Lately, there has been lot of discussion about the delay in implementing the direct taxes code bill that propose to cut down the tax rates for corporate bodies and individuals. With this, the government hopes to increase tax collection. It has become the topic for debate in many countries across the globe, if tax rates are to be increased in order to cut down on deficits. The principle that highly drives the tax debate is the Laffer Curve.
The Laffer Curve could be defined as the geographical representation of the relationship between tax rates, tax revenue and taxable income. The principle behind the Laffer curve theory is that a zero tax rate would produce zero revenue, while 100% tax rate also results in generating zero revenue, because there would hardly be any incentive to work. Therefore the matter of fact is, there should be an optimal tax rate that yields most of the revenue for the government.
The change of tax rates brings along two major effects that needs to be taken care of- the arithmetic and the economic effect. Simple arithmetic says, of the tax rates are lowered, tax revenues will drop in the same proportion, while the increase in the tax rate would eventually increase the revenue collection for the government. The economic effect of the tax rates being changed, works at a more subtle level and finds out the fact that high tax rate will make people less inclined to work and more prone to find ways in order to avoid taxes. It is not surprising, if due to high tax rates, corporate and individuals think of shifting their assets to less taxing jurisdiction. Hence, if the arithmetic effect is in favour of saying that higher tax rates leads to higher collection of revenue, economic effects has its adverse effects too.
Indian individuals and corporate are expecting the government to cut tax rates in the annual budget. A very recent statistics says, when almost 46 percent of the chief executives of The Confederation of Indian Industry were polled, they expected the finance minister to cut down the corporate tax rate to 30 percent, from about 36 percent. However, things may appear little strange, as India’s highly indebted government would want to reduce taxes, when it has very minimum control on the expenditure side of the budget, which has many subsidies and interest payments. Nevertheless, cutting down on tax could be the best way to put an end to the budget shortfall, if we consider the Indian economy. Again, this is also the fact that revenue deficit means limiting fresh borrowing to the developmental spending.
The changes in the Indian tax scenario, keeping in mind the Laffer curve, indicate beneficial for the Indian economy. Furthermore, critics believe, that implementation of the Laffer curve made by the Indian Finance minister and further cut in the tax rates would worsen the fiscal scenery. But, the part critics failed to understand is that the direct taxes which includes- corporate levies and income grew almost seven folds in between 1990 and 2001. This marked the opening of the Indian economy to the world and almost compelled local companies to compete on a global basis.
Keeping in mind about the principles of Laffer curve, economists hope, it works equally well for the Indian economy too.