Friday, September 7, 2007

Exit Tax on IIT and IIM graduates

The Parliamentary Standing Committee on HRD, recently submitted a report recommending an "exit tax" on those students passing out from the premier government institutions like the IITs and IIMs, who leave the country after graduation. The rationale behind the exit tax is that, the State subsidises an IIT and IIM student to an extent of Rs 1.5 lakh and Rs 3.5 lakh each year respectively, and only a small portion of this is recovered as fees. It is hoped that an exit tax will stem the brain drain and also recover atleast the expenditure incurred on the student.

There are evidently two objectives - deterring brain drain and cost recovery/revenue generation. Before we proceed any further, we need to examine whether these two objectives are desirable or not? Assuming the objectives are desirable, is the exit tax the best solution? If not, are there better solutions to achieving these objectives?

While revenue generation and cost recovery is a no brainer, I am not convinced of the need to deter brain drain. Brian drain can arise from graduate students pursuing higher studies in foreign, mainly US, universities, and those getting recruited by MNCs to work outside the country. The brain drain that results from students pursuing higher studies abroad, also generates very useful positive externalities. It is undeniable that those who go abroad for higher studies amass susbtantial value addition, for which there limited opportunities available in India. These talented individuals, exposed as they are to the best practices and latest technologies, and equipped with world-class professional expertise, have contributed immensely to the spectacular growth of our software and knwoledge based industries.

Many of them, graduates of our premier professional institutes, have returned back to India to capitalize on their professional expertise, either as part of the large number of MNCs operating here in various sectors, or by themselves starting companies. Those who have not returned yet, play a significant role in influencing, in our favor, the investment and other strategic decisions of MNCs and even Governments across the globe. Many of these graduates occupy the highest echelons of the private (and even Government) sector bureaucracy. They also form a significant proportion of the scientific manpower pursuing cutting edge research across the globe. It is arguably true that their foreign education and exposure to opportunities, which are unavailable in India even now, have catapulted them into their present status.

The multiplier effect on the Indian economy due to them is arguably many times more than the expenditure incurred in training them. In purely business terms, if India were a company and these graduates its investment, then the Chief Financial Officer of India would have to be given a hefty bonus for generating such handsome Returns on Investment (RoI). It will be interesting if some study can attempt quantifying the IRR on investment in these graduates!

The arguement against the other category of brain drain, to the private sector, is fallacious. At first sight, those graduates who take jobs abroad may appear to be a loss to our economy. But a closer scrutiny reveals that the graduates from IITs and in particular IIMs, invariably join private MNCs, who have operations across the globe. The highly skilled professional manpower of these companies increasingly belong to a category of "global employees", who frequently navigate across the geographical boundaries of operation of the company.

The dilemma we face is simple. Do we retain our best talent in India as semi-finished human resources or permit them to utilize all the opportunity available to realize their full potential? I am inclined to believe in the latter. We need to acknowledge the reality of a global workforce, unconstrained by the physical limitations imposed by national boundaries.

The arguement about cost recovery and revenue generation through the exit tax is a red herring. Even assuming full cost recovery from all the graduates from these institutions, we are talking about just a few crores of rupees, while the costs are substantial. Any tax causes distortions in the incentive structure. The issue we need to consider is whether the benefits of an exit tax by way of additional revenues, outweigh the costs incurred by way of distortion in the incentive structure.

I am convinced that any attempt at effectively utilizing these local talent to our advantage, without compromising on the full potential for value addition, has to be incentive compatible. Without the appropriate incentive structure, any regulatory approach will lead to sub-optimal outcomes. Further, in an age of the "global employee", it may not even be appropriate to look at individual talent as the exclusive property of any country. Knowledge industries are not circumscribed by the physical limitations of national or company boundaries and thrive on the free movement of ideas and people across nations and companies. Since India prides itself as a knowledge superpower, it may be ironical for us to impose restrictions on the free movement of our human talent.

In any case, simplistic supply side fixes to such social and economic problems generally fail. They do not properly appreciate the complex demand side, incentive structure that drives issues like brain drain.

With points and counter-points flying in all directions, it is imperative that the debate be illuminated by more informed analysis of facts. I am surprised that there is no empirical study of the likely consequences of an exit tax or the positive externality generated by brain drain. We need to compare and study large enough samples of students who have gone abroad for higher studies, jobs, and those who have stayed at home.

It would help if we could have reliable data on the proportion of these graduates who come back to India after acquiring skills abroad, and on an average how long they stay abroad. What is the influence of Indian employees of these MNCs on the investment and other India specific decisions of the company? How do students, with comparable initial backgrounds, who pursue higher studies and professsional career in India and abroad, stack up against each other? The absence of such studies is all the more surprising since the issue in question is IITs and IIMs, which boast of excellent resources to carry out precisely such studies.

It is of course a different issue if the Government is concerned about the talent from IITs and IIMs not joining the public sector. A brain drain to the private sector, can be a more reasonable cause for concern. Are our best and brightest staying away from the Government sector? This is an issue which requires a different set of incentives. It strains credulity to accept that an exit tax will incentivize these graduates to stay on in India and join say, ISRO or BPCL, or pursue higher studies at IISc or the IITs.


gaddeswarup said...

What about considering these subsidies as loans with a small interest and recover from all after they get jobs. This ia roughly the Australian system. The amounts vary for courses and students are periodically reminded of the amounts they owe. Recovery from those who go abroad is a bit tricky. One of my daughters did not pay when she was working abroad.

Urbanomics said...

I agree. If the tax were imposed as a means to recover the expenditure incurred on training these students, then it would have made more sense. In fact, we can even consider recovering the entire expenditure.

This can be done either through taxation, like the exit tax, or as you suggest, by treating them as loans. Theoretically atleast, the second option is more economically efficient, and surely easier to administer. In an age when individuals randomly move across geographies and companies, it may be difficult to monitor and collect taxes. Loans in contrast, are simpler to recover. Given the fact that all these graduates end up earning impressive salaries, it may not be too much of a burden to cover the fees as loans and recover the same after they get jobs.

But in this case, it may be more appropriate to recover the expenditure from all the students, not just those leaving the country. If the Government so desires, some of the loans can be subsidized as interest-free or low-interest ones, or even partially as grants, which can even be academic performance (or grades) linked. Unlike taxes, which can distort incentives, loans can be targetted and are less distortionary.

Nitin Goyal said...

You have an interesting analysis. I posted some supplement to this one on my blog :