January 25, 2017 12:00:32 am
The economic experts, also known as glitterati at budget time, are at it again. Which means that not only do old myths get rehashed but also, new myths get created. One of the favourite all-time Indian myths is that one must increase tax rates to increase tax revenue and the tax rate on Indian corporates is too low. This year, there is a greater urgency to the myths. State elections for five major states are coming up, including UP, a 204-million population state. If it were a country, it would be the fifth most populous country in the world, just ahead of Brazil (201 million) and some 54 million behind Indonesia (258 million).
The stakes are high because of state elections and a people’s verdict on demonetisation. If the Modi-Jaitley combine were to bring about an economically popular budget (not populist), then the fear among the political opposition is that the Modi-led BJP will run away with all the prizes. Unlike previous budgets, where indirect tax changes were paramount (an excise duty cut for Tweedledum, an excise duty increase for Tweedledee), in the 2017-18 budget, direct tax changes should (will?) reign supreme.
Personal income tax rates were reduced to a three-tier structure (10-20-30 per cent) in 1997. The flat corporate tax rate was reduced to 35 per cent in 1997 and 30 per cent (where it now stands) in 2005. Perhaps not coincidentally, both these changes were brought about by P. Chidambaram. The finance ministry and budgets have come forth with additional taxes in the form of surcharges and cesses over the years, but the tax rate has been considered sacrosanct.
This year, there is good reason to hope that the government will change the structure (tax slabs and rates) in a major way. Previously (in joint work with Arvind Virmani, appearing in The Indian Express, titled “Towards an Income Tax Revolution”, January 10 and “Taxing Your Way to Popularity”, January 19), I have discussed the desirability of increasing tax revenues by reducing tax rates. Two options, both with a negative income tax component, were offered — either a flat tax rate of 12 per cent, or a two-tier tax schedule of 10 and 20 per cent.
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This article is concerned with what needs to be done with our corporate tax rate structure. The existing reality is a tax rate of 30 per cent and an effective tax rate of 25 per cent — the 5 per cent gap between stated and effective tax is because of exemptions. How does this effective tax rate compare with other countries, especially our competitors? Very badly. The Indian corporate sector is one of the most heavily taxed in the world. Don’t believe me; do believe every major study done on this subject in the last decade.
In a 2012 study, published in National Tax Journal, a major academic publication, Douglas Markle and A. Shackelford, in “Cross Country Comparisons of Corporate Taxes”, find that for the two-decade 1988-2009 period, India had the fifth highest effective corporate tax (23 per cent) rate. In a 2015 study, Chen and Mintz, in “The 2014 Global Tax Competitiveness Report”, aggregate corporate income taxes for 95 countries for every year since 2005 to 2014. India had the 14th highest corporate tax rate for the manufacturing sector (29.5 per cent).
Every year, the Centre of Business Taxation, Oxford University, aggregates corporate income tax rates across 48 countries. They estimate two indicators of taxation — Effective Average Tax Rates (EATR) and Effective Marginal Tax Rate (EMTR). In 2016, India had the fourth highest EATR of 30.8 per cent. The top three are the United States, France and Argentina. India ranks 7th highest with an EMTR of 22.8 per cent.
One of the Modi government’s major goals has been to improve business conditions in India, also known as “Ease of Doing Business”. For the last two years, our rank stayed constant at 130.5 (131 and 130 in 2015 and 2016 respectively). The major reason for our rank not changing is the high rate of taxation of the corporate sector. The World Bank estimates that in 2016, Indian corporates paid a tax rate of 60.6 per cent of corporate profits — this is composed of 21 per cent corporate income tax, 4 per cent dividend distribution tax, 15 per cent social security contributions, 14 per cent central sales tax, etc.
How much do our East Asian competitors pay? An average of 35 per cent. Our South Asian neighbours pay 38 per cent, Bangladesh corporates pay 35 per cent. India’s rank on tax rates — 172 out of 190 countries.
So, stop wondering why the investment rate has been steadily going down and is now close to zero for the corporate sector. Stop blaming all as to why Indian manufacturing doesn’t grow and lags behind every major country in the world. Start blaming ourselves and our penchant (inherited from the socialist Congress) for taxing the rich in order not to have money to pay for the poor — “suit-boot ki sarkar” is what Modi inherited from the Congress.
Finance Minister Arun Jaitley had announced he wanted to move to a 25 per cent corporate tax rate, to be comparable to our East Asian competitors. Let us say that Jaitley removes all exemptions and reduces the corporate tax rate to 25 per cent. If the cess and surcharge stay, then this policy will do nothing to improve India’s competitiveness; the 5 per cent reduction in tax rate will be exactly equal to the exemptions now
removed. If the corporate tax rate is reduced to 25 per cent, and no cess or surcharge or removal of exemptions, then India’s competitiveness will begin to improve and the “Make in India” slogan will start to have meaning. If exemptions are to be removed, which they should be, then the corporate tax rate should be reduced to 20 per cent. This is compatible with the maximum marginal personal income tax rate of 20 per cent.
If tax rates are brought down, wouldn’t tax revenues decline? No. They will increase because of increase in tax compliance. If the Modi government believed that reduction in tax rates did not increase tax compliance, then they were entirely wrong in their demonetisation policy. Demonetisation explicitly (and correctly) targeted tax evasion: A meaningful reduction in effective corporate tax rates is the correct follow-through to the logic, and pain, of demonetisation.
I have talked to several individuals about the possibility of significant, non-tinkerisation tax reforms in the 2017-18 budget. As with much else since May 2014, opinion is divided not along caste lines but around whether you voted for Modi (not the BJP) in 2014. The people arguing for bad tax policy (that is, don’t change effective corporate tax rates) are the same who don’t want Modi to be an economic reformer. If, especially post-demonetisation, corporate tax rates are not reduced, the economy will be hurt — and Modi’s popularity will begin to take a hit. Most importantly, the economy’s growth rate will begin to falter. This must be what the opponents of meaningful economic reform want.
For obvious reasons, these opponents of economic reform cloak their Trojan horse arguments in terms of helping Modi, that is, don’t cut tax rates for corporates because this will confirm in people’s minds that the Modi government is really “suit-boot ki sarkar”. What will truly damage Modi (and the BJP) is if economic growth does not accelerate, if job growth does not begin to happen, if demonetisation pain is not replaced by demonetisation gain.
A necessary political and economic strategy for India’s success is for Modi/Jaitley to do the opposite of what the Nehru-Gandhi Congress has done for the last 70 years — make a significant cut in the corporate tax rate.
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