One of the highlights of finance minister Arun Jaitley’s budget speech on Saturday was his announcement that corporate income tax rates are going to be reduced in the next four years to a marginal rate of 25% from the current 30%.

The reason for this, Jaitley said, was that while the marginal tax rate was 30%, the effective collection is only around 23% (paragraph 97 of the budget speech,(, with much of the difference being accounted for by various kinds of exemptions. The lowering of the tax rate will be accompanied by the removal of some of these exemptions, said Jaitley, in an effort to make the tax rate competitive vis-à-vis other Asian economies.

A good tax administration is one in which tax codes are clear and unambiguous, and where there is little wiggle room for uncertainty. Such a tax code levels the playing field for companies, and leaves little room for discretion and litigation.

More importantly, a clear and unambiguous tax code makes it significantly easier to do business, on several counts.

The lack of ambiguity reduces the chances of disputes, and also allows for better planning by businesses. Exemptions of any kind distort incentives for companies, and introduce ambiguity in planning.

From this perspective, it can be argued that the closer the effective tax rate is to the marginal tax rate, the better administered the tax system is. The question is where India falls on this measure.

Aswath Damodaran, a professor of finance at the Stern School of Business in New York University, has compiled “effective corporate tax rates" for different countries for 2013 (

He has calculated this by looking at the total taxes paid by companies and the total taxable income and computing a simple ratio. Comparing this to marginal tax rates (available from this database published by KPMG,, it is possible to judge the effectiveness of various tax regimes.

Based on the data compiled by Damodaran (available in Microsoft Excel format here:, India had an effective tax collection rate for 2013 of 26.17%.

The same year, the marginal income tax in India (as reported by KPMG, which has a detailed explanation) was 33.99%, giving a difference of 7.82 percentage points, which is a rather high number (going by numbers presented by Jaitley in the budget today, this difference is about the same).

Most of this difference can be accounted for by way of various exemptions, and it is this difference that Jaitley is targeting.

So, where does this difference of 7.82 percentage points leave India vis-à-vis other countries? Chart 1 shows a scatter plot of marginal and effective tax rates for different countries. Countries that lie on the red line (drawn at 45 degrees to the axes) are the best tax collectors—their marginal and effective tax rates are identical. The distance of a country from the red line indicates the degree of “inefficiency" in its tax collection.

It can be seen from chart 1 that India is on the higher side when it comes to marginal tax rate (going by the KPMG figure of 33.99%), with only the US, Japan and Brazil (among prominent countries) being higher.

On effective tax rates, however, India seems a fair distance away from the red line—countries such as Russia, the UK and France are much closer to the red line compared to India. The US, however, is clearly worse than India when it comes to tax collections.

So what company does India keep in terms of having an effective tax rate much lower than the marginal tax rate? And where does India stand? From Damodaran’s data set of 90 countries, there are 15 whose shortfall is much worse than India, so India is clearly in the bottom quintile when it comes to tax effectiveness. Chart 2 shows the bottom 20 countries in terms of difference between marginal and effective tax rates.

The countries surrounding India in this table are Kuwait, Spain, Qatar and Belgium—not exactly great company to keep, but not too bad either.

Countries significantly worse than India in this table (i.e., those that are above India) include the US (with a difference of a staggering 13%), but also Zambia, Nigeria, Cambodia and Sudan. Perhaps expectedly, the table is topped by Venezuela and Greece!

From Damodaran’s analysis, the global average difference between marginal and effective tax rates is about 2.6%. Considering that Jaitley mentioned in his speech that the current effective tax rate in India is 23%, targeting a 25% marginal tax rate seems reasonable.

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