Home / Opinion / Structural reforms: now the difficult, fiscal part

The angst of the Indian industry to the proposed changes in corporate tax structures reinforces a simple fact: fiscal reforms can be quite difficult. Such resistance, seen across countries and societies, isn’t hard to understand or explain. Taxation changes influence the real spending and borrowing behaviours of households and firms; they can create both winners and losers depending on how incentives are placed or changed. Removals, reductions, increases or changes often embody an adjustment burden, making fiscal reforms nearly always politically difficult or costly even in normal circumstances. When times are hard, as now—business investment falling and spare capacity in factories rising—people are unhappier, as the domestic industry seems to be.

Interestingly, the government’s present emphasis upon structural policies too conforms to another stylized feature observed globally: the strongest reform momentum tends to coincide with periods of economic stress or turbulence. A recent study by International Monetary Fund (IMF) that analysed reform experiences of 108 countries to infer linkages between structural reforms and macroeconomic performance finds that reform efforts gathered pace in the mid-1970s (breakdown of the Bretton Woods system and the first oil price shock), the late-1980s and early-1990s (Latin American debt crisis and recession in many countries after the 1987 stock market crash), and again in the late 1990s and early 2000s, when many emerging markets faced financial crises. When growth goes down, revenues decline and macroeconomic policy support is constrained by insufficient space as is now the case (on already-enlarged fiscal deficit and inflation concerns), governments are compelled to focus upon structural policies to raise output.

That said, fiscal reforms on the revenue side are much required. A perennial fiscal deficit that widens alarmingly whenever growth dips and revenues fall is a fundamental macroeconomic problem carrying inherent instability risk. Restructuring of public finances to widen the tax base and increase revenue efficiency has long been delayed. The current corporate tax structure is very complex. It is extensively punctured with concessions and deductions that operate as incentives for one or another desirable activity, for example, investment, and research and development. Eliminating preferences while lowering the tax rate to 25%, which is how the contemplated reform (also part of the earlier Direct Taxes Code, subsequently shelved) aims to rationalize the corporate tax structure, is likely to raise tax efficiency as also equity.

Consider that the effective tax rate, as calculated by the government for about 5.6 lakh firms, was 23.2% in 2013-14, against a statutory tax rate range of 32-33%, explaining the anguish of some firms. Effective tax rates descends with firm size, meaning that larger firms paid lower taxes as proportion to profits—about 21% for profits above 500 crore against 27% for those with profits in the 0-1 crore region. The highest tax rates and payments are observed for firms with largest shares in total profits and incomes; manufacturing firms faced somewhat lower rates (22%) than services (24%), while public sector firms escaped with a far lower effective tax rate of 19% against 24% for the remaining private firms in the sample. Assumed revenues foregone by the government for these reasons are estimated in the range of 0.5% of the GDP. Reasons enough to reform, no matter the difficulties.

Renu Kohli is a New Delhi-based macroeconomist

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