From the second Budget presented by Finance Minister Arun Jaitley on behalf of the National Democratic Alliance (NDA) government, much was expected. The NDA government was elected with a clear mandate, which many hoped would translate into a sensible push towards structural reform. Naturally, this push towards reform is not a single-year project. It would have required some years of adjustment, but as long as a coherent road map was laid out, with a desirable goal in sight, few would have complained. Seen from that perspective, the Budget as presented on Saturday contained many useful provisions, especially given the difficult fiscal conditions, but few of the promises made had a time frame attached.
However, among the many medium-term promises Mr Jaitley made in the Budget, the one on reducing the tax rate on corporations' income to 25 per cent in four years stands out. It outlines a goal, and brings stability and certainty to the way companies can plan their activities. It is welcome also because there is now an attempt to bring the rate of taxation of companies in line with Southeast Asian standards - a promise made to India Inc a couple of decades ago. It is very important for a country seeking to break into export markets to ensure that companies are not disincentivised from locating here. In addition, small companies and start-ups are disproportionately hurt by a high-tax regime with many exemptions. The effective tax rate for companies with a profit before tax of over Rs 1 crore is 21 per cent; for those with a profit before tax of below Rs 1 crore, it is 27 per cent. As a report in this newspaper shows, there are quite a few companies that continue to pay taxes at rates ranging between 15 and 20 per cent. Indeed the finance minister said in his Budget speech that the effective corporation tax rate came to about 23 per cent, compared with the basic rate of 30 per cent. Thus, India was developing the reputation of being a high-tax destination for companies - without the exchequer getting the benefits of the taxation. In other words, the objective of this reform is laudable.
However, two problematic questions arise. While outlining its plan to reduce the corporation tax rate to 25 per cent in four years, it needs to make its strategy clear. Is the intention to raise the current effective rate of corporation tax from 23 per cent ? Or is it to keep the effective rate at the same level or lower it? The Budget speech and subsequent clarifications by government officials would have done well to make that clear. The point is if the nominal tax rate is to be reduced to 25 per cent in four years, and quite a few of the main exemptions stay, then the effective rate of tax will probably come down even further. That will undercut the tax base of the economy, which will be undesirable.
The second related question, trickier and, therefore, more challenging, pertains to Mr Jaitley's promise to phase out exemptions. Successive governments' track record in dealing with exemptions is quite poor. While Mr Jaitley has promised to remove exemptions on corporate direct taxes, he has increased the number and complexity of exemptions when it comes to indirect taxes in the very same Budget. On customs alone there are 19 rates and over 2,000 exemptions - a list the finance minister has added to in this Budget. It is important for the government, therefore, to work towards improving its credibility in this respect. So it needs to come out with a clear strategy on what direct tax exemption will be phased out when. Note that many of the exemptions are for production in special economic zones (SEZ). Does this mean the tax-exempt status of SEZs will come to an end? That would be a good move. But this sort of clarity is exactly what is required. This, as the finance minister promised, would further help corporate taxpayers to plan, and not get a sudden jolt on tax policy changes.
