Let us start with some no-brainers. Given the state of the economy, tax increases are ruled out; equally, rationalisation of expenditure is ruled in so that the net result is that India embarks on a structural fiscal reduction path, a program that gets India to a Central fiscal deficit of 3% of the GDP and a consolidated Centre-plus-state deficit of around 5.5 % of the GDP. This will entail a reduction of around 2.5-3% of GDP from the present obscene levels. This and a subsequent column will discuss how corporate and personal income taxes can be restructured according to non band-aid thinking.
Around the Western world, there is heightened concern about rich fat-cats increasing their income at the expense of everyone else. There was the 99% Occupy Wall Street movement, and now there is the economist Pikettys 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, corporates are already taxed at the highest effective rate in the world. (An effective tax is simply the ratio of the 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 very 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, at 29%, is a full 11 percentage points higher than most of our East Asian competitors, and 15 to 20 percentage points higher than Germany and Sweden!
The objective of corporate taxation should be three-foldsimplicity, 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, on dividends, on surcharge, and on education). This tax rate should be reduced to 21%. 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 year rather than the range of -3% to 3% 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. Welfare expenditures are as decided by the NAC and the High Command. The financial markets and ratings agencies decide the fiscal deficit level at the Centre. The bureaucrats in the Ministry of Finance then decide how much to tax. But they are constrained by one obstaclethey cannot change tax rates. So, they work overtime to cook the budgetretrospective 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! Kafka or 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% plus a surcharge of 10% (3% tax) and an education cess of 1%. Estimated corporate tax collections on the basis of the 30% rate are reported to be close to R4,05,000 crore. Corporate tax deductions (accelerated depreciation and other special deductions, both approximately equal in magnitude) together are estimated to account for about R84,000 crore. The estimated pre-tax corporate income is therefore R15,26,000 crore.
But waitthe UPA is not done taxing yet. Apart from the statutory 30% tax rate, there is a tax surcharge of R32,400 crore and an education cess of R13,100 crore. The total tax paid by the corporates is therefore R 4,05,000 crore plus R45,500 crore, or R4,50,500 crore. So, the give-away to fat corpcats is only R38,500 crore (84,000 crore 45,500 crore ). In other words, the effective tax rate paid by corporates in India in 2014-15 is the ratio of tax paid (R4,50,500 crore) to income (R15,26, 000 crore) or 29.5 %, i.e., by far the highest in the world! Note that the effective tax rate is almost identical to the stated 30 % rate, a feat unmatched in the world, and India, possibly ever. That is the UPA gift to the economy and socialism.
The accompanying table documents the effective tax rates in different countries and regions circa 2005-2009 (and the most recent budget estimate for
India). Note the convergence of effective tax rates at 21%. The exceptionally low corporate tax countries, besides tax-havens, are the East Asian economies at 18%, Canada (14%),
Germany (16%) and Sweden (a super-low 10%). 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 programs. 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 corporates. In other words, you end up with zero industrial growth for three years, no increase in revenues, and a bloating fiscal deficit which 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 recently concluded parliamentary elections.
The author is chairman, Oxus Investments, an emerging market advisory firm, and a senior advisor to Zyfin, a leading financial information company. Twitter: @surjitbhalla