Concerns on taxation front have persisted for a major part of the last two decades. Despite a series of reforms since then, we didn’t witness a big-bang direct tax reform and kept kicking the Direct Tax Code can into the future. The story wasn’t any different on the Goods and Service Tax. However, GST became a reality in the first tenure of Mr Modi and indeed, corporate tax rates were also reduced but the reduction was small, spread over years and it covered firms only till a turnover of Rs 250 crores.
The first budget of Modi 2.0 increased this limit to Rs 400 crores and this ensured that a bulk of Indian firms faced a corporate tax of 25 per cent with the relevant surcharges as applicable. Since then, the DTC report has been submitted and there have been talks of further lowering our corporate tax rates to a level comparable to some of our competitors. In a joint article with Dr Surjit Bhalla for the Indian Express, we arrived at a figure of 22 per cent as the optimal level of the corporate tax rate. The article can be read by clicking here.
Recently, the Hon’ble minister lowered the tax rate to 22 per cent without the exemptions thereby taking India towards the optimal level that would maximize our corporate tax revenue. This figure of 22 per cent is important as the Finance Ministry – and the CBDT would have definitely carried out an extensive exercise to arrive at the figure. But, more importantly, it shows how we’ve moved away from our skewed understanding of a linear relationship between tax revenue and tax rate. This is by far a more important take-away as it implies that in future our taxation policies will be more guided by rationality than by concerns of morality.
The fact that there’s a concessional rate of 15 per cent for new manufacturing companies is another move that is clearly looking at making India one of the most tax competitive countries in the region. It is enough to make many firms that are exiting China look at India as a viable if not a better alternative to shift their supply chains.
A likely outcome of these changes is that in the medium term we may see a swift expansion of non-farm employment opportunities for India which will reduce the burden on agriculture and have a positive impact on wages of both farm and non-farm labour. Further, lowering of tax rates will also help Indian firms have better-retained earnings- before the tax rates our firms had one of the lowest retained earnings.
There are many reasons to believe that in our context trickle-down economics is likely to work; for starters, the tax cuts will help improve retained earnings and help our firms deleverage. Given the extent of positive investment opportunities in India, we will see a lot of these retained earnings get reinvested – the fact that we discourage dividends will implicitly result in them being productively utilized. Consequently, we may be able to absorb a lot of surplus labour from agriculture to Industry helping wages grow in both the farm and non-farm sector while improving productivity.
A key point worth remembering is that so far India has witnessed only a couple of years of reforms at a stretch. This has changed since the time PM Narendra Modi came to power. The reduction in corporate tax rates without exemption is not less than a reform or at least a part of the larger direct tax reforms that will happen sometime over the next couple of years. One is optimistic that with this continued series of reforms, we may finally transform the Indian economy by unleashing the animal spirits of the private sector.