Congratulations to Abhijit Banerjee and Esther Duflo, along with Michael Kremer, for winning the Nobel prize for their research in applying randomised control trials for anti-poverty interventions. We, Indians—and, more particularly, the economists’ community—are proud of their achievement. With the achievement, comes the burden of having to answer the media and public’s questions about the appropriateness or otherwise of many government policies and programmes; and they expect ready answers. Having won the highest award, the winners, too, think that they have answers to the questions posed.
The case in point relates to the emphatic answer by Banerjee on the effectiveness of the corporate tax cut in reviving the economy. He is reported to have said that reducing taxes to boost investments is a myth spread by businesses. “You don’t boost growth by cutting taxes, you do that by giving money to people”, he states. The question, however, is whether it helps growth or employment by driving out businesses through high taxes. The best approach to tax policy and reforms is to broaden the base and lower the rate, and to develop a simple and transparent tax system. The base should be broadened by minimising exemptions and concessions. In a world where capital is mobile, taxing it at high rates may lead to its flight, resulting in adverse effects on economic activity and employment, and incomes of labour. A tax on capital, thus, may turn out to be a tax on labour. The strategy of raising revenues, by levying high rates on corporates, to finance anti-poverty interventions may be self-defeating.
In fact, the government’s move to reduce the corporate tax was in keeping with the principle of broadening the base. By stipulating the condition that the lower rate will be applicable only to those companies that do not avail the various tax concessions, the finance minister cleverly steered the politically difficult path of eliminating tax preferences which had been benefiting various interest groups. The revenue budget, in the revenue foregone statement, records various corporate tax concessions under 28 heads, and these include items like accelerated depreciation, export profits of units located in SEZs, area-based concessions to north-eastern and Himalayan states, incentives for investments in infrastructure, oil exploration and energy sectors, and donations to charitable trusts and institutions. No serious tax economist advocates loading the tax policy with so many objectives, and providing avenues for evasion and avoidance of the tax by proliferating concessions. The costs of tax concessions in terms of revenue foregone and distortions are high; their efficacy in achieving the professed objective is doubtful.
The decision to reduce the rate of tax on companies to 22% is conditional on not availing tax preferences and concessions. The effective rate of tax after the reduction is expected to be 25.17%, which is only marginally lower than than that of 29.49% prevailing in 2017-18. The revenue loss from the reduction works out to a much lower `1.2 lakh crore, lower than the declared `1.42 crore. If one adjusts for overestimation of revenue in the budget, the loss works out to be Rs 98,579 crore, as estimated by Rangarajan and Srivastava (bit.ly/2NbVi1S). Of this, the additional dividend likely to accrue to the central government from public sector companies is expected to be over Rs 30,000 crore. Not surprisingly, the stock market, which went euphoric in the two sessions after the announcement of the tax cut, shed over two-thirds of the gains in the next few sessions as reality dawned.
The high international mobility of capital presents a formidable challenge for taxing it at high rates as the flight of capital in response to after-tax rate of return could result in loss of employment. Besides, highly progressive tax systems are not costless. They increase the cost of economic efficiency, and when distortions are taken into account, adverse impact on economic activity may outweigh any gains from progressiveness. That is precisely the reason for suggesting that focus shift from vertical to horizontal equity, and from changing income distribution to poverty alleviation, which has to be carried mainly through the expenditure side of the budget. In fact, some tax experts, like Auerbach and Shaviro, argue for discriminating income taxation, with capital income taxed at lower and less progressive rates except in the case of natural resource-based industry. They go on to recommend replacement of the present system of corporation tax with destination-based VAT on goods and services (GST), with labour costs deductible in addition to the input costs. Even if we do not go that far, it is important to realise that ensuring competitiveness to attract investments requires, besides competitive levels of infrastructure and governance, reasonable tax rates comparable to the competitors’. In the case of personal income taxation, too, the steeply progressive taxes, with highest marginal rates exceeding 90%, which used to be fashionable even in countries like the US and the UK in the 1950s and which continued in India until the mid-1980s, are no longer considered desirable, not least because they were ineffective in changing the income distribution, and instead made tax evasion a legitimate activity.
Surely, reduced corporate tax rate, alone, cannot be a solution to the present slowdown, but it certainly can be a part of the solution to arrest the declining investment ratio by making India a better investment destination and discouraging Indians from investing abroad. The reduction in the corporate tax would check outflow of Indian investments, besides attracting inflow of some additional investments. This is important for reducing distortions. The measures to augment demand, too, are important, and the time is opportune to raise substantial revenue through strategic disinvestments to enhance public spending. This is the time for the government to loosen the purse, and reform the proliferating subsidies and transfers to targeted cash transfers. The government should persuade the GST Council to simplify and rationalise GST by simply converting the 28% category into 18%. This would help in the revival process as the high tax rate has hurt not only the automobile sector, but also the employment-intensive construction sector. The challenge of economic slowdown should be converted into an opportunity to undertake reforms to fast-track the resolution process, effectively enforce property rights, and undertake governance reforms in the ailing public sector financial institutions. Reforms in the land and labour markets, too, have been spoken of for long, but are crying for action.[“source=financialexpress”]