No more bandaid tax policy

The effective corporate tax rate in India is identical to the stated 30 per cent rate. This has killed corporations and the economy.

Written by Surjit S Bhalla | Published:June 7, 2014 1:00 am
Perhaps we should call it the Sen (Amartya)-NAC-Piketty policy of taxation. Perhaps we should call it the Sen (Amartya)-NAC-Piketty policy of taxation.

There can be many positive side-effects of the Narendra Modi-BJP mandate. The electorate has provided the BJP with a free hand in charting India’s economic and social policies. Some of the structural changes demanded by the electorate will require deft manoeuvring between the Centre and states, or between Lok Sabha and Rajya Sabha. However, the forthcoming budget, that is, the maiden tax and expenditure policy document, is per se only constrained by the imagination, thinking and boldness of PM Modi and Finance Minister Arun Jaitley. They have only two choices in formulating the budget. Either they continue with a little bit of tinkerisation here and a little bit of bandaid there. This is the policy followed by every government of India budget, with only one exception (February 1997) since the breakthrough 1991 budget. Or they decide to chart an intelligent new course in formulating tax and expenditure policies.

Let us start with some no-brainers. Given the state of the economy, tax increases are ruled out; equally, rationalising of expenditures are ruled in so that the net result is that India embarks on a structural fiscal reduction path, a programme that gets India to a Central fiscal deficit of 3 per cent of GDP and a consolidated Centre plus state deficit of around 5.5 per cent of GDP. This will entail a reduction of around 2.5 to 3 per cent of GDP from the present obscene levels. This and the next article will discuss how corporate and personal income taxes can be restructured according to non-bandaid thinking.

Around the Western world, there is heightened concern about rich fat cats increasing their incomes at the expense of everyone else. There was the 99 per cent Wall Street movement and now there is economist Thomas Piketty’s recommendation that there be a super fat cats tax. The jury is still out on increasing tax rates for wealthy individuals and rich corporations in the West. In India, the tax-the-rich recommendation has preceded Piketty by at least five years. Perhaps we should call it the Sen (Amartya)-NAC-Piketty policy of taxation.

In India, corporations are already taxed at the highest effective rate in the world. (An effective tax is simply the ratio of tax paid to income earned. The difference between the stated nominal and the actual effective arises because of legal tax deductions.) And this sock-it-to-the-rich fat cats policy has had predictable effects. High and onerous tax rates have slimmed the Indian corporate sector so much that they are too starved to produce any additional output. Industrial output in India has not increased by even one widget over the last three years. The 2014-15 Indian effective tax rate of 29 per cent is a full 11 percentage points higher than most of our East Asian competitors, and 15 to 20 percentage points higher than competitors in Germany and Sweden.

The objective of corporate taxation should be threefold — simplicity, fairness and broadly revenue-maximising. Regarding simplicity, there is considerable improvement that can be made. First, there should be only one tax rate, rather than the plethora of corporate tax payments involved (on income, dividends, surcharge and education). This tax rate should be reduced to 21 per cent (see table). Second, there should be only one corporate tax exemption (accelerated depreciation). This simple tax code can help industrial growth to be in the range of 5-10 per cent per year rather than the range of -3 to 3 per cent for the last three years. The extra growth and extra compliance can easily recover the lost tax revenue in just two years.

In sharp contrast, the UPA policy towards budget-making was broadly as follows. Decide on welfare expenditures as decided by the NAC and the high command. Financial markets and ratings agencies decide the fiscal deficit level at the Centre. Bureaucrats in the ministry of finance then decide how much to tax. But they are constrained by one obstacle — they cannot change tax rates. So they work overtime to cook the budget — retrospective tax legislation, education cess and surcharges. A parallel army of ideological economists then find supporting documents as to why the tax rate should actually be substantially higher. Franz Kafka or Joseph Goebbels anyone?

The UPA-NAC budget math on corporate taxes for 2014-15 is broadly as follows. The corporate tax rate is composed of a basic rate of 30 per cent plus a surcharge of 10 per cent (3 per cent tax) and an education cess of 1 per cent. Estimated corporate tax collections on the basis of the 30 per cent rate are reported to be close to Rs 4,05,000 crore (or Rs 405 tc). Corporate tax deductions (accelerated depreciation and other special deductions, both approximately equal in magnitude) together are estimated to account for about Rs 84 tc. The estimated pre-tax corporate income is therefore Rs 1,526 tc.

But wait — the UPA is not done taxing yet. Apart from the statutory 30 per cent tax rate, there is a tax surcharge of Rs 32.40 tc and an education cess of Rs 13.10 tc. The total tax paid by corporations is therefore Rs 405 tc plus 45.50 tc, or Rs. 450.50 tc. So the give-away to fat corpcats is only (84-45.50) Rs 38.50 tc. In other words, the effective tax rate paid by corporations in India in 2014-15 is the ratio of tax paid (Rs 450.50 tc) to income (Rs 1,526 tc) or 29.5 per cent, that is, by far the highest in the world. Note that the effective tax rate is almost identical to the stated 30 per cent rate, a feat unmatched in the world, and India, possibly ever. That is the UPA’s gift to the economy and socialism.

