Structural Challenges with Indian Tax Regime

The Indian tax regime is said to be under a myriad of structural challenges. India has one of the highest effective corporate tax rates and personal income tax is highly skewed against the rich who account for a lower amount of revenue realisation.

Personal Income Tax Rates

• The budget 2019-20 has again increased the personal income tax for the rich.
• This strategy to increase tax rates is more a tactic of old-fashioned morality (tax the rich) than revenue maximisation at play.
• The government plans to raise Rs 5,000 crore more of the total personal income tax collection which is budgeted at Rs 5,00,000 crore by socking it to the rich.
• Government may not be able to realise even this minuscule target of Rs 5000 cr since tax arbitrage between the much lower corporate tax rate and the near highest individual income tax rate (only 10 per cent of countries have a higher than 43 per cent top PIT rate) will move animal spirits towards payment of corporate tax.

Effective Corporate Tax Rates

The Laffer curve explains the non-linear relationship between tax rate and tax revenue (as per cent of GDP). With zero tax rates, one would get zero tax revenue and with a 100 per cent tax rate, one would again get zero tax revenue.

The report and Laffer curve shared by the OECD makes the following observations:

• The lowest bang for the tax buck is obtained in India, possibly because tax rates are set on the basis of morality rather than revenue maximisation.
• India taxes at 44 per cent to get 3.5 per cent of tax revenue (as a percentage of GDP). Both Korea and Israel (and other countries) obtain this same amount of revenue with half of India’s taxation levels.
• The Laffer Curve suggests that the tax rate level at which revenue is maximised is around 23 per cent i.e. half India’s tax level.
• Firms in India are required to pay corporate tax followed by a surcharge and an additional 15 per cent dividend distribution tax (DDT).
• The DDT has become a double whammy. On one hand, the resource mobilisation from DDT is just around 8 per cent of the total corporate tax revenue. On the other a steep 15 per cent DDT only dissuades firms from issuing dividends to their shareholders.
• In addition to this, an individual earning more than Rs 10 lakh of dividend income must pay an additional 10 per cent tax. So the same income is taxed thrice in India.

Way Forward for India

The budget and the Economic Survey emphasizes on the need to revive private investment to ensure sustained long-term growth. This makes a strong case for further and aggressive reduction in tax rates on the grounds of the revival of investment and helping India become a $5 trillion economy.

India must realize that the tax rates must be set to maximise tax revenue and tax revenue depends on both income and tax compliance. Tax compliance must be viewed through the lens of more firms revealing a closer approximation to true income rather than more firms filing taxes.