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The Controller General of Accounts released provisional revenue and expenditure figures for the Union government for 2020-21 some weeks ago. Without losing ourselves in numbers, we can simply state that its collections of indirect taxes were more than of direct taxes, and personal income tax collection exceeded corporate income tax collection. Both are unwelcome and would need either explanation or course correction, or both. While one year does not make a trend, as one would expect in India, these data points have been picked by critics as examples of the government favouring the rich over the poor.

For nearly four years after 2015, the government seemed in ‘thrall’ to an opposition leader’s ‘Suit boot ki sarkar’ jibe. It expanded the rural employment guarantee and food security programmes, and launched many black money collection raids, including demonetization. Then came the Real Estate Regulation Act, etc. After the government was re-elected in 2019, it mustered the confidence to lower the top marginal corporate income tax rate to 22% and announced a special dispensation for companies that set up new manufacturing facilities before 1 April 2023.

An analysis of corporate income tax receipts and other data, available in the receipts budget, shows that India’s effective tax rate from companies, given that they had many exemptions too, was around 28% up to 2018-19. Second, thanks to the information gathered as part of the demonetization exercise, the number of corporate taxpayers had jumped quite a bit in 2017-18 from 2016-17. So did corporate tax collection in 2017-18. Therefore, reducing the tax rate to 22% with no exemptions was a gamble. Why did the government do it?

I guess that the Centre did it for the following reasons. China’s top marginal corporate tax rate was 25%. India reckoned that its 22% with cess and surcharge would come to 25%. The 15% bait was to lure global firms looking to diversify their supply chain dependence away from China. Further, India’s corporate sector appeared to have de-leveraged their balance sheets. So, the government must have felt that leaving more profits in the hands of companies would lead them to boost their capital formation rates.

In 2019-20, corporate tax collection declined. It could be due to either the lower tax rate or a lower base. Profits before tax of incorporated entities declined significantly. However, that excuse vanished in 2020-21. Companies appear to have boosted their earnings before tax. Yet, the government’s tax collection from companies has declined further. Now, the benefits of adding on more taxpayers in 2017-18 appear to have been surrendered. At the same time, the covid virus struck. With lower capacity utilization and higher uncertainty, companies may wait to invest. Further, the government increased indirect taxes on fuel products, once in 2014-15 and again in 2020-21. The first time, it did so to fix the fisc that it was handed down by the previous government. The second time, it did so to prevent an even bigger deficit than it faced in 2020-21. The result is the tax structure distortion described at the start.

Indirect taxes (excise, customs and goods and services tax) are like direct taxes on production. Consumption is production less inventory accretion, after all. Direct taxes are taxes on incomes accruing to factors of production. Indirect taxes keep the cost of production up, thus reducing the growth of incomes accruing to factors of production. In the process, tax collection through direct taxes also suffers. Apart from being regressive, as they are borne equally by the rich and poor alike, indirect taxes also hold back growth of gross domestic product (GDP) and the government’s revenue pie. On top of that, direct taxes subject regular income from labour to a heavier burden than they do earnings from capital. What’s to be done?

To wean oneself off the reliance on fuel taxes is not easy because both state governments and the Centre depend on them for revenue. What looms larger in their eyes is the revenue loss if duties are rationalized than the cascading effect of these duties on costs and economic activity. There must be a point of indifference (break-even) between the two, such that higher economic activity can compensate for the revenue loss of lower duties. Of course, to the extent that high fuel prices deter individual modes of transport, they serve India well at least on two counts: carbon emissions and traffic congestion. But public transport is not ubiquitous and safety is a factor too. Notwithstanding the use of higher fuel duties as public goods, a case can be made for their rationalization.

Just as India’s goods and services tax itself took more than a decade to implement, the project to bring fuel products under this regime, which would entail much lower rates, could take a decade. In the short run, the government can provide relief to households below specified income thresholds through coupons that can be exchanged for fuel. For the long run, the Centre could initiate a study on the cascading effect of fuel taxes and the efficiency, growth and revenue gains that could accrue if duties are dropped to reasonable levels. It may also help to keep an open mind on the ideal top marginal corporate tax rate.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.

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