[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...

MORE MARKETS, LESS GOVERNMENT
ed dividend tax, property tax and tax on
insurance contracts. 8 India’s tax system
demands a radical change towards a reduction
in taxation of productive behavior
such as labor supply and investment nevertheless.
The demand and supply of labor
is elastic which supports the thesis
that labor supply is highly sensitive and
responsive to tax rates. 9 Recent highlights
in empirical investigation of the behavior
of labor supply has shown that labor supply
responds dramatically to lower tax
rates on work whereas productivity has
been soaring due to cutting taxes on productive
activity. India’s particular competitive
advantage in terms of tax system
could be innovative; public products such
as internationally competitive territorial
tax system, a model in which Indian provinces
could compete to attract inflows of
direct investment on the international basis.
A strong argument in favor of open
territorial tax competition is that it is rational
to expect lower tax rates on productive
behavior and thus adversely positive
effects on output and productivity growth.
Recent research evidence by Djankov,
Ganser, McLiesh, Ramalho and Schleifer
(2007) has shown consistent and large
adverse effect of corporate taxation on
investment and entrepreneurship. According
to authors’ calculations, a 10 percentage
point increase in the effective
corporate tax rate reduces the investment
to GDP ratio by about 2 percentage
points. 10 Alternatively, India could consider
a possible move in a direction of
abolishing the corporate tax due to its effect
on capital creation and entrepreneurial
activity. Also, India should consider a
fundamental tax refom in a pro-growth
direction. Practically, India may switch its
taxation regime from income tax to consumption-based
tax. In case of cutting-off
income taxes and alternatively adopting
taxes on consumption, higher savings
would dramatically boost the productivity
and living standards. The encouragement
of competitiveness deserves a concrete
treatment of pro-growth tax and economic
policy proposals that could boost output
performance. A significant amount of
empirical evidence suggests that the reduction
in corporate and individual taxation
boosts the operating capacity of the
economy in going for growth as well as
private initiative in fighting India’s structural
weaknesses and human capital creation
which is, by any means, an essential
ingredient of growth in an economy with
astonishing growth potentials. 11
Despite a moderately free fiscal and
public consumption , 12 India’s structural
defects are mostly subject to an inefficient
administrative environment, weak property
rights, government involvement in
the financial sector and widespread perception
of corruption. For instance, India
ranks 72nd out of 188 countries included
in Transparency International’s Corruption
Perception Index. 13 A spiral of structural
deficiencies contributes to the hindering
of India’s growth sustainability and
international macroeconomic and microeconomic
competitiveness. Corruption is
a huge cost reflecting the governance of
institutions enforcing private property
rights, the rule of law and competitive
framework of the economy and individual
interaction. Noteworthy, tax complexity
and high costs of tax compliance contribute
a significant fraction to the legal
and illegal level of corruption. In European
Union, pressures for harmful tax
harmonization 14 aim to expand the scope
Research evidence shows a consistent and large adverse
effect of corporate tax on investment and entrepreneurship.
A 10% point increase in the effective corporate tax
rate reduces the investment to GDP ratio by about 2%
of government bureaucracy in tax collection.
Tax rebates, exemptions, loopholes
and numerous deductions contribute to
the rise of hidden corruption within legal
limits. Fighting against corruption requires
an active approach codified by the
enforcement of competitive law, deregulated
product markets and the elimination
of government involvement in financial
sector and any other sector in the economy.
Of course, in economic theory and
practice there are externalities and market
failures which excuse the role of government
in certain areas. But such approach
would be needed under
cost-benefit analysis, clearly defined competitive
rules and under the absence of
government coercion and political intervention.
Anti-corruption legislation and
THE INDIA ECONOMY REVIEW
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