Reduce the taxation of corporations

Business Standard, 1 July 2019

India is unusual, when compared with emerging markets or the G20 countries, on the high taxation of corporate profit. The Indian corporate tax rate was higher than the G20 median, by about 9 or 10 percentage points, in 2001, 2005 and 2006. After that, India's gap has risen to 21 percentage points, as corporate taxation has declined the world over. India gains by reducing corporate taxation as this improves the appeal for investing in India for local and foreign persons, it reduces double taxation of the corporate form, and it generates increased property and tax revenues through indirect channels. This reform was begun in 2015, and needs to feature in the 5 July speech.

India vs. the world on taxation of corporations

Year India 25th percentile emerging market Median emerging market 25th percentile G20 country Median G20 country India's gap against EM median India's gap against G20 median
200048.1 30.0 30.0 35.0 35.0 18.1 13.09
200143.9 29.0 30.8 35.0 35.0 13.1 8.90
200245.1 28.0 30.0 34.5 34.5 15.1 10.55
200344.1 27.0 30.0 34.0 34.0 14.1 10.09
200444.9 26.0 30.0 33.5 33.5 14.9 11.38
200543.0 22.0 29.0 33.5 33.5 14.0 9.46
200643.3 20.0 28.0 33.5 33.5 15.3 9.87
200745.2 20.0 27.0 33.5 33.5 18.2 11.73
200845.2 20.0 25.0 30.0 30.0 20.2 15.21
200945.2 20.0 25.0 29.7 29.7 20.2 15.52
201044.3 19.5 24.2 29.7 29.7 20.1 14.57
201143.4 20.0 24.2 29.8 29.8 19.2 13.63
201243.4 20.0 24.2 29.8 29.8 19.2 13.61
201345.2 20.0 25.0 29.8 29.8 20.2 15.38
201445.2 20.0 25.0 29.9 29.9 20.2 15.35
201547.9 20.0 24.2 29.9 29.9 23.7 18.03
201647.9 20.0 24.0 29.9 29.9 23.9 18.02
201747.9 20.0 24.2 28.8 28.8 23.7 19.10
201848.3 20.0 25.0 27.7 27.7 23.3 20.66

The OECD runs a measurement system which shows the total taxation of the income of corporations. On 27 June, Krishna Kant and Sachin P. Mampatta wrote about this in the Business Standard. India stands out in two respects.

In 2018, India stood at a high rate of 48.3%. This was out of line when compared with the median emerging market (which was at 25%) or the median G20 country (which was at 27.7%).

India is also out of line in the lack of change, over the years. In 2000, the Indian rate was at 48.1%, which is essentially the same as where we are today. But over this period, the median EM dropped rates by 5 percentage points and the median G20 country dropped rates by 7.3 percentage points. This has made India stick out, to a greater extent, as a high tax jurisdiction.

It is striking to see that the Indian gap, over G20 countries, was at its lowest values in 2001, 2005 and 2006. This was the period when a great business cycle expansion was ignited. We do not, for a moment, wish to suggest that there is a mono-causal explanation, that improved tax competitiveness sets off an investment boom. Many elements of policy making went into India's remarkable period from 2002 to 2008. It is likely that tax competitiveness was one of them.

Why is this an important issue? There are three arguments in favour of low taxation of corporations.

Problem 1: Corporations are only a tool for individuals to obtain income

The first principles idea is that we should focus on taxation of individuals. Let's measure the total income of each individual, and apply a personal income tax on it. Once this is done, there is no need to additionally tax the organisational structure adopted through which the income is generated, whether it is a partnership or a proprietership or a limited liability company. By penalising the corporate form, we give incentives for businesses to be organised in other ways, which is inefficient for the economy. Rules demanding substantial dividend payouts by corporations can ensure that corporate profits show up as personal income, where personal income tax is applied.

Problem 2: Capital is mobile

The second key insight is about the mobility of capital. Taxation of capital or of financial transactions works poorly because these markets are quite mobile. In the modern world, Indian and global holders of capital choose from a global menu of options for investment. Small changes in taxation can kick off disproportionate responses by way of shifts in capital. Shifts away from India, in the patterns of investment, are particularly harmful for India as we require vast amounts of investment in order to achieve prosperity.

This is why the right focus of tax policy in India should be upon three elements of the economy where flight of activity is difficult, i.e. (a) the property tax, (b) the consumption-based GST and (c) the residence-based personal income tax. All other attempts at taxation are termed `bad taxes' as they lead to large changes in behaviour, which are not good for the country.

Problem 3: High taxation of corporations harms prosperity and general tax revenues

The third key insight is that the country and the government gain amply when an Indian or global corporation chooses to place operations here in India. Prosperity of the people of India goes up when firms decide to operate here. In addition, the government gets more tax revenue. Corporations that rent or buy property generate improved property tax revenues. Corporations that buy labour generate personal income tax, both at the first round effect (corporation hires one person) and through downstream impacts (this person buys a biscuit, which generates personal income and personal income tax payment at the seller of biscuits). Thirdly, the Indian residents that obtain income from the corporation will turn around and consume, which generates GST revenues as the GST is a consumption tax based on a destination principle.

Implications

These three ideas have generated a historic movement, all over the world, away from high taxation of corporations. The average global corporate tax rate has steadily declined since 1980. Even in rich countries with an expensive welfare system, where large tax/GDP ratios are required, the focus is on getting the money through the three good taxes only (the GST, the personal income tax, and the property tax).

We should not be content to match the median value of emerging markets. We should be competitive by world standards. The 25th percentile value among emerging markets is 20%. Thus, if India goes to a 20% corporate tax rate, we will be better than three-quarters of emerging markets. In particular, we will be more attractive than China, where the rate is 25%.

In 2015, such an announcement was made, with many future dates on which the announcement would take effect. This led to a tepid response on the part of domestic and foreign investors, and their skepticism was proved right by the lack of follow through. It would be efficient for the July 2019 speech to introduce this action effective right now. This might generate some fiscal stress in 2019 and 2020. With a lag, the gains would kick in.

This is comparable to the thought process of cutting customs duties, from 1991 till 2003, where tax officials steadily protested the loss of tax revenue, but this was amply compensated by the economic dynamism that came from removing protectionism.

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