High tax rates spook growth & revenue

Taxation plays a vital role in any economy irrespective of whether it is developed or a developing one. In developing countries such as India, the problem is collecting enough revenue to provide essential public infrastructure and human development services and at the same time reducing the fiscal deficit . 

Therefore, finalising tax rates involves a tight-rope walk with several parameters to boost the country's economy.

Various studies on the impact of corporate tax on economic growth have demonstrated that high corporate tax rates reduce investment, entrepreneurial activity and economic growth. Paradoxically, high corporate tax rates do not appear to result in higher tax revenues.

Trends indicate that instead of increasing tax rates, widening the tax base results in better tax revenues over a period of time, coupled with simpler and voluntary tax compliance. 

In India, historically corporate tax rates had been on the higher side. However, over the last decade or so, they have come down from approximately 40% to 33.2%.

At the same time, the share of direct tax revenues in the gross tax revenues for the country has risen from 43% in 2005-06 to 58% in 2009-10.

The share of corporate tax revenue in the gross tax revenue has risen from 28% in 2005-06 to 40% in 2009-10, reflecting a shift in our tax structure where historically indirect taxes formed a major share of the tax revenues.

Corporate tax is also a big lever for governments to enhance the attractiveness of a country as an investment destination.

Like corporations, governments also compete with each other to attract the maximum foreign direct investment (FDI) into their countries.  

In today's global environment, India is competing with the likes of China, Brazil, Russia, Singapore, Malaysia, the Philippines, etc for attracting global FDI. The tax rates for some of these countries are significantly lower.  

China, which is considered as the 'manufacturing hub' of the world and a significant competitor to India, pegs its corporate tax at 25%. The effective corporate tax rate for the Philippines is 30%.

In the financial services space, India competes closely with Singapore; Singapore's effective corporate tax rate is 17%.

There is a case for India to look at corporate tax rates very closely, considering the global competitive strong landscape.

The government undertook a major exercise in the form of the first draft of Direct Tax Code (DTC) whereby corporate tax was reduced to 25% - a welcome shift towards simplification and competitiveness. 

However, this was watered down in subsequent versions of the DTC, wherein the corporate tax rate was restored to 30%.

With the DTC still some time away, the Government should seriously consider the opportunity to introduce this reduced effective tax rate in the coming Budget 2011 and give India that competitive advantage.