direct Tax Revenues (1970-2006)

2b) Customs Revenues and Imports of Principal Commodities Dependent Variable:

} CR = customs revenues {YtPossible Independent Variables {X } to test for Cointegration with CR tER = excise revenues ITR = income tax revenues CTR = corporation tax revenues DTR = total direct tax revenues IMP = imports

Yt = β + β X0 1 t + ut

Y , X ~ Cointegration (d,b) if both series are integrated of same order i.e. d=b t t Testing for Stationary using Augmented Dickey-Fuller Test (ADF Test)

Variable ADF Test Statistics*

First Difference ADF Test Statistics* Second Difference ADF Test Statistics*

Order of Integration

CR 0.837 Δ CR -3.05 - - I(1) t t(non

stationary) (stationary)

ER 3.818 Δ ER -0.958 Δ ER -6.367 I(2) t t t-1(non stationary) (stationary)

ITR 3.710 Δ ITR 0.038 Δ ITR -4.256 I(2) t t t-1(non stationary) (stationary)

CTR 3.801 Δ CTR 0.907 Δ CTR -1.787 > I(2) t t t-1(non stationary) (non

stationary) DTR 4.319 Δ DTR 2.734 Δ DTR -3.104 I(2) t t t-1

(non stationary) (stationary) IMP 2.344 Δ IMP 3.514 Δ IMP -0.560 > I(2) t t t-1

(non stationary) (non stationary)

*Compared with (-2.975) Critical Value at 5% level (Table 4, Appendix B and Table 5, Appendix C) Conclusion: We can conclude that any regression model containing CR with any other variable mentioned above would be meaningless and cannot be tested for Cointegration since they are integrated of different orders.

2 Food & live animals, beverages & tobacco, Crude materials, inedible, except fuels, Mineral fuels, lubricants and related materials, Animal and vegetable oils and fats, Chemicals, Manufacture goods classified chiefly by material, Machinery and transport equipment, Miscellaneous manufactured articles

4

EMPIRICAL STUDY II Testing for Causality between Customs Revenue and Effective Customs Duty CR = Customs Revenue ETR = Total Customs Revenue/GDPmp Where ETR is the effective tax rate (customs duty) and GDP has been taken as a proxy for a tax base for customs duty.

2Ln CRt = β0 + β1 (ln ETRt) + β (lnETR2 t) + ut

Variable ADF Test Statistics*

First Difference ADF Test Statistics*

Order of Integration

Ln CR -1.712 Δ ln CR -3.611 I(1) t t(non stationary) (stationary)

Ln ETR 2.001 Δ ln ETR -3.359 I(1) t t(non stationary) (stationary

2

*Compared with (-2.975) Critical Value at 5% level

Ln CRt = 18.53 + 2.81(lnETRt) + 0.14(lnETRt)2

(4.91) (2.28) (14.49)

R2 = 0.9673 DW statistic = 0.13

Figures in parentheses are t-values (5% level of significance) (Table 4, Appendix B and Table 5, Appendix C) Testing for stationarity of residuals in the model using ADF test ADF test statistic = -1.342 Interpolated DF 5% critical value = -2.972 MacKinnon approximate p-value = 0.6098 Observations:

1. Errors are non stationary 2. Durbin-Watson statistic value considerably less than 2.0 implies that the errors

serially correlated Conclusion: It can be concluded that the above regression is spurious since both X and Y variables are stationary of same order but the error term is non-stationary. However, we can apply OLS to the appropriately differenced series (taking into account the appropriate lag length using either AIC or SC).

(LnETRt) 0.075 Δ ln ETR2 -3.222 I(1) t(non stationary) (stationary

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2 2ΔlnCR = 0.06 - 0.23ΔlnCRt t-1 + 0.29ΔlnETRt-1 + 1.36ΔlnETR + 0.04Δ (lnETR ) + 0.007Δ (lnETRt t t-1) (5.9) (-1.24) (0.97) (8.8) (2.6) (0.38)

ΔlnCR = 0.057 - 0.11ΔlnCRt t-1 + 0.09ΔlnETRt-1 + 0.95ΔlnETRt

(5.4) (-0.63) (0.59) (25.29) ΔlnCRt = 0.03 + 0.26ΔlnCRt-1 – 0.1Δ (lnETRt) 2 2 + 0.03Δ (lnETRt-1) (2.93) (1.69) (-13.5) (1.92)