The table documents effective tax rates in different countries and regions circa 2005-09 (and the most recent budget estimate for India). Note the convergence of effective tax rates at 21 per cent. The exceptionally low corporate tax countries, besides tax-havens, are the East Asian economies at 18 per cent, Canada (14 per cent), Germany (16 per cent) and Sweden (a super low 10 per cent). Most references to Sweden are that it is an ultra-socialist economy but clearly the Swedes know from where, and how, to get money for their welfare programmes. Their motto seems to be to maximise output and then spend on welfare. Contrast that with the old Congress-high command way: maximise welfare payments and then tax the hell out of the “rich” corporations. In other words, you end up with zero industrial growth for three years, no increase in revenues and a bloating fiscal deficit that you try and correct by introducing retrospective taxes. Now we have a genuine explanation for Sonianomics, and why the Congress got only 44 seats in the just concluded parliamentary election.

The writer is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Zyfin, a leading financial information company

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  1. O
    Observer
    Jun 7, 2014 at 6:58 am
    Cant understand any logic of Bhalla nor his figures, except his rants against Amartiya sen. But if modi or jaithly can follow his logic, and reduce effective tax rates for all, it will be a good gesture, hopefully for the fatcats and the poor
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      abhi
      Jun 7, 2014 at 10:35 pm
      Simpler way to tax a corporation and keep executive pay in check is to double count executive compensation in corporate tax.Only regular employees compensation should be allowed for direct tax deduction, not executive compensation.The shareholders and company tax pressure would automatically keep executive compensation in check.So, a TCS CEO will not get 60% or higher raise, when a normal employee can't even afford commuting to work by his vehicle.
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        adra
        Jun 7, 2014 at 4:26 pm
        Like all corporate stooges with the change of Govt. he is in business now. By cherry-picking data he is posing as a great economist. Sweden has very high personal tax and that significantly foots their social budget. How the can you compare india to Germany, Canada and East Asian economies.
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        1. B
          Bhantunana
          Jun 7, 2014 at 1:04 pm
          As usual an excellent analysis by Bhalla. The work of Chidambaram in last 3 years is only to fudge the figures and claim a great budget. That UPA is gone, is a divine intervention.
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            ashok
            Jun 7, 2014 at 7:28 am
            Balla has so much hatred for congress (and therfore for the poor) that he needs help.
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              sarangi
              Jun 7, 2014 at 12:02 pm
              So the only thing wrong in this country is the over-taxed 'corporates?' Waah
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                Varghese
                Jun 7, 2014 at 4:55 pm
                But for the usual rants that Mr Bhalla is famous for, this article hardly says anything. He seems to talk of just easing the corporate from paying a tax. As usual Cong is his enemy, so nothing new again
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                  Navin Sharma
                  Jun 7, 2014 at 8:36 am
                  I can't see the table Mr Bhalla refers to but shouldn't government mandated social security costs imposed on companies also be included? I refer to Social Security/Medicare in the US or National Insurance in UK. Add these in and the PF equivalent in India, how do things stack up? Secondly, corporate tax rates need to be this high in India, who else is the govt going to collect money from for public services.
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                    Navin Sharma
                    Jun 7, 2014 at 10:55 am
                    Shouldn't government mandated social security costs imposed on companies also be included? Social Security/Medicare in the US or National Insurance in UK. Add these in and the PF equivalent in India, how do things stack up?
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                      Navin Sharma
                      Jun 7, 2014 at 10:56 am
                      You can't reduce taxes for all and still provide the same level of public services. Things cost money.
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                      1. S
                        SCS Pathania
                        Jun 7, 2014 at 12:12 pm
                        I had posted 02 comments they have disappeared?
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                        1. S
                          SCS Pathania
                          Jun 7, 2014 at 11:37 am
                          I may further add there should be only EXPENDITURE TAX when people have more money they will spend more and the tax collection will be more, above all all these income tax forms and sections can be done away with, a big headache and a great source of fleecing for some.
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                          1. S
                            SCS Pathania
                            Jun 7, 2014 at 11:32 am
                            I question why there should be income tax ? Every time we buy anything ,avail of a service we end up paying tax where do we pay this from? obviously from our income so is it not our income being taxed again after having pa income tax. Why tax the same income again and again. Let there be one tax only.
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                              Goyal
                              Jun 7, 2014 at 4:53 pm
                              In my opinion income tax for ried cl should not be more than 10%. For corporate it should not be more than 20%. For PSU Banks there should not be any tax, these will bring costs of the manufacturing down, surplus with the consumer and reduce burden of govt for recapitalisation of PSU Banks. This will bring momentum in the economy.Goyal
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                                Pukhraj Mittal
                                Jun 7, 2014 at 7:39 am
                                Very well written article but fails to explain the phenomenon of ever increasing generation of "Black" money. Do we have to believe that common-man is generating it and therefore responsible for all of it? If not, is the cash being generated after paying taxes on profits?
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                                  rkannan
                                  Jun 7, 2014 at 2:21 pm
                                  The need to work on areas like DTC, GST reform etc are far more important than tax ratescome tax is levied only on profits but competetiveness is hit more by multiple taxation & confusion in calculation of different taxes.
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