The missing tax trick: What Jaitley needs to do to raise both tax collections and FDI at one go

By Hardayal Singh

Corporate taxation in India is a dense thicket of frequently changing exemptions, deductions, rates, surcharges and cesses. The system is unstable, hard to implement and difficult to comply with. Even so, finance minister Arun Jaitley’s proposal to extend the cut in basic corporate tax rate from 30% to 25% was a bright spot in the recent Budget.

The revised rate applies to all domestic companies with a turnover of up to Rs 250 crore. The reform covers 693,000, or 99%, of Indian corporate taxpayers. It will have a positive impact on both the revenues of GoI as well as the economy as a whole.


First, in a tax non-compliant society like ours, where both evasion as well as avoidance are rampant, a tax cut reduces the incentive for both. When the gains involved in avoiding or evading tax are small, taxpayers prefer to comply with the law rather than circumvent it.

Second, a rate cut places more money in the hands of the taxpayer, and facilitates expansion of business. The requirements of borrowings decline, and along with that, interest cost reduces and profitability increases. Enterprises report higher profits and begin to pay more tax.

Finally, at the macro level, a tax cut significantly increases private investment and augments rates of economic growth and employment. In a pre-election year, at a time when banks are grappling with non-performing assets (NPAs) and other crises, it makes sense to reduce their burden by helping enterprises to generate funds internally.

So, it’s difficult to understand GoI’s hesitation to extend the tax cut to the remaining 1% of taxpayers whose turnover exceeds Rs 250 crore. Not to apply the cut uniformly to all corporates and comparably placed firms and limited liability partnerships (LLPs) will further complicate the already complex rate structure. For a small, but economically significant, class of corporates whose turnover exceeds Rs 250 crore and net profit exceeds Rs 10 crore, the rate of taxation will actually increase from 34.61% to 34.94%, since the existing educational cesses of 3% have been substituted by a new health and education cess of 4%.

The finance ministry has calculated revenue losses in a mechanical, unidimensional way. For 2018-19, it has estimated a revenue loss of Rs 7,000 crore by finding how much revenue is collected from this category of taxpayers at the current tax rate of 30% and then subtracting from this figure the revenue expected at the proposed tax rate of 25%. This kind of calculus is simplistic and overlooks recent fiscal history.

In the past, higher corporate-tax collections have often accompanied cuts in tax rates. Basic corporate tax rates, for example, were slashed in 1990-91 from 50% to 40% for widely held companies, and from 55% to 50% in closely held companies. For all domestic companies in 1996-97, they were further reduced from 40% to 35%, and in 2005-06, from 36.59% to 33.66% (inclusive of surcharges and cesses).

On all occasions, corporate-tax revenues spurted: in 1990-91 from Rs 4,729 crore to Rs 5,335 crore (by 12.81%); in 1996-97 from Rs 18,567 crore to Rs 20,016 crore (7.80%), in 2005-06 from Rs 60,289 crore to Rs 75,187 crore (24.71%).

The Laffer Curve best explains this phenomenon. Tax collections, according to the economist Arthur Laffer, will be zero when the tax rate is either 0% or 100%. Between these two extremes, they will first rise with every increase in the marginal rate, reach an optimum, and then begin to decline with every successive increase in this rate. Conversely, once revenues have crossed the optimum, every reduction in the marginal rate will result in an increase in revenue. The revenue graph will, thus, resemble an inverted U.

The Laffer Curve doesn’t appear to be applicable to western societies. Tax cuts in the US in the 1980s did not result in higher revenues. In India, however, the dynamics are totally different. Cuts in income-tax rates have invariably resulted in higher revenues in the past, and there is no reason why they should not generate a similar response in the future.

The tax reforms committee set up by GoI now needs to focus on reforming the entire corporate rate structure. If it wants to attract more foreign direct investment (FDI), GoI should try and subsume multiple rates, cesses and surcharges in a single rate, and reduce the latter to international levels (US 21%, Britain 19%, Singapore 17%, Malaysia 24%). It should abolish all but a few necessary exemptions and deductions, and strive to tax all entities at a figure as close as possible to their commercial income.

The writer is former chief commissioner of income tax