Cut the corporate tax rate to 20%

India should cut its tax rate on corporate profits from a statutory rate of almost 33% to 20%, while simultaneously ending all exemptions in a phased manner. Indian corporate tax rates are relatively very high, with the Organisation for Economic Co-operation and Development (OECD) statutory average, including surtaxes and sub-federal rates, being around 25%. Such a cut would help in three ways. First, it would remove government from the business of picking winners and influencing capital allocation, which harms economic efficiency. Second, currently the smaller or less profitable a company, the higher is the effective tax rate paid—and hence a rate cut with exemption removal would actually be “progressive”. Thirdly, such a cut will almost be revenue-neutral in a static sense since the average effective corporate tax rate in India is currently 22.85%, whereas in a dynamic sense (even assuming very moderate Laffer curve effects—which shows that tax rates beyond a certain point reduce tax revenue) it would almost certainly yield more revenue as a percentage of GDP (gross domestic product), especially given the reality of profit shifting and transfer pricing. Let us explore all these three arguments in a bit more detail.

First, what are the exemptions that are causing most “tax expenditures” or foregone revenue? Fortunately, the budget every year has a “Statement of Revenue Foregone” and hence this is easy to look up. Out of an estimated net ₹ 76,000 crore foregone in corporate taxes in the year 2013-14, around ₹ 42,000 crore was because of “accelerated depreciation” under Section 32. Such depreciation obviously favours industries over services (the latter’s effective corporate tax is 23.7% compared to 21.1% for the former), and there is no reason why this should be so—who is to say that investing in employee training is less valuable than buying expensive capital equipment?

Moreover, depreciation is not a scientific term—it is an accounting one with enough subjectivity favouring faddish ideas, provided one can influence the right actors in government. So in India we favour wind mills with Section 32, while “Deduction of profits of industrial undertakings derived from production of mineral oil and natural gas” also accounts for ₹ 9,000 crore foregone. One line item here— ₹ 15,000 crore foregone in case of special economic zone (SEZs)—should not be quickly unwound given that government policy should be credible and not change on a dime. But here too, the MAT (minimum alternate tax) applies since 2011-12, and the whole benefit is anyway de facto nullified. Lobbying and silly ideas have led us to this convoluted mess. If we want to end cronyism and corruption, a wholesale simplification of the tax code is required.

Second, currently the bigger or more profitable the company is, the lower its effective tax rate. For the smallest companies—those with less than ₹ 1 crore in profit—the effective tax rate is 27%; then 25.3% ( ₹ 1-10 crore), 23.3% ( ₹ 10-50 crore), 22.7% ( ₹ 50-100 crore), 21.9% ( ₹ 100-500 crore), and just 21% for the largest 272 companies showing a profit of more than ₹ 500 crore. Clearly, here the left-liberal progressives can form a common front with the right-liberal free-marketeers and push for a tax rate cut so that the smaller entrepreneurs do not end up de facto subsidizing large corporations. Moreover, as things currently stand, the statutory tax rate for foreign companies is 40% compared to 30% for domestic ones—which is counter-productive if we want to attract investment from outside (though foreign companies are given the token concession of having a lower surcharge). Finally, on this point, the surcharge for companies earning more than ₹ 10 crore is higher than for those earning ₹ 1 crore or more. Still, those earning less than ₹ 1 crore pay the highest de facto share of profits as taxes, and those earning more than ₹ 10 crore much less so.

Last but not the least, one has to look at this proposed policy in a larger international and inter-temporal context. “Inversions” are breaking news every other day in Western, especially American, pink papers—with US companies often trying to be acquired by smaller European and other companies to escape high American corporate taxes and America’s global-tax net. While the lay man may think of America as low tax and Europe as high tax, and this would be true for individual and especially consumption taxes, for corporate taxes it is clearly the opposite given intensifying cross-border rush for capital and corporate headquarter locations (even if the top management stays put in, say, the US—a loophole which American Democrats are trying to close instead of simply lowering taxes, and charging them on a “territorial” basis).

Even in Japan, Prime Minister Shinzo Abe is cutting high corporate tax rates while scaling back exemptions. Increasingly, Indian companies have Singapore offices or headquarters to escape high taxes. One cannot wish away international tax competition. Moreover, while anybody who argues that a big statutory tax cut without reducing exemptions would lead to higher revenue as a percentage of GDP is almost certainly wrong: we cannot ignore the more moderate Laffer-type effects given the reality of transfer pricing in multinationals, and the desire of activist shareholders to reduce the tax outflow as much as possible. While India should work to prevent blatant tax evasion, it should also accept reality and make its economy more competitive.

A seemingly steep cut in the corporate tax rate from 30+% to 20% may seem untenable, but it is actually both practicable as well as beneficial for the Indian economy. There are already murmurs of corporate tax reductions in the next budget, but given the lack of communication from the government, the issue needs to be emphasized by all those who want higher growth and lesser cronyism.

Rajeev Mantri and Harsh Gupta are co-founders of the India Enterprise Council.