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Saturday, Oct 19, 2002

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Corporation tax receipts — How much comes from private sector?

P. R. Brahmananda

Over the last five years, various factors have conspired to drag down growth and profitability in the private corporate sector, with the inevitable fallout that its contribution to corporation tax receipts has dipped considerably. It is, in fact, the public sector that now accounts for the bulk of the tax receipts. Why, then, the continued mollycoddling of the former, asks P. R. Brahmananda.

THE Reserve Bank of India has been presenting year-by-year detailed information on the working of the private business sector. In recent years, the information pertains to 1,242 public limited companies. In this article, we examine the course of growth of these companies by deflating the RBI figures by the price index of manufactured products. This enables us to know the course of performance of private industry in real terms.

In nominal terms these companies together have increased their sales by about 55 per cent between 1997-98 and 2001-02. In real terms the growth over the period is by 37 per cent, yielding a yearly growth rate in log form of 9.45 per cent. Gross profits increased over the period in nominal terms by 37 per cent and in real terms by 22 per cent, the yearly growth rate being 6.6 per cent.

Clearly, sales have grown at a higher rate than gross profits. However, interest expenditures in nominal terms have grown by 33 per cent over the period and in real terms by 17.9 per cent, that is, at a yearly rate of 5.72 per cent. Interest expenditure has grown at a lower rate than gross profits, both in nominal and real terms.

Profits before tax in nominal terms have grown 40 per cent and, in real terms, by 24.4 per cent. The yearly rate of growth of profits before tax has been about 7.4 per cent, higher than the real growth rate of interest expenditures. Tax provisions in nominal terms have grown 64 per cent, and in real terms by 46 per cent. The yearly rate of growth of tax provisions in real terms is 10.2 per cent. Profits after tax have grown in nominal terms by 35 per cent and in real terms by about 19.6 per cent, yielding a real rate of growth of 6.6 per cent. Paid-up capital in nominal terms has grown 48 per cent (in real terms, 9 per cent).

The profitability ratios in nominal terms have all been declining over the period. The gross-profits-to-sales ratio has been declining at a rate of - 2.8 per cent; profits before tax at - 2.3 per cent; and profits after tax to sales at - 2.92 per cent. The ratio of interest expenditures to sales has been declining at a higher rate, of - 3.9 per cent, as also the ratio of interest payments to expenditure, by - 4.1 per cent.

It may be noted that there has been a reduction in the prime lending rates and thanks to the RBI's monetary policy initiated by the Government, the private corporate sector seems to have gained by the higher negative growth rate of interest payments. When interest expenses go down, the profits before tax go up.

The index of industrial production between 1997-98 and 2001-02 increased by 19.9 per cent. This is higher than the increase in sales over the period at 37 per cent. The companies whose information is collected by the RBI seem to have increased their sales in real terms at a higher rate than the index of industrial production.

Profits after tax to sales was 5.5 per cent in 1997-98, 5 per cent in 1998-99, 5.1 per cent in 1999-2000, 4.9 per cent in 2000-01 and 4.8 per cent in 2001-02. The reduction in this ratio would have been higher had interest rates not been brought down. But there are limits to reductions in the prime lending rates. Unless the growth rate in industry improves in a big way, in all probability, the profit rates may not revive, even to the levels of 1997-98.

In these conditions, it would be difficult to expect, on an average, higher growth rates of industrial production than, say, 5 to 6 per cent per annum over the immediate and probably medium-term future.

The cost of raw materials will keep rising, staff costs with the huge salaries at the top would also go up, even though employment may be going down.

Unless the terms of trade between industrial products and raw materials improve in favour of industry, it would be difficult to expect higher growth rates in the index of industrial production over even the medium-term future. When profit rates are low the plough-back rates will also be low and, hence, real capital formation in industry will be slow.

This, then, leads to the vicious cycle of low industrial growth, low growth of plough-back and low growth of real capital stock in this sector. The price index of manufactured products has increased over the period by 12.27 per cent, yielding a yearly growth rate of roughly 3 per cent.

All these have an effect on corporation tax receipts. The corporation tax receipts over the period have been increasing by 20.4 per cent. But the tax provision of the companies covered by the RBI has been going down as a percentage of corporation tax receipts. In 1997-98, the tax paid by the companies was about 14.6 per cent of the corporation tax receipts.

This proportion has been dropping steadily. In 1998-99, it was 12.5 per cent; in 1999-2000 it was 12.7 per cent; in 2000-01, it fell to 11 per cent; and in 2001-02, it further dipped to 10.9 per cent. One can understand why the general public grudges the high attention paid by the Finance Ministry and the Government to the private corporate sector.

It is not at all a milch cow for the Government from the angle of tax receipts. It is well known that the major portion of corporation tax receipts flow from the public sector, for which there are no smiles from the Government. What Mr Shourie should sometimes think about is the effect of more and more disinvestment on the potential decline of corporation tax receipts!

We have tried to work out the elasticity of tax provisions in real terms to the real growth rate of industrial index. The elasticity is about 0.6 — far from unity. The growth rate in the industrial index does not lead to proportionate increases in corporation tax receipts from the private corporate sector. This is a point about which the Laffer Curve enthusiasts should ponder.

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