2lnETR and (lnETR) Granger cause lnCR

EMPIRICAL STUDY III Estimating a Laffer curve for customs duty revenues and effective rate (customs duty) for India (1970-2006) using a log-lin model.

lnCRt = 228.8ETRt – 3012.2 (ETR )2t

(14.5) (-7.6) R2 = 0.928

tlnCR 228.8 6024.4 tt

ETRETR

∂= −

∂

tlnCR 0 0.0379tt

ETRETR

∂= => =

∂ or 3.79% FOC:

2t

2

lnCR (6024.4) 0tETR

∂= − <

∂SOC:

Since the quadratic term is negative and significant, the Laffer curve has a bell shape. Taking the first derivative of lnCR, with respect to ETR, and setting the first derivative to zero, we find that the revenue-maximizing tax rate is 3.79%. This can also be seen from the graph below. We may draw a conclusion that the Federal government is likely to raise more tax revenues by raising the tax rate up to this level.

(Table 4, Appendix B and Table 5, Appendix C)

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7

Appendix A

Table 1: Tax revenues as % of GDP (1950-51 to 2002-03)

Source: Indian Public finance statistics, 2006

Table 2: Relative Share (in %) of Central Taxes in Gross Central Taxes

Year Excise customs Year Excise customs Year Excise customs 1950-51 0.68 1.58 1968-69 3.40 1.15 1986-87 4.65 3.69 1951-52 0.81 2.21 1969-70 3.57 0.99 1987-88 4.64 3.87 1952-53 0.80 1.68 1970-71 3.85 1.15 1988-89 4.47 3.75 1953-54 0.48 1.41 1971-72 4.21 1.42 1989-90 4.61 3.71 1954-55 1.01 1.73 1972-73 4.31 1.59 1990-91 4.31 3.63 1955-56 1.34 1.55 1973-74 3.97 1.52 1991-92 4.30 3.41 1956-57 1.47 1.34 1974-75 4.17 1.72 1992-93 4.12 3.18 1957-58 2.05 1.35 1975-76 4.02 1.71 1993-94 3.69 2.58 1958-59 2.10 0.93 1976-77 4.70 1.73 1994-95 3.69 2.65 1959-60 2.30 1.00 1977-78 4.38 1.80 1995-96 3.38 3.01 1960-61 2.43 0.99 1978-79 4.87 2.20 1996-97 3.29 3.13 1961-62 2.69 1.17 1979-80 4.97 2.42 1997-98 3.15 2.64 1962-63 3.06 1.26 1980-81 4.52 2.37 1998-99 3.06 2.34 1963-64 3.25 1.49 1981-82 4.40 2.55 1999-00 3.20 2.50 1964-65 3.06 1.52 1982-83 4.28 2.72 2000-01 3.28 2.28 1965-66 3.25 1.95 1983-84 4.66 2.54 2001-02 3.19 1.77 1966-67 3.30 1.87 1984-85 4.54 2.87 2002-03 3.34 1.82 1967-68 3.13 1.40 1985-86 4.66 3.43

Year Income Corp.tax Excise Customs Year Income Corp.tax Excise Customs 1950-51 33.0 9.7 16.7 38.8 1977-78 11.3 13.8 50.2 20.6 1951-52 28.6 8.0 16.7 45.5 1978-79 11.2 11.9 51.0 23.0 1952-53 27.6 9.3 18.7 39.0 1979-80 11.2 11.6 50.2 24.4 1953-54 29.1 8.9 12.9 37.8 1980-81 11.4 9.9 49.3 25.9 1954-55 28.9 8.1 23.8 40.6 1981-82 9.3 12.4 46.8 27.1 1955-56 27.2 7.5 29.9 34.8 1982-83 8.9 12.3 45.5 28.9 1956-57 26.5 8.8 33.4 30.4 1983-84 8.2 12.0 49.3 26.9 1957-58 23.8 8.0 39.6 26.0 1984-85 8.2 10.9 47.5 30.0 1958-59 24.5 7.7 44.6 19.7 1985-86 8.8 10.0 45.2 33.2 1959-60 16.9 12.1 41.1 17.8 1986-87 8.8 9.6 44.1 34.9 1960-61 18.9 12.3 46.5 19.0 1987-88 8.5 9.1 43.6 36.4 1961-62 15.7 14.8 46.4 20.1 1988-89 9.6 9.9 42.4 35.5 1962-63 14.5 17.2 46.6 19.1 1989-90 9.8 9.2 43.4 34.9 1963-64 15.5 16.8 44.6 20.5 1990-91 9.3 9.3 42.6 35.9 1964-65 14.6 17.2 44.0 21.8 1991-92 10.0 11.7 41.7 33.0 1965-66 13.2 14.8 43.6 26.2 1992-93 10.6 11.9 41.3 31.9 1966-67 13.4 14.3 44.8 25.4 1993-94 12.0 13.3 41.8 29.3

