“No man is an island, entire of itself…Therefore, send not to know for whom the bell tolls, for it tolls for thee”
Anglican poet John Donne’s immortal lines have a ringing resonance in the world of dry finance today. With a generation of easy monetary policy seemingly firmly behind us, the world has to look for alternate policy mechanisms to solve for its the enormous resource requirements – from climate change to infrastructure, and to the enormous challenge of providing decent quality of life for citizens in poorer countries. With “money printing” not an option anymore, taxes will need to do the heavy lifting. Out of the three primary tax sources – personal income tax (PIT), corporate tax and indirect taxes (like GST), the bell surely tolls loudest for the second. Why? India’s a good case study, with its large resource needs and low tax base.
In fiscal year 2022-23, important for being the first normal post-Covid year, India’s central tax-to-GDP ratio was a shade above 11 per cent. A number that has remained stubbornly flat over several years (typically ranged between 9 and 11 per cent for nearly two decades). To put it in recent context, it was ~11 per cent in FY19, the last normal year pre-Covid. But more than the headline number, it is the composition that is of interest. Contribution of PIT went up from 2.39 per cent of GDP (FY2019) to 2.97 per cent (FY2023). GST went up from 2.42 per cent to 2.64 per cent. But corporate taxes went down from 3.51 per cent of GDP to 3.03 per cent. It is rather exceptional, given the roaring recovery in corporate profits from the bottoms formed in 2020. Corporate profits, which bottomed at ~2 per cent of GDP in FY2019, doubled its share in FY2023, when corporate profits landed at 4.1 per cent of GDP. Not very far from the 21st century high of 4.7 per cent seen in FY2008.
The reason for this “negative spread” is simple – sharp cut in corporate tax rates in September 2019. For large companies, the applicable tax rates were pegged at 21 per cent (which meant an effective tax rate of 25 per cent, including surcharges and cess). It meant that even as corporate profits soared in the last three years, its relative share in taxes dipped even as national income at an aggregate level has not reverted to the trend of growth in pre-Covid era. As a result, the central fiscal deficit runs at ~6.5 per cent level today, from a ~3.5 per cent pre-Covid, as the government needed to spend more to counter the worst impact of the pandemic.
The cuts in corporate taxes were done with the assumption that they would spur investments. In turn, fresh investments will trigger a virtuous cycle of higher consumption, income and savings. It hasn’t quite panned out that way. While corporate profits have gone up, share of the corporate sector in investments (or Gross Fixed Capital Formation, as it is known technically) has gone down sharply. From over 7 per cent of GDP in FY2011, corporate investments have gone down to less than 3 per cent of GDP in FY2023. To be sure, the nominal trend is up – there has been a smart pick-up in corporate investments in the last couple of years. But it is nowhere near the expectations when the tax-cuts were being cut.
Meanwhile, the two other sources of taxes have had to remain stickily high. PIT rates have inched up, primarily on account of surcharges and cess. Peak personal income tax rates in India (at ~40%) are close to the levels seen in much of the developed world, and higher than some higher-income Asian countries. At the same time, taxes on fuel products have also remained high. With higher price of crude oil, it is an additional effective tax on household incomes. While the economy has been struggling with the problem of aggregate consumption demand for quite some time (at least since 2017), sticky taxes magnify the issue further.
It is this policy tilt in favour of capital and enterprise that is in question. If higher corporate profits do not result in higher investments, is there a better trade-off to use that elsewhere? Maybe to reduce GST on consumer goods, or a higher direct cash transfer to the poor – to spur consumption.
To be fair, it isn’t just an India issue, but a global one. Several large global corporations, especially multi-national companies in the digital space, pay very little tax by moving profits to low/no-tax jurisdictions – via a process known as BEPS (Base Erosion and Profit Sharing). There are several multilateral initiatives, including by G20 and OECD, underway to plug this obvious gap. But between competing national interests and political pressures, the issue remains mostly unresolved.
India’s problems are larger due to our scale. We have larger development challenges. Corporate taxes are a fair question, given the outcomes seen till today. The bell tolls for sure.
(The author is the Chief Investment Officer at ASK Wealth Advisors. The views and opinions expressed in this article are personal)
