Why penalise telecom?

Business Standard, 1 February 2006

Indian telecom is burdened with a strange menagerie of taxes. This is bad tax policy, for no industry or sector should face higher or lower taxes than any other. I make no argument that telecom is somehow a good thing and requires favoured treatment. I argue that telecom should be treated on a level playing field, like any other good or service in the country, and be placed into a single flat rate VAT. Simultaneously, all other taxes/charges being imposed upon the telecom sector should be removed, while allocating spectrum through an auction.

At present, the telecom sector pays a share of revenue named "licence fee", an "access deficit charge", a "universal services obligation", a "spectrum charge", and a "wireless charge", in addition to the service tax.

The access deficit charge (ADC) and the universal services obligation (USO) are based on the wrong-headed notion that the State will tax urban consumers to subsidise rural telephony. If the State wants to run a social program, it should do so, but this should be paid for by the general exchequer. It is bad tax policy to impose a tax upon one industry to finance a certain social program. If the State believes that rural telephony is important, it should be willing to pay for it out of general tax revenues.

More importantly, it is time for us to wake up and abandon notions of a State that helps rural telephony. For decades, the achievement of socialist Indian telecom policy was telephony that was the preserve of the rich. Then, policy was wrested away from the DOT. Government monopolies were broken, VSNL was privatised, private/foreign companies were brought in, and competition was unleashed. In December 2005 alone, 4.5 million mobile phones were added. The crash in prices has brought phones to poor people on an unimaginable scale.

A few years of modern policies have done more for poor people accessing telecom than fifty years of socialism. It is, hence, time to abandon government meddling in rural telephony, and scrap the ADC and the USO. Merely removing these two charges will drive down prices and take phones to more poor people than the government achieves.

The next issue is the licence fee. If someone runs (say) a restaurant why should the government collect a fraction of his revenues as a "licence fee", over and beyond the VAT? The license fee is an excise on one industry and diverges from the core public finance principle of a single-rate VAT for all firms. Such a flat rate VAT should have VAT credits flowing in both directions. The buyer of telecom should get VAT credits for the VAT on his bill, and the telecom company should get VAT credits on the goods/services purchased by it. Every industry has the right to demand such a level playing field - including telecom.

Looking forward, telecom is an area where there can be enormous gains by entry of innovative companies in areas such as voice on IP, long distance, broadcast through mobile phones, and broadband. All these new businesses, which would buy some kinds of telecom services and sell some kinds of telecom services, should have the identical tax treatment, of a flat rate VAT.

The last puzzle is the allocation of spectrum. The armed forces are squatting on a great deal of spectrum, thus reducing the amount available for civilian use. The first task of policy should be to replicate (say) the US/UK situation on frequencies taken up for defence. This would free up a great deal of spectrum.

Large chunks of the spectrum need to be freed up as a public good, for technologies such as WiFi, where smart protocols handle the sharing of spectrum between multiple users. With technology like WiFi, spectrum is non-rival (the use by one person does not preclude use by another), and there is no role for the State in allocation. As with public parks, the role of the State lies in setting aside the resource, and then blocking encroachment.

But there are problems requiring a fixed spectrum allocation. There are many competing claimants: GSM and CDMA mobile phones, radio and TV stations, etc. This allocation should be done using an auction, for a period of five years at a time. If a TV station wants a piece of spectrum more badly than a CDMA company, it would bid a higher price. GSM is an inefficient user of spectrum, so in the auction, GSM would be rightly penalised. Such an auction would depoliticise spectrum allocation between vendors and between technologies.

The reason for having relatively short contracts is to help all parties rethink the situation five years from now, when everything will have changed in technology. This will help avoid failures such as the European spectrum auction.

The telecom sector generates roughly 0.25% of GDP as non-tax revenue. There is a mechanical tendency to think that each proposal for removing a bad tax should be matched by a proposal for some other way to commensurately raise revenue. This is the road to bad tax policy. Sound tax policy consists of funding the State using exactly two taxes - the income tax and a flat rate VAT applied on all goods and services. For example, customs was a bad tax, and has been steadily eliminated in India, without requiring the introduction of new taxes to fill the gap.

In practice, fiscal stress is unlikely. Telecom is a fast growing sector. The elimination of the bad taxes would generate a drop in prices, and further spur growth. The flat rate VAT should be roughly 12%, reflecting a middle road between the present rate on goods and the present rate on services. The spectrum auction will also generate revenues. Put together, India will obtain considerable efficiency gains, without adverse impact on government finance.

Finally, telecom reminds us of the difficulties that will come if specific services are allocated to state governments for the State VAT. Telecom is a national level service. It is extremely cumbersome to tax it, one state at a time. The two-part GST, as proposed by the Kelkar Task Force, is the only rational approach which is consistent with the 88th amendment to the constitution. This involves having a State GST on all services.

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