September 4, 2007EconomyPublic Policy

Ministry for Human Resource Damagement

The exit tax is the latest of its follies

This is an archived blog post from The Acorn.

The mandarins and the ministers at India’s human resources development (HRD) ministry can perhaps be excused for not having heard of Uri Gneezy and Aldo Rustichini. But surely someone there must have read Steven Levitt’s best-seller, Freakonomics, that mentions them? Gneezy and Rustichini conducted a field study in a group of day-care centres in Israel.

Parents used to arrive late to collect their children, forcing a teacher to stay after closing time. We introduced a monetary fine for late-coming parents. As a result the number of late-coming parents increased significantly. After the fine was removed no reduction occurred. We argue that penalties are usually introduced into an incomplete contract, social or private. They may change the information that agents have and therefore the effect on behavior may be opposite than expected. If this is true, the deterrence hypothesis loses its predictive strength, since the clause everything else is left unchanged’ might be hard to satisfy. [SSRN]

No, the HRD ministry is not—at least, not yet—considering imposing fines on late-coming parents. But it is considering something similar. A parliamentary standing committee has recommended imposing an exit tax on graduates leaving the country. The idea appears to have originated from a World Bank report that was published two years ago. The justification for the tax is the recovery of the huge government subsidy for tertiary education.

The presumption, of course, is that keeping the graduate in India is the only way of getting a return on the government’s subsidy. As Reuben Abraham wrote two years ago (via Prayatna), that assumption is questionable considering the effect of remittances. Indeed, as Mukul Asher and Amarendu Nandy argue in an article in the June issue of Pragati, using those remittances to fund education and infrastructure creates a positive dynamic for development.

But let’s consider how the exit tax might influence behaviour. Before that, let’s ask why the government should subsidise higher education in the first place? Well, because education has external benefits. A doctor or an engineer, even when working for private benefit, creates benefits for the society. [Let’s digress a little. On this account, there is justification for those courses where the externality is large, like medicine, civil and irrigation engineering, for instance. And also, that such expenditure is justified only when there is market failure, resulting in a shortfall in the number of graduates. This justification obviously does not apply to India, as the government controls the number of seats, and is responsible for any shortage!]

So how does the government set the quantum of the exit tax? If the reason it funds higher education is because there are externalities, then it stands to reason that merely recovering the subsidy (ie, the difference between the fees charged and the real costs) underestimates the actual loss to society. How does the government price the benefits to society’? Well, it can employ a lot of economists and accountants to calculate these costs each year, adjust for inflation, exchange rates, financial status of the family and yes, the graduate’s caste too. And create a table of exemptions and penalties to ensure that the exit tax is not only accurate, but also ensures social justice. The cost of implementing the exit tax will be borne, ironically, by the taxpayers. It will also be a huge waste of resources, and due to the complexity, will be a veritable goldmine for rent-seeking officials all the way from the university administrators to immigration officers at the airport.

Most importantly, and this is where the Israeli day-care centres come in, it is likely to be counter-productive, and cause many more graduates to leave and never return. That’s because once the implicit social contract is translated into monetary terms—into what is claimed as a small fraction of the graduate’s salary abroad—it can be paid off without any guilt’. It’s entirely possible that like Israeli parents, the number of emigrating graduates might increase.

In any case, unless the government can guarantee its graduates of equivalent employment, there is no moral basis to stop people from seeking a better living abroad. And there is no justification for the government to give such guarantees. So the exit tax is a non-starter from this moral perspective.

Indeed, the bogey of brain drain’ is just that, a bogey. The Indian government has no business discouraging its citizens from migrating abroad. If it is worried about its expenditure being wasted, then it should not spend its money where it is likely to be wasted. In today’s economic conditions, there is no reason for the government to subsidise higher education, certainly not at IITs and IIMs. There are numerous means to finance the education of students who cannot afford the fees, without having to involve subsidies. There is no reason for it to sit atop an artificial shortage of doctors, nurses, engineers or management graduates. It should immediately deregulate higher education. Given the abysmal state of India’s primary & secondary schools—the root cause of most contemporary evils—every rupee spent on higher education is a rupee snatched from the poor and the marginalised by depriving them of better education.

And if the government wants to raise revenues for primary education, here’s how it could do so without raising taxes: the HRD ministry’s department of higher education intends to spend about Rs 6483 crore (about US$1.43 billion) next year. How about scrapping this department and its programmes and use the funds for primary & secondary education instead?



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