US Judge, Oliver Wendell Holmes Jr. once stated : “Taxes are what we pay for civilised society”
Holmes J. was right in his statement because taxes are the important source of revenue for the government to fund its interest.Revenue earned from the taxes is used by the government to initiate public schemes which benefit a large section of society.Revenue earned from the taxes are also used to fund for the essential services provided by the State and the central government.
Since the beginning of the Industrial revolution it has been a debated topic that how much tax should be imposed on corporations, so that it neither hurts the corporate interest nor the public interests and economic growth at large. In the present paper,the scholar attempts to analyse the effect of corporate tax on economic growth and also what are the pros and cons of cutting the corporate tax rate.
In the initial year of Industrial revolution the corporate taxes were very high but the researches of modern time emphasised on corporate tax cut. Few argue that it is equitable, practical and politically reasonable for the corporations to pay tax while few others argue that higher tax rate discourages inward investment and enterprise.
Keywords
Tax Rate, Corporate, Employment, Government, Market, Revenue, Economic growth, Corporations
Introduction
About 2300 yrs back Chanakya advised this to the king about the tax system through his book Arthashastra – “Just as a bee collects honey from flowers, drop by drop, over a period of time (without harming them), so too should a king collect taxes from his subjects for future use (without hurting them).” So, the government should collect the tax from corporations in such a way that neither hurts the core of the corporations nor does it affect the government welfare steps. Corporations are the biggest source of direct revenue as well as they also give employment to many people.
Corporations are not the Novel idea of the modern era, they are institutions of very ancient time. But the type of corporations that we see today evolved appeared in England during the commercial revolution. A body of corporate during the 17th & 18th century could be brought into existence either by royal charter or by a special act but it was only the 19th century when the registration and incorporation of the company was made compulsory in England.
History of Company law in India began with the Joint Stock Companies Act of 1850.But it was only 1956 when the most comprehensive legislature came into effect in the form of Companies act,1956. But it was not exhaustive so the organisation for the purpose of business can still be incorporated by special act of Parliament. In 2013,Companies Act of 1956 was replaced by Companies Act of 2013.
Economic growth is a long term increase in product potential of an economy. It is the increase of production of goods and services in one period of time compared with a previous time in an economy. It is affected by the number of internal and external factors, policy is one of the such significant.Traditionally, Economic growth is measured in terms of Gross National Product (GNP) and Gross Domestic Products (GDP). Economic growth has always been a deliberate topic in Political, Legal and economical forums. It is also assessed as an important factor to assess the political tenure of a politician.
Corporate tax is the taxes paid on a company’s taxable income, it includes revenue minus expenses. Corporate tax is one of the main sources of income for the governments.
Research methodology
This paper is of analytical nature and the research is based on the secondary sources for the analysis of impact of corporate tax rate on economic growth of a nation. Secondary sources like Websites,Book, Online Research papers, Reports have been used for the research.
Review of literature
The Benefit of setting a lower limit on Corporate taxation by Aquib aslam & Maria Coelho
In this blog of the IMF, the authors examine how different types of domestic minimum tax regimes can help countries to preserve corporate tax base and mobilize revenue. In this paper the authors mention that in 2021, G7 countries agreed in principle to ratify a global minimum corporate tax rate to counter the possibility of undercutting each other to attract investment. This blog also quoted the 2018 IMF data that says that the number of countries with minimum corporate taxes continues to grow and the governments are turning to minimum taxes to preserve their tax base. They(writers) also tried to justify the tax cut by saying that the minimum taxes are computed using the simplified tax base that avoids the complexities of the standard corporate tax base.It is based on gross turnover instead of corporate income that explicitly limit the number of deductions and exemptions allowed.Authors also quoted the study in their blog related to the impact of minimum taxes on revenue and economic activities, what they find is that introduction of minimum tax rate is associated with an increase in average effective tax rate.In the blog authors stated an IMF report on Average corporate income tax revenue, it’s finding is that since year 2000 those countries having turnover based minimum taxes have outperformed those without minimum taxes. In their blogs writers advised that minimum tax alone can not replace reform that broadened the corporate tax base and they also stated that proliferation of multiple rate and special preferences within the standard corporate tax system causes low revenue and encourages tax avoidance and evasion.
Reforming business taxes by World Bank by World bank
In this article the author of World Bank analyses the beneficiary of low corporate tax.Authors of this research article stated that the studies suggest that lowering corporate tax rate can increase investment, reduce tax evasion by formal firms, and ultimately raise GDP. Authors of this paper quoted that a decrease in the effective corporate tax rate of 10 points is associated with an increase in FDI equivalent to between 1.6 and 2.1 of GDP and associated with an increase in domestic investment equivalent to 2 percent of GDP. This paper further analysed the U.S Tax Reform Act of 1986 in which a decrease in 10 percent marginal tax let to an increase in 20 percent increase in investment. Authors of the paper quoted a study (with-in India) which depicts that the increase in effective tax rate ensuring the tax rates ensured from the Finance Act of 2000 increased tax evasion by formal firms by 10.6 percent of sales.Another study in this paper finds that 10 percentage point decrease in the effective corporate tax is associated with an increase in the total number of registered business.