8

Contd

Source: Indian Public finance statistics, 2006

Table 3: Estimated Annual Buoyancy of Central Taxes

Year Income Corp.tax Excise Customs Year Income Corp.tax Excise Customs 1951-52 1.52 0.57 4.23 7.58 1977-78 -1.22 1.82 0.41 1.32 1952-53 8.59 -1.02 1.65 13.43 1978-79 2.08 0.30 2.46 3.91 1953-54 -0.05 -1.15 1.63 -0.98 1979-80 1.42 1.15 1.23 2.13 1954-55 -1.39 0.15 -2.61 -3.08 1980-81 0.65 -0.31 0.43 0.88 1955-56 0.28 -0.77 18.74 -5.38 1981-82 -0.12 2.91 0.82 1.51 1956-57 0.76 1.99 0.63 0.21 1982-83 0.55 0.93 0.74 1.63 1957-58 2.89 3.40 14.24 1.27 1983-84 0.50 0.85 1.62 0.55 1958-59 0.39 -0.21 1.25 -2.03 1984-85 1.14 0.21 0.77 2.20 1959-60 -2.50 17.85 2.83 2.39 1985-86 2.28 0.91 1.22 2.67 1960-61 1.40 0.31 1.62 0.94 1986-87 1.23 0.86 0.98 1.71 1961-62 -0.33 7.11 2.92 4.14 1987-88 0.79 0.62 0.97 1.40 1962-63 1.65 5.52 2.96 2.11 1988-89 1.80 1.50 0.78 0.81 1963-64 2.44 1.61 1.47 2.42 1989-90 1.21 0.48 1.24 0.92 1964-65 0.31 0.86 0.59 1.13 1990-91 0.35 0.76 0.55 0.85 1965-66 0.36 -0.53 2.18 6.45 1991-92 1.70 3.18 0.99 0.53 1966-67 1.03 0.60 1.15 0.66 1992-93 1.19 0.91 0.66 0.47 1967-68 0.33 -0.33 0.65 -0.72 1993-94 1.05 0.88 0.19 -0.45 1968-69 2.72 -0.58 2.53 -2.20 1994-95 1.78 2.09 1.00 1.16 1969-70 1.83 1.77 1.52 -0.51 1995-96 1.71 1.11 0.44 1.94 1970-71 0.81 0.71 2.24 3.48 1996-97 1.12 0.83 0.79 1.31 1971-72 1.89 3.85 2.41 4.60 1997-98 -0.55 0.69 0.58 -0.55 1972-73 1.61 1.77 1.25 2.26 1998-99 1.28 1.57 0.77 0.08 1973-74 0.86 0.21 0.55 0.76 1999-00 2.38 2.23 1.45 1.69 1974-75 0.99 1.20 1.34 1.87 2000-01 3.02 2.07 1.36 -0.23 1975-76 5.20 2.87 0.47 0.87 2001-02 0.09 0.29 0.67 -1.75 1976-77 -0.21 1.83 3.37 1.22 2002-03 1.80 3.10 1.60 1.35

Source: Indian Public finance statistics, 2006

1967-68 13.8 13.2 48.8 21.8 1994-95 13.0 15.0 40.5 29.0 1968-69 15.1 11.9 52.6 17.8 1995-96 14.0 14.8 36.1 32.2 1969-70 15.9 12.5 54.0 15.0 1996-97 14.1 14.3 34.7 33.0 1970-71 14.8 11.6 54.9 16.3 1997-98 12.3 14.4 34.4 28.9 1971-72 13.9 12.2 53.2 18.0 1998-99 14.1 17.1 37.0 28.3 1972-73 13.9 12.4 51.6 19.0 1999-00 14.9 17.9 36.0 28.2 1973-74 14.6 11.5 51.3 19.7 2000-01 16.8 18.9 36.3 25.2 1974-75 13.8 11.2 51.1 21.1 2001-02 17.1 19.6 38.8 21.5 1975-76 16.0 11.3 44.0 18.7 2002-03 16.6 20.8 37.1 20.2 1976-77 14.5 11.9 51.1 18.8

Appendix B

Table 4: GDP & Import figures along with the calculated ETR (=Revenues/GDP)

