Retro Tax Out, Reforms In

Context: The idea that great powers can shepherd regional actors towards pre-defined goals in Afghanistan is an illusion. There are too many independent actors in the region with high stakes in the country.

Background

• The repeal of the retrospective tax was long overdue and strongly signifies that the reformist trend in Modi 2.0 is not only continuing but also strengthening.
• In recent days, because of this, India has been losing cases in its own Supreme Court (the ITC case noted above) and in international courts (Cairn and Vodafone).

Recent tax reforms

• Reduction of corporate taxes: At around 27 %, India had one of the highest effective corporate tax rates in 2019 (and earlier). (An effective tax is simply the ratio of the tax paid to income earned. The difference between the stated nominal and the actual effective arises because of legal tax deductions). 
• In October 2019, when the finance ministry reduced corporate taxes to near world competitive levels. 
• In parallel, after having one of the highest real policy rates in the world, RBI induced trend is for India to have a competitive real policy rate.

Implications of the repeal of retrospective taxation

• More capital reforms to come: The Commerce Department HLAG committee report 2019 had argued for several reforms, including some major reforms in the capital market.
  • Opening up of the market will allow Indian investors to directly buy and sell foreign securities.
  • Commission rates in India will go down for all investors, including domestic. Markets will be more stable as a collection of individuals.
• Indian sovereign (and corporate) bonds can become part of global bond indices.
  • The cost of borrowing for governments and corporates will come down as individuals across the world invest in the now high nominal (and real) Indian yields. 
  • Today, Europe and Japan have zero nominal 10-year yields, and the US is at 1.3 %.
• More capital will mean more investment: and more investment means higher growth.
  • While China has enjoyed superlative economic growth for three decades, its growth is stylised by an inverted -U pattern and is on the decline (its growth peaked a decade ago).
  • There is only one country in the world that has the scale to match China. India can enjoy a late-comer advantage for the next two decades.

Conclusion: India cannot grow with a retrogressive tax regime. It needs to be trusted completely on the rule of law. The rule of law will also help privatisation and other associated best practices. This is likely the real reason why the retro tax had to be formally booted out.