Corporation
What is a Corporate?
Section 2(17) of the Income Tax Act, 1961, defines a Corporate as any Indian company or anybody incorporated by or under the laws of a country outside India. The definition also includes Institution, associations and bodies of individuals which have been assessed as a corporation for any assessment year after 1922.
Apart from these, the Central Board of Direct Taxes (CBDT) can declare an institution,association or body of individuals to be taxed as a corporation.
A corporation is a legal entity independent from its shareholders,It has certain rights and duties of its own.
Type of Corporations (Companies)
In India, corporations can be divided into two categories:
- Domestic Corporations – Any company whose management and control is entirely situated in India and is registered under the Indian Companies Act of 1956 or 2013 is referred as a domestic corporation. If the Indian arm of foreign company is wholly controlled and managed within the country, it may also be deemed as a domestic corporation.
- Foreign Corporations- A company that is based outside India or has a portion of its operations controlled and managed outside the nation’s border is referred to as a foreign corporation.
Income of a company-
- Profits and gains from business activities.
- Interest and dividend income from treasury operations.
- Capital gains from the sale of assets.
- Rental income from the property.
Corporate tax
A corporate tax is a tax on the profits or net income of a corporation. Corporate tax is paid on a company’s taxable income which includes company’s revenue after deductions such as cost of goods sold, general and administrative expenses, selling and marketing, depreciation, research & development etc.
Corporate tax is an Income Tax for income earned by corporations.
Corporate Tax rate cut in India-
Corporate tax in India is a direct tax regime for businesses.It applies to both domestic as well as multinational organisations operating in India.
In the year 1991 the corporate tax was at 45%, which is now 25% of profits for domestic firms with 400 cr gross turnover and 30% for those with higher turnover. Indian companies have a lower tax rate than other developing nations like Mexico and Argentina.
Corporate tax matters-
In the modern world, the economic growth of a country depends on the corporations of a country and the investment of corporations largely depends on the tax rate of corporations. Supporters of business tax cuts argue that increases in job creation justify the losses in the revenue while the detractors argue that tax cuts only benefit firms and it has very little impact on the economy.
It is a general presumption among capitalists that the Corporate tax rate has a negative correlation with the GDP or the economic growth.When firms choose a location, they trade off higher productivity, which is partly location specific, with lower taxes and production costs. Thus, a location that lowers its taxes attracts more firms that were, on the margin, more productive elsewhere.
Since the deduction of tax from the income of a corporation reduces the supposed profit of a corporation and it is the general aim of the companies to minimise tax and maximise profit and the tax is directly against their primary goal.
In some countries the taxes are low for the corporation and the logic behind this is that after submitting tax the extra money can go back to business and help it to grow whereas the tax paid by the corporation passed on to the government . Corporate taxes in an open economy are conventionally thought to reduce both efficiency and equity.
High tax rates lead to revenue losses as the investment is directed towards a lower tax economy.
Different countries of the world compete to attract businesses and investors in their territory by offering different types of incentives including special exemptions. On the other hand, once multinational enterprises established successfully they are accused of not paying their fair share of corporate tax, it is often said that the burden falls on local firms.
Governments of the world are turning to minimise the taxes to preserve their tax base especially the developing countries,which faces the challenges in taxing multinationals.
Minimum Tax Rate
Proponents of using business tax cuts as incentive for firms argue that increases in job creation justify losses in revenue.
A study conducted by OECD in 88 countries, finds that from the 1980s the corporate tax rate has fallen from 40-50% to 21.4% in 2018. This kind of trend makes society believe that lower rates encourage inward investment and enterprise.
Databases collected by the IMF show how the minimum tax tends to report higher corporate tax revenue as a share of GDP and how the minimum tax rates are found in countries with higher statutory corporate tax (the rate imposed by law).Minimum taxes based on modified corporate income lead to the largest increases in effective tax rates (average income at which the earned income is taxed), followed by those based on assets and turnover. Ultimately, the revenue impact also depends on the rate applied.
Pros of corporate tax cutting-
- Raising the corporate tax rate increases the cost of investments in the country.
- Under the higher tax rate, small investors hesitate to invest and if they invested it leads to less capital formation, and fewer jobs with lower wages.
- It reduces global competitiveness .
- Economic evidence indicates that it is workers who bear the final burden of corporate taxes.
- High taxes make the country a less attractive place for investment and encourage companies to shift their assets to tax haven countries which sometimes lead to situations like tax evasions.