Year

GDP at market prices ( at 1993-94 prices)

(in Rs.crore)

Imports (in Rs.crore)

Effective tax rate etr^2 (customs)

1970-71 326925 1634.2 0.001602814 0.000003 1971-72 332516 1824.5 0.002090125 0.000004 1972-73 330594 1867.4 0.002592304 0.000007 1973-74 341050 2955.4 0.002920393 0.000009 1974-75 345101 4518.8 0.003862637 0.000015 1975-76 376731 5264.8 0.003766613 0.000014 1976-77 383163 5073.8 0.004055715 0.000016 1977-78 410873 6020.2 0.004439328 0.000020 1978-79 434437 6810.6 0.005579635 0.000031 1979-80 411663 9142.6 0.007102897 0.000050 1980-81 439201 12549.2 0.007761822 0.000060 1981-82 467139 13607.6 0.009204969 0.000085 1982-83 484217 14292.7 0.010571706 0.000112 1983-84 518491 15831.5 0.010767786 0.000116 1984-85 539874 17134.2 0.013041932 0.000170 1985-86 570267 19657.7 0.016704456 0.000279 1986-87 597850 20095.8 0.019193778 0.000368 1987-88 623371 22243.7 0.02198049 0.000483 1988-89 684832 28235.2 0.023078653 0.000533 1989-90 728952 35328.4 0.02474237 0.000612 1990-91 771295 43192.9 0.026765375 0.000716 1991-92 778289 47850.8 0.028597346 0.000818 1992-93 819318 63374.5 0.029019257 0.000842 1993-94 859220 73101.0 0.02582924 0.000667 1994-95 923349 89970.7 0.029012865 0.000842 1995-96 993946 122678.1 0.035974791 0.001294 1996-97 1067444 138919.7 0.040143558 0.001612 1997-98 1115248 154176.3 0.036039518 0.001299 1998-99 1182020 178331.9 0.034405509 0.001184 1999-00 1266283 215236.5 0.038237108 0.001462 2000-01 1316201 230872.8 0.025955762 0.000674 2001-02 1383705 245199.7 0.020481244 0.000419 2002-03 1440632 297205.9 0.022141671 0.000490 2003-04 1564620 359107.7 0.022105048 0.000489 2004-05 1612201 501064.5 0.025934111 0.000673 2005-06 1699056 660408.9 0.02745348 0.000754 2006-07 1760539 862301.5 0.033110315 0.001096

Source: CSO and Statistics on Indian Economy, RBI

9

Appendix C

Table 5: Central Government Receipts of major components (Rs.crore)

Year

Indirect tax (net)

Excise duties

(net) Customs

duties Income Corporation

tax tax 1970-71 1940 1369 524 114 371 1971-72 2342 1586 695 75 472 1972-73 2691 1757 857 137 558 1973-74 3052 1971 996 213 583 1974-75 3956 2528 1333 362 709 1975-76 4530 2988 1419 480 862 1976-77 4895 3193 1554 542 984 1977-78 5319 3335 1824 327 1221 1978-79 6726 4128 2424 471 1256 1979-80 6617 3481 2924 475 1392 1980-81 7465 3723 3409 438 1311 1981-82 9024 4181 4300 459 1970 1982-83 10294 4567 5119 438 2185 1983-84 12310 6165 5583 527 2493 1984-85 14276 6625 7041 697 2556 1985-86 17442 7331 9526 665 2865 1986-87 20296 8164 11475 719 3160 1987-88 23915 9423 13702 603 3433 1988-89 27730 10922 15805 1492 4407 1989-90 32321 13096 18036 1088 4729 1990-91 36075 14100 20644 1250 5335 1991-92 39966 16017 22257 1627 7853 1992-93 41969 16367 23776 1831 8899 1993-94 40927 17224 22193 1355 10060 1994-95 49045 21064 26789 3468 13822 1995-96 59652 22176 35757 4318 16487 1996-97 68326 23463 42851 4715 18567 1997-98 68500 25516 40193 3589 20016 1998-99 72532 28581 40668 5760 24529 1999-00 86836 34944 48419 9131 30692 2000-01 87007 49758 34163 23766 25177 2001-02 85828 54469 28340 22106 25133 2002-03 96932 62388 31898 27779 33893 2003-04 110392 70245 34586 30765 45706 2004-05 128854 77241 41811 35443 60289 2005-06 149572 86642 46645 45238 75187 2006-07 177201 92304 58292 59667 108880

Source: CSO and RBI

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