No to investment allowance

FICCI and CII are reported to have suggested the reintroduction of investment allowance, a 20% tax break for new fixed investment. The finance ministry should say no, because this would be an undesirable distortion benefiting an undeserving few.

Apparently a FICCI study suggests that, historically, investment allowance was associated with a faster growth of investment.

So many factors affect investment that it would be rash to read much into any such correlation. The greater correlation is between the reduction of distortions and faster growth, and this implies that we must avoid distortions like investment allowance.

Besides, during a recession, there is no reason to favour investment over consumption. If investors feel they already have excess capacity, why subsidise the creation of further excess capacity, especially when global demand looks like staying weak even if the recession ends? Investment allowance promotes capital-intensive projects over labour-intensive ones, reversing the normal priority in a recession.

It will be availed of mainly or solely by those planning to invest already, and so will be an unwarranted bonanza for a few. A big Keynesian investment push is desirable, and is being given through public investment in infrastructure.


Why was investment allowance ever given? To compensate for uncompetitive and exorbitantly high interest rates, low profitability arising from the licence-permit raj, and high corporate tax rates. Investment allowance was a distortion given to counter other existing distortions.

We need to consign that approach to the history books. For competitive interest rates, we need sound monetary policy, fiscal prudence and a climate that induces global monetary inflows. Restoring corporate profitability through disbandment of the licence-permit raj has already been achieved in substantial measure, so Indian corporate profitability is among the highest in the world today without requiring a tax-break boost.

The right tax reform would be to reduce the corporate tax rate and exemptions too. We should not continue with a high corporate tax rate and add yet another distortion in the form of investment allowance.