Late on Friday night, the United States Senate with overwhelming support from Republicans passed a bill that would reduce corporate tax from the top bracket of 39 to 20 per cent. The domestic debate has ranged from whether this is a giveaway to the rich and how it will exacerbate deficits, but the global implications are clear. US companies have long set up headquarters in low-tax geographies spanning the world and will now have no cause to do so. Trillions of dollars of global profits that were subject to high US tax will be allowed to return and many economies, from UK to Singapore, will have to devise new plans on how to retain companies in their shores rather than be based in the US.

India will probably become an outlier in terms of our tax structure. The country has high corporate tax, in addition to a surcharge for companies earning more than Rs 10 crore of profits, a dividend distribution tax for companies, and a tax in the hands of recipients if the dividend received is higher than Rs 10 lakh. Individuals and firms that receive salaries, fees or interest on loans from companies pay tax once on their income. A company’s salary or interest expense is pre-tax. Dividend in India may have the same money taxed three times. While there may have been social justification to devise such a tax structure in the past, it creates a perverse economic incentive of discouraging the setting up of one’s business in India. This is especially true for manufacturing companies. Manufactured goods such as electronics can be freely traded. India has free-tax agreements with various countries in South-east Asia that allows tax-free import of manufactured goods. Even otherwise, India is a member of  the World Trade Organization and cannot raise import duties beyond a point.

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For instance, a company based in Thailand can manufacture electronics, enjoy duty-free entry into India, and pay a domestic tax at 20 per cent. The same product made in India may attract a 33 per cent tax, including surcharges if the company is of medium size and has an overall income of Rs 10 crore. In these circumstances and for products that can be easily traded “Make in India” will not be an attractive option. The exceptions are mainly for companies dealing in goods where transport is a major share of cost, such as for cement, so import is unviable, or for firms that need access to the low cost Indian labour. Otherwise, at current tax levels, import makes sense for a vast array of goods. Most electronic goods, for instance, are imported. The total import bill for electronics has now caught up with India’s historically high oil bill and gold imports. This drives a hole into our deficit, fails to create the requisite manufacturing sector employment and effectively incentivises import.

It is well known that many of the South-east Asian companies that sell manufactured goods to India are actually owned and managed by Indians, so the choice of locating the company outside India isn’t about know-how. India is projected to consume $400 billion of electronics hardware by 2020, and only a quarter is expected to be made in the country, according to a report by Deloitte.

Services cannot be traded as easily. If a mobile phone retail outlet or repair shop, for instance, is subject to a higher tax it may not have an option to relocate. Service sector jobs will possibly remain in the country even if taxes aren’t favourable. This lopsided structure where service-based companies are located in India but manufacturing companies do not may cause strange outcomes. Services are usually located close to major consumption points which are usually urban areas; so jobs in cities continue to be created. Manufacturing is usually undertaken far from these cities because of cost of land and wages. Absence of manufacturing jobs alongside many service-sector jobs result in large cities that are huge draws for potential employees but with fewer opportunities outside.

Let’s take an example of Oppo, a popular mobile phone brand. Oppo is made in China, but it has many service centres and sales-points across cities in India. Indian television channels and newspapers carry its advertisements, and an Indian star, Deepika Padukone is its brand ambassador. Oppo is the official sponsor to the Indian cricket team. So while many sectors ~ sport, media, urban job-seekers ~ benefit from Oppo operating in India, a small town that may have hosted a large Oppo factory loses out. Simpler jobs requiring lower education do not get created. Learnings typically developed from manufacturing industries ~ supply chain management, robotics and quality management ~ do not get incorporated into the business environment.

It is not suggested that low corporate tax will alone or immediately solve all the problems that result in Oppo not being made in India. Interest rates may be a factor that raises cost of capital. The ease of setting up business, laws related to employment that may discourage hiring of permanent staff may cause businesses to be wary. However, the easiest to solve, and a key competitive disadvantage today is our rate of corporate tax.

There is of course a question of what a lower corporate tax rate will do to the total receipt from corporate taxes for the Indian exchequer. India receives around Rs 5 lakh crore from corporate taxes. If the rate is reduced by 20 per cent, what would it do to this receipt ~ will it reduce by Rs 1 lakh crore? And if that happens, what shall be the implications? There are three points to consider. First, the fact is that if taxes are reduced, many more companies will be based in India. Whether enough new companies will be attracted to the lower tax to offset the lower receipt depends on several factors, including non-tax aspects such as ease of setting up business, availability of talent and transport costs that will be saved. However, the loss of receipt will certainly be much lower than Rs 1 lakh crore because many more companies will be encouraged to manufacture in India.

Second, along with a reduction of tax rate we ought to start rationalising tax exemptions. Many companies receive exemptions to such an extent that what the government effectively receives is far less than the corporate tax rate. Exemptions range from tax holidays for being located in various states to being rewarded for being small-scale or making something that the government approves. All these tax rebates are probably well intentioned but create a confusing maze that benefits creative accountants and dodgy companies rather than building our manufacturing industry.

Third, lower receipts alone should not turn off the government from looking at a reduction in corporate tax. It makes necessary for government to have all the receipts it needs to fund infrastructure, health, safety and security and in a poor country such as India an enlightened government should fund social security programmes such as NREGA, fund a good education and subsidise those who need support. But a huge amount of our corporate taxes go into subsidising failing government enterprises and their redundant staff.

Many of these enterprises were needed when they were established after Independence.  Thus the government got into refining petroleum, running airlines on a large scale and also operating bakeries and distributing milk on a smaller scale. Over the years, as Indian industry has matured many government companies serve no purpose and there are often cheaper and better alternatives to the state-run producer. Often, consumers will even notice if the state exits these industries. For instance, government subsidy to Air India amounted to more than Rs 25,000 crore between 2012 and 2016. For most sectors today, consumers have other options to fly. Recapitalising state-owned banks is expected to cost the exchequer Rs 2 lakh crore. Some bank failures are common and every country protects the financial industry, but high taxes from productive industries have also been used to write off dishonest borrowers. These funds may have been better spent on tax rebates to manufacturers.

Lowering the corporate tax rate was a promise of the current NDA government. A step was taken in this year’s budget for small-scale enterprises which hardly addresses the manufacturing challenge. Let us hope it will be something that will be boldly and effectively done in the upcoming budget. With the United States now slashing its tax rate, India cannot afford to remain an outlier.

(The writer is Chairman, Obeetee Limited and Executive Director, Luxmi Tea)