Tax corporates less to revive economy

December 1, 2014

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

If Finance Minister Arun Jaitley’s comments from last week are any indication, the union budget in February has the potential to usher in a new fiscal architecture in India.

“There was a misconception that higher tax rates lead to higher tax revenues … direct and indirect tax rates have to be brought to reasonable levels so that the basket increases and there is no incentive for evasion,” Jaitley said. That is how India’s first wave of reforms started in 1991 under the Narasimha Rao government (which lost pace and direction subsequently).

Surely, revenue – earned from taxation of incomes, commodities and services – is the prime consideration for a finance minister in order to keep the budget deficit in check.

The main source of government revenue comes from taxation of incomes, particularly from profits of the corporate sector. Presently, this sector generates more than a third of the central government’s gross tax revenue even though it is not in the prime of health. Production in the manufacturing sector is nearly static and profits come mainly from inflation. Had industry been growing faster, the government would have already reached its target of zero revenue deficit.

This has not happened because the previous Congress-led government increased the tax liability of the corporate sector by adding education cess and surcharges. The effective tax rate consequently climbed from 30 percent to 34 percent.

Many other countries have lowered their tax rates. Brazil has cut its rate to 25 percent, China to 25 percent, Germany to 29.5 percent, Canada to 26.5 percent, UK to 21 percent, Singapore to 17 percent, and so on.

The commonly accepted model corporate tax rate is 25 percent. This is possibly for India, although the process has to be gradual, starting with the next budget. As a first step, corporate tax should be freed of surcharges and cess so that the tax rate comes back to 30 percent.

Tax reduction will have a two-way effect. First, it will increase profitability of companies, attract more investment and generate growth. That means more revenue for the government from corporate profits, excise and customs. Second, lower taxation will discourage tax evasion.

Jaitley’s first full-year budget has to lay out a sound plan for policy reforms which can transform the economy.

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