Cutting taxes sensibly

When the government was reluctant to reduce tax on petrol and diesel, critics called the government anti-poor and pro rich. This criticism and the recent bypoll losses have forced the government to slash taxes on petrol and diesel. The BJP-ruled States also followed with some reduction of VAT.

Comparing the corporate tax cut with that of petrol and diesel cut is inappropriate.

A cut in petrol and diesel taxes will raise their consumption, resulting forex outgo and more pollution. It will also stymie efforts to switch over to EVs and green energy.

In September 2019 the government had reduced base corporate tax rate to 22 per cent from 30 per cent with riders.

Th Prime Minister had then said that this move would boost ‘Make in India’, attract more investments and create more jobs.

It is well settled that a lower corporate tax rate reduces the cost of capital; and investments that were not feasible earlier can be undertaken after reduction. This will lead to new investment in machinery, equipment, factories etc., which in turn will result in larger capital stock that boosts worker productivity. Higher productivity will lead to greater output and over time higher wages.

When the corporate tax reduction was announced, the main criticism was that most companies (99.1 per cent) have a gross turnover of below ₹400 crore (small and medium companies) and are already taxed at the base corporate tax rate of 25 per cent (with surcharge and cess, their tax rate varies from 26 per cent to 29.12 per cent) and this rate cut will not benefit them.

But a recent OECD study says: “Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes. Recurrent taxes on immovable property appear to have the least impact.”

So the reduction in corporate taxes (unlike reduction of tax on consumption) will encourage higher investment by corporate which will boost growth and also wages by workers.

We cannot have higher corporate tax compared to other countries as it will lead to companies relocating to other countries. New investment may not come to India. So reducing corporate tax rate was the need of the hour. Now at international level there is an agreement for a basic tax to discourage companies move capital to zero tax places. A corporate income tax rate closer to that of other nations will discourage profit shifting to lower-tax jurisdictions.

Economic evidence suggests that corporate income taxes are the most harmful type of tax and that workers bear a portion of the burden. Reducing the corporate income tax will benefit workers as new investments boost productivity and lead to wage growth.

Finally reduction in rate will increase better tax compliance and better collection and this is proved by the following figures where the government is reaping a bumper harvest from tax collections in the ongoing financial year ending March 2022.

Both corporate and personal income tax collections shrunk in the financial year 2020-21 by 18 per cent and 2.3 per cent, respectively. This is partly due to Covid impact on business and reduction of corporate tax. However direct tax collections for FY 22 have risen 47 per cent on-year to ₹6.45 lakh crore as of September 22, with net collections having risen 74 per cent on-year to ₹5.7 lakh crore and advance tax collections up by 65 per cent to ₹2.53 lakh crore.

Hence the reduction of corporate tax is good for the economy whereas the reduction of taxes on petrol and diesel may be only good politics and harmful in the long term.

The writer is a retired banker

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