The absurd story of the relative corporate tax burden

BIG IS BEAUTIFUL - The absurd story of the relative corporate tax burden

Cutting Corners Ashok Mitra

The Economic and Political Weekly continues to surprise. Perhaps only the Dutch periodical, Ekonomist, shares with it the idiosyncrasy of combining comments on contemporary political, economic and social events in the first half with serious, often abstruse, articles on grave themes in the social sciences in the later pages. Juxtapositions of this nature can pose problems. Separating the mundane from the profound is not always that easy a task. This is where the EPW scores. It has met the challenge with rare panache. Even the presence of papers with formidable-looking mathematical equations has failed to scare away its readers who include members of academia as well as policy-makers. Some of the articles it carries in the latter half of the journal have acute relevance to contemporary problems affecting the polity and the economy. Consider, for instance, the issue of May 19 last. It carries a fascinating article, “Corporate Size and Effective Corporate Tax Rate”, summarizing the results of an empirical work undertaken by a young, hitherto-unknown scholar, Atulan Guha. His institutional affiliation is not mentioned, but that hardly matters. The message his paper puts across should make one sit up. The sample Guha chose for his investigation consisted of panels of Indian private companies mentioned in the database published by the Centre for Monitoring Indian Economy, the reputed Mumbai-based research institution. This was, in a sense, the only source available to him, since the ministry of finance does not publish detailed data on the collection of corporation tax at the company level. The ‘proxy’ data covering the period, 1992-2001, were fed into an econometric model. The results Guha arrives at are startling. The simple-minded may have an idealized view of the system of taxation: the bigger the size of the company, the larger its capital stock and the magnitude of its turnover and gross profits, the higher must be its tax liability. But no; Guha has discovered it works the other way. The effective tax rates, that is, actual taxes paid by firms as a proportion of their gross profits, are inversely correlated with their size. The larger companies pay taxes at lower rates while relatively smaller-sized firms are charged at higher rates. A topsyturvy situation, you and I will be tempted to say. In the kind of society we subsist, this is how the cookie crumbles. Guha speculates on the factors which lead to this kind of a denouement. A number of things appear obvious. Bigger firms enjoy larger benefits in the way of write-offs for depreciation and obsolescence. They often have a substantial turnover of exports, thereby qualifying for further tax concessions. None of this tells the entire story though. The bigger the firm, the greater, Guha is sanguine, is its ability to hire accountants and tax experts who are conversant with the nooks and corners of the entire range of tax exemptions a company can lobby for and avail itself of. They are equally cognizant of the various loopholes in the tax structure. In some cases, these highpriced tax advisers can fudge the accounts in such a marvellous manner that revenue officials are totally bamboozled. Guha also hints at the likelihood of the greater ability of the bigger firms to hire top-notch lawyers who argue their case with super aplomb, starting all the way from the level of junior tax authorities through the rungs of tax tribunals and further on through different layers of the judiciary. With presumably a twinkle in his eye, Guha drops, at the next state, a half-hint: the big cheeses in the corporate sector are in a position to either arm-twist or otherwise ‘influence’ officials in the department of revenue to get tax assessments adjusted in their favour. The modalities of such influence-peddling are well known and hardly need to be spelled out in detail. Guha is more explicit about a fourth reason he adduces for the effective relative lightness of the tax burden for bigger firms: it is their nexus with the political administrative system. What he implies is fairly obvious. The fat cats in the corporate sector have the ability to maintain a close liaison with the political top brass. In a rigidly hierarchical institutional arrangement, there are ways and ways of applying moral suasion from the top; where tax assessment is concerned, the benefits of such suasion accrue to the larger firms. It is a class-biased society. Guha’s findings will not put to shame either the corporate sector or the government’s revenue-collecting apparatchik. Nor will it embarrass the politicians who rule the roost. There can, however, be some major spin-offs on account of the manner the tax system has been made to operate in favour of the richer corporations. The government foams in the mouth while exhorting each and all to participate in the free market where every one is supposed to have equal clout. The reality is simply not so, as the regime of effective tax rates so vividly illustrates. Small and medium-sized entities in the corporate world will soon learn the lesson this kind of tax regime imparts. To survive and prosper in such a milieu, the smaller firm will quickly decide to come to an arrangement among themselves and cultivate the art of being big. Given the built-in inequity in the effective tax rate structure, small- and medium-sized firms will convince themselves that only the big is beautiful; they will begin to think in terms of forming carte-type organizations of their own — or in terms of mergers. Some legal impediments may exist making it inconvenient to form cartels or arrange amalgamations. Devices nonetheless exist through which an informal system of collusion can be worked out by the relatively smaller firms. By coming to a tacit understanding with one another in the matter of purchase of inputs, pricing of products and regulation of output, they could develop enough power and bargaining capability to draw the same respect and attention from the revenue authorities as are accorded to the biggies in the corporate sector. The capitalist system as currently unfolding in India would, in any case, have hastened the arrival of a network of monopolies with near-total command over the economy: the ‘tax breaks’ that the top layer of the corporate sector enjoys will further advance the dawn of that ethereal day. And one can have a fair hunch of the total fiscal anarchy likely to ensure once the giant-sized special economic zones are ushered in. Ask not what the SEZs will do for the nation; ask what further blessings the nation can shower on the SEZs. Given this frame of mind of the political masters, nothing need be left to the imagination. There is a tailpiece, though, to this absurd story of relative tax burden. For nearly fifty years now, a group of economists, particularly those trained in London and Chicago, have been haranguing the policy-framers on the advantage accruing from low tax rates. They have based themselves on the so-called Laffer Curve, according to which the elasticity of income of tax collections — or whatever the jargon is — is greater than unity, meaning thereby that a lowering of the tax rate will yield a more than proportionate increase in tax revenue. Guha’s research ought to set everybody to rethink on the soundness of the proposition. If the tax rate is lowered, there would be that much of extra money in the kitty of a company with the help of which it could hire more accountants and more smart lawyers to explore fresh and fresher avenues of tax avoidance; it would, at the same time, have a larger slush fund at its command from which consideration money might be offloaded to tax officials and ruling politicians. Adieu, Arthur Laffer!