Corporates squirm but accept logic

From an average of 21.7 per cent of pre-tax profits, Kelkar is recommending corporates pay at rates of 30–35 per cent, obviously they’re going to protest,” says former Confederation of Indian Industry (CII) Chief Economist Omkar Goswami, who now heads economic and corporate consulting firm CERG Advisory.

“The progressive types,” Goswami adds, “will welcome the cleaning up of countless exemptions, but no one wants to pay so much more.”

As if on cue, the caveats begin to roll in. “This is the way forward and we welcome the proposal to lower tax rates,” says Federation of Indian Chambers of Commerce and Industry (Ficci) President YK Modi, “but we think the tax rates should be around 20 per cent and not the 30 per cent proposed.”

Under the Kelkar proposals, an additional amount of nearly Rs 10,000 crore is t be realised by taxing corporates at a higher effective rate next year, while the tax rate is to be brought down from the existing level of 35.86 per cent for domestic companies to 30 per cent. Also, depreciation is to be reduced from the existing 25 per cent to 15 per cent, and a host of other benefits are to go.

By 2008-09, Kelkar’s proposals will lead to a 17 per cent hike in corporate tax collections, from Rs 178,667 crore in the baseline scenario to Rs 208,363 crore under the reforms scenario.

CII President Sunil Munjal says: “The CII has been asking for the removal of exemptions and so we welcome the proposals. Removing area-based incentives is a very good thing, such incentives for Himachal Pradesh and Uttaranchal in recent times have already seen industries moving out of Punjab. Some exemptions, like those for education and health, are directional ones and need to be kept because these are national goals. I think the larger point is that if depreciation rates are to be reduced and other changes made, to keep all things equal, corporate tax rates have to be brought down to around 22–23 per cent or so.”

CII Director-General N Srinivasan adds industry needs a period of 3–5 years to adjust to the lower depreciation rates “so that investments can be ramped up”. Perhaps a “sunset clause” approach needs to be adopted to some concessions in Srinivasan’s view.

Surjit S Bhalla, who runs a fund management firm, Oxus Research and Investments, says: “I think both corporate as well as income tax rates need to be brought down to around 25 per cent if you want genuine compliance... at 30 per cent, the compliance may not kick in.”

For those who came in late, this is precisely how Vijay Kelkar’s tax proposals came undone the last time around. Kelkar’s first report too wanted to do away with a series of exemptions (this time around, a chastened Kelkar has retained the ones for individual taxpayers), but lobbies slowly began to talk of how investments wouldn’t happen without specific incentives, and so on. (Interestingly, studies by researchers at the Indian Council of Research on International Economic Relations and at consulting firm McKinsey show that tax incentives are relatively unimportant for investments—while these studies have been done for foreign direct investment (FDI), their conclusions hold for domestic investments as well.)

Kelkar’s report has a better chance this time because it has been packaged much better, and focuses on a very definite target the central government has to meet— the deficit reduction targets of the Fiscal Responsibility and Budget Management Act.

While the Act requires the revenue deficit be eliminated by 2008-09 and the fiscal deficit be brought below 3 per cent of gross domestic product (GDP) by this period, Kelkar has forecast revenue and expenditure patterns till 2008-09, assuming the sort of changes made over the past 3-4 years in gathering more revenues and in cutting expenditure will hold.

And this very clearly shows the government will fall way short of the target. In the event, increased revenue mobilisation is the only solution (see Kelkar Redux: The CMP of Taxation).

Kelkar’s report points out, in a manner fashioned to meet the Common Minimum Programme’s goals, a higher tax mop-up will mean public expenditure will go up by 0.6 per cent of GDP by 2008-09 (that’s by an amount equal to fund two National Highway Development Project programmes), an increase in Plan spending by Rs 20,000 crore, as well as a lot more funds for states since they will now get part of the service tax to be levied by the Centre.

Kelkar’s challenge will come from several in the tax department who many not be too keen to get rid of the exemption-raj, which is a source of great power for them.

The biggest hurdle, of course, will come from the political system itself. It is well known that Kelkar was opposed to removing large chunks of the textiles sector from the tax net, but politics triumphed. The turnover tax, similarly, was an idea that Kelkar had opposed.