Our governments have regularly used special incentives to businessmen targeted to stimulate economic growth. There were in the recent past initial investment allowances where the full cost of the investment in the very first year of investment is set off against the Profit and Loss Account. Now there are tax incentives offered for shifting the location of garment factories outside the Colombo District. These are all subsidies to particular businesses. Economists have found little evidence that these tax incentives have generated benefits to the public to even cover the true economic costs of such incentives.

Market friendly not business friendly policies

While a broad low tax structure is very conducive to economic growth, such selective tax incentives are a different story. They distort relative prices and the corresponding profit rates and generally destroy wealth by encouraging firms to shift resources into obtaining these preferential government favors. A distinction must be drawn between business friendly and market friendly policies. Economists recommend market friendly policies instead of business friendly policies designed to help particular businesses or particular businessmen.

Why does a government make efforts to change the location of a business? Of course they will say it is to correct the imbalances in regional development caused by markets. It is true that there are wide regional imbalances and the Western Province is over- developed relative to the rest of the country. So those who advocate special incentives for businesses in the other Provinces argue that there will be new jobs created elsewhere through such incentives and there will higher incomes generated as well.

But these imbalances should be corrected not be giving special tax incentives but by strengthening the market price system in these provinces. The claim to generate new jobs and higher incomes is often exaggerated. When a factory is moved say from a location in the Western Province to another province, it doesn’t mean that those employed, are all new employees from the province. They are often from adjoining areas who had worked in the earlier factory location.

Suppose a brand new factory is established in the recommended location. All the employees are unlikely to be new employees. A much smaller percentage of the employees would be drawn from the ranks of the unemployed in the province. Similarly the extra income generated in the new location also has to be corrected to refer only to the difference in wages the employees will draw less what they drew earlier. Whatever activity they were engaged in previously will now be given up. It is not strictly true that the unemployed were not engaged in any economic activity before. So generally there is over-estimation of the benefits of tax incentives by way of employment generation and raising of incomes as a result of the tax incentives.

Companies receiving generous tax subsidies would not meet the expected increases in employment or incomes. Further, after the tax incentive period has expired, the company may move back its factory to the original location. Or else the company may run down its production or production capacity. We have seen such footloose firms in the garments industry. Even in the rare case where the company actually attracts people from other provinces to the low cost local work force, it will be necessary for the company to incur additional costs by way of public services.

Economists object to such selective taxes because they create distortions in economic activity by favoring one set of industry to the exclusion of other. The government will seek to recoup the losses on the tax subsidies from other businesses. Thus it will be forced to raise rates all round. So the over-all level of taxation is likely to increase the over-all rate of business taxation.

These selective tax incentives also encourage businessmen to lobby politicians for more government benefits rather than concentrate their energies on running the business efficiently and successfully. They will devote their valuable time and money to lobby for tax benefits. Politicians also like to cultivate businessmen for financial support for their election campaigns, welcome such lobbying. Our economic landscape is marred by such efforts and politicians have created favorites among businessmen. We are all familiar with the big names in business who have built fortunes on the special patronage of ruling politicians. The recent Supreme Court judgment in the case against John Keells Holdings on the Lanka Marine Services expose how the highest public servant, a post held by such eminent persons like the late Sir Arthur Ranasinha, has given away public assets free. The JKH Group has been gifted with eight acres of the land belonging to the Port.

The perception among businesses is that the tenders go only to government favorites. There is no level playing field. Often bribes have to be paid to win the tenders because tenders are ultimately decided not by the officials but by the minister. The tender procedure is a mere farce to appear to conform to the Financial Regulations which require all government purchases or sales of goods and services to be put up for competitive bidding. But in fact officials find loopholes to award the tender not to the best bidder but to steer contracts to those whom the minister wants to award them. Too often the tender process is circumvented. All tender notices invariably carry the clause that the tender need not be awarded to the best offeror and that the tenderer is not bound to give reasons for any such variation. Often the same firm does business with the organization and the tender is a mere front.

South Korea is a country that allowed cozy relationships between businessmen and politicians as did Japan earlier. As political and business scandals were exposed in the mid -nineties of the last century, the Koreans used to say "One President was a butcher, one was a thief and one is above the law". In 1995 ex-president Roh Tae Woo was charged with taking $369 million in bribes from businessmen while in office. The leading businessmen who were chairmen of the Chaebols, (- the Korean business conglomerates) the Daewoo Group and the Samsung Group, were jailed. These conglomerates were built on cheap loans extended by government banks.

Combining political and economic power poses a threat to democracy

The cozy relationships between ruling politicians and leading businessmen pose a threat to democracy itself. A free society is built upon checks and balances. There are the internal checks & balances within the polity such as the separation of the Judiciary and the protection of its independence from the legislature and the Executive. But there has also to be a separation of political and economic power bases. As Michael Novak stated in his Moral Case for Capitalism "Where citizens are corrupt, dishonest, half-hearted in their work, inert, indifferent to high standards, willing to cheat and to steal and to defraud, eager to take from the public purse but unwilling to contribute to the common weal and is entirely self-aggrandizing, self government must fail. Many peoples of the world in fact have shown themselves incapable of making the institutions of liberty work."