Opinion
Revise direct taxes: Corporate taxation needs to be progressive
Summary
- Businesses making more profits have been paying lower effective tax rates. It’s only fair that richer firms must bear a bigger tax burden. Note that the tax relief they got five years ago has done little to increase corporate investment and employment.
Direct tax reforms have been on the agenda for more than two decades. Unfortunately, much of the discussion has revolved around income-tax reforms and very little around corporate taxes.
This is despite the fact that corporate taxes accounted for more than half of India’s total direct taxes until 2019-20, although their share is now less than half.
Corporate taxes accounted for an average of almost two-thirds of total direct taxes during the United Progressive Alliance (UPA) government’s second term. Their share went below half under the National Democratic Alliance (NDA).
In the last five years, corporate tax collections rose at 6.5% per annum, almost a third of the 17.2% growth annual in income-tax collections. The decline in growth rate of corporate taxes is not an aberration, but part of a longer trend, falling from 27.4% during the UPA-1 period to 13.1% in UPA-2 and further to 11% during NDA-1. The growth rate of the income-tax intake slipped from 20% during 2004-09 to 17.2% during NDA-2.
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The deceleration in corporate tax collections is largely a result of generous concessions that successive governments have doled out. The last major move was in 2019, when massive tax relief was rolled out.
As against the average statutory tax rate of 34.69%, a concessional rate of 22% for existing domestic companies and 15% for newly incorporated domestic companies was introduced. The immediate impact was a loss of revenue for the government, but the new levies also changed the nature of corporate taxation.
Since 2007, an annual statement has been made as part of the Union budget on revenue forgone due to various tax measures that provides the effective tax rate for companies by various levels of profit-before-tax. After the zero-profit category, the lowest one is of companies reporting profits in the range of ₹0-1 crore.
This is the largest group of companies that pay taxes. Firms with profits in the range of ₹1-10 crore, ₹10-50 crore, ₹50-100 crore, ₹100-500 crore and with profits above ₹500 crore are in separate brackets. The highest profit-making companies are the smallest in number but together record the bulk of profits.
As against the statutory tax rate of 34.6% in 2017-18, the effective tax rate for all companies was 29.5%. In 2018-19, it declined marginally to 27.8%. But even in these two pre-2019 years, the lowest effective tax rate was for the richest companies, at 26.3% in 2017-18 and 25.9% in 2018-19.
However, the tax rate was at least progressive in lower brackets till the ₹100-500 crore category. In 2018-19, the effective tax rate for the ₹0-1 crore category was 26.6%, rising steadily to 28.3% for the ₹100-500 crore category.
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The immediate consequence of the 2019 tax breaks was a sharp decline in the effective tax rate to 22.5% in 2019-20 from an average of 29% in the preceding years. It has remained at that level till at least 2021-22 (for which data is available).
The largest beneficiaries were the richest companies, for whom the effective tax rate declined from an average of 26% to 20%. But for the ₹0-1 category, it was only a marginal decline from an average of 26% to 25%.
In fact, for 2021-22, the effective rate pattern is an inversion of 2018-19’s: the poorest companies have borne the highest effective tax rate, with the rate declining as a firm goes up the profit brackets. Thus, the 2019 changes not only reduced effective tax rates, but also made the tax structure regressive.
Tax incentives would have been justified had they led to job creation or more investment. Neither happened. Not only did the private sector reduce its employee costs as a proportion of sales, its profit share rose sharply. Corporations used the subsidy to deleverage themselves, lowering their interest outgo. Private investment, meanwhile, has stayed sluggish.
Most of this is known. The Economic Survey too lamented the private sector’s failure to generate investment or employment despite tax relief. But then, corporates are not to be blamed, as raising profits is their mandate.
It is the state’s duty to create an enabling environment for them to do this in a competitive setting. But it is also for the state to collect taxes from them. A tax policy should not only be reasonable, just and progressive, but also efficient.
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Progressiveness is necessary from the equity point of view. Today’s corporate tax regime is regressive and inefficient, penalizing the small and medium firms that are crucial for job generation. For meaningful direct-tax reforms, we must go beyond income tax. Fixing corporate taxation is just as important.
