“No man is an island, by himself alone…Therefore, refrain from asking “for whom the bell tolls” since it is for you.
The timeless poetry of Anglican poet John Donne rings true in today’s arid financial environment. Since the era of easy monetary policy appears to be coming to an end, the world must look for alternative policy mechanisms to address its enormous resource needs, including those related to infrastructure, climate change, and the enormous challenge of ensuring a decent standard of living for people living in poorer countries. Since “money printing” is no longer a possibility, taxes will have to carry the bulk of the burden. The second of the three main tax revenue sources—personal income tax (PIT), corporation tax, and indirect taxes (including GST)—certainly rings the loudest. Why? India is an excellent case study due to its substantial resource requirements and small tax base.
India’s central tax to GDP ratio was slightly more than 11% in the fiscal year 2022–23, which is significant since it was the first regular post–Covid year. a percentage that has steadfastly held steady for a long period of time (it normally fluctuated between 9 and 11% for over 20 years). To put it in more current perspective, it was 11% in FY19, the last regular year prior to Covid. However, the composition is more important than the headline figure. From 2.39 percent of GDP in FY2019 to 2.97 percent in FY2023, PIT’s contribution increased. GST increased from 2.42 to 2.64 percent. However, corporate taxes decreased from 3.51% of GDP to 3.03%. Given the explosive comeback in corporate earnings from the bottoms created in 2020, it is very extraordinary. Corporate earnings, which hit their lowest point in FY2019 at 2% of GDP, quadrupled their proportion in FY2023, when they reached 4% of GDP. In close proximity to the 21st century peak of 4.7% recorded in FY2008.
This “negative spread” is due to a significant reduction in corporation tax rates in September 2019. The relevant tax rate for big businesses was set at 21% (resulting in an effective tax rate of 25% when surcharges and cess are included in). It meant that even if corporate profits increased during the last three years, their relative share of taxes decreased even though overall national income did not return to the pre-Covid era’s pattern of rise. As a consequence of the government’s increased spending to combat the pandemic’s worst effects, the central budget deficit has increased from 3.5% before Covid to 6.5% as of today.
The idea behind the corporation tax reductions was that they would encourage investment. Fresh investments will then start a positive cycle of increased spending, income, and savings. That’s not precisely how things have worked out. While corporate earnings have increased, the percentage of investments made by the corporate sector (also known technically as gross fixed capital formation) has significantly decreased. Corporate investments have decreased from over 7% of GDP in FY2011 to less than 3% of GDP in FY2023. The nominal trend is undoubtedly upward since business investments have wisely increased during the last several years. However, it is much below what was anticipated when the tax cuts were implemented.
The two additional tax sources, however, had to maintain their prohibitively high rates. PIT rates have risen a little bit, mostly because of surcharges and cess. Peak personal income tax rates in India are higher than those in certain better-income Asian nations and are comparable to those in a large portion of the industrialized world (about 40%). Fuel-related taxes have also continued to be high at the same time. There is an extra effective tax on family income due to the increased price of crude oil. Sticky taxes amplify the problem of aggregate consumer demand, which has been a concern for the economy for a while (at least since 2017).
The issue is this policy’s slant in favor of business and money. Is there a better trade-off to utilize that money elsewhere if larger corporate earnings do not translate into higher investments? To encourage consumption, it could be beneficial to lower the GST on consumer products or increase direct cash transfers to the needy.
To be fair, it’s a worldwide problem, not simply one that affects India. Many major multinational organizations, particularly those in the digital sector, pay relatively little tax by shifting earnings to countries with low or no tax rates. This practice is known as BEPS (Base Erosion and Profit Sharing). To close this glaring gap, a number of global efforts are in the works, led by the G20 and the OECD. However, because of conflicting national interests and political demands, the problem is still largely unsolved.
Due to our size, India’s concerns are more significant. Greater development difficulties face us. Given the results thus far, a legitimate debate is whether corporate taxes are necessary. Yes, the bell does ring.