- Multinational corporations which shift profits to low-tax countries (tax haven countries) at the expense of domestic taxpayers due to high corporate tax in case of tax cuts will start investing in the domestic market and in the form of investment (Wages to workers) that tax evasion can be controlled.
- Lower corporate tax encourages corporations to invest highly in Research & Development, innovations and in job creation which lead to long term growth.
- If a company moves away due to tax burden, productivity and wages for the relatively immobile workers fall
- Tax cuts are associated with an increase in the number of local firms.
- Business tax cuts increase the local labour demand of incumbent firms and lead to the entry of relatively less productive firms..
- Empirical studies show that labour bears between 50 to 100 percent burden of corporate income tax.
- The Higher the tax,the higher the cost of capital, the less capital that can be created and employed.So,in the long run it reduces the size of the economy.
- More capital in the company will give it(company) a chance to share different kinds of incentives and compensation.
- As businesses invest in additional capital, the demand for labour to work with the capital raises and wages rises too.
- Raising the corporate tax reduces the new investment, new job reaction, lower wage growth,incentives for workers and this finally hinders economic growth.
Cons of Corporate tax rate cutting
- Low corporate tax rates increase income inequality. By shifting the tax burden from corporations to individuals, governments are forced to compensate by cutting public services or raising taxes on lower-income brackets. This perpetuates a cycle of wealth concentration at the top, widening the gap between the rich and the poor.
- It hampers government investment in vital public goods and services. Infrastructure projects, education, healthcare, and social welfare programs suffer as a result, stifling long-term economic development and social mobility. Inadequate funding for these sectors impact deeply on the economy.
- It encourages profit shifting and tax avoidance strategies by multinational corporations. They exploit loopholes and offshore tax havens to minimise their tax liabilities, depriving governments of crucial revenue streams.
- Low corporate tax revenue can lead to higher government debt levels, as authorities resort to borrowing to cover budget shortfalls, like in US Federal revenue as a share of the economy(GDP) was at 20% while in 2019 (after 2017 corporate tax cut) federal revenue had fallen to 16.3% of GDP.
Case Studies
Tax rate of any country plays a crucial role in impacting its economy. Low Corporate tax rate encourages investment, business expansion.There are three case studies of countries having low CIT (Corporate income tax).
Ireland-: it has one of the lowest corporate tax rates at 12.5%. Due to the low tax rate many Multinational pharmaceutical and technology companies has attracted to Ireland. This investment has created a lot of job creation, innovation and economic growth to the country. The GDP per capita of the country has surged.
Singapore-: it has just 17% corporate tax, the low CIT has transformed the country into a global financial hub and is the preference of MNCs to open regional headquarters. The country’s economy thrived on FDI and infrastructural development. The low corporate taxes have fostered a business friendly environment.
United Arab Emirates (UAE)-: In UAE there are many free zones where there is zero tax. This business strategy made the UAE a premier business destination of the Middle east.Due to large investment in UAE many new infrastructure projects have been completed which are now attracting the tourists and diversifying the UAE economy. It is now a big economy.
Suggestions & Conclusion
After researching much on this topic,it can be concluded that the corporate tax has a significant influence over business operations, investment decisions, and overall economic growth. So, low corporate tax rates have numerous advantages, including providing an environment to Invest, expand and create jobs. Low corporate tax rates attract both domestic and foreign investment. When businesses face lower tax burdens, corporations retain more profits to reinvest in their operations, expand their businesses, and create new employment opportunities. This influx of investment stimulates economic growth, leading to increased productivity and higher GDP growth rates. Low tax motivates entrepreneurs and innovators to take risks.Lower taxes also enhance global competitiveness and attract more businesses seeking favourable tax environments. High corporate tax rates often incentivize tax avoidance and evasion strategies, leading to complex tax planning schemes and the erosion of tax bases. Conversely, lower tax rates reduce the motivation for such practices, resulting in improved tax compliance and a more efficient tax system.Lower corporate taxes can indirectly benefit workers by boosting wage growth. Lower corporate tax rates incentivize the repatriation of profits earned abroad. By reducing the tax penalty associated with bringing foreign earnings back home, businesses are encouraged to reinvest those profits domestically, stimulating economic activity and job creation.
But the government must also be aware about the disadvantage of low corporate tax rate; it can lead to reduced government revenue, potentially limiting funding for essential public services.This can exacerbate societal inequalities and hinder long-term economic growth. Low corporate tax rate may incentivize profit shifting and tax evasion strategies by multinational corporations, depriving countries of their fair share of tax contributions. It can also create an unequal tax burden, placing a heavier financial strain on individuals and small businesses. These drawbacks must be carefully considered to ensure a balanced and equitable fiscal policy.
Anugrah Dwivedi
2nd year
Faculty of Law
University of Delhi
(15 March 2024)