In an early measure to reverse the slowdown, the government lowered the corporate tax rate to 22%, effectively a little over 25%, including surcharge and cess but excluding the dividend distribution tax, for those who eschew all tax-planning opportunities. It also announced a lower tax rate of 15%, effectively 17%, for fresh investment in manufacturing. The Budget is the right opportunity to correct the mistake of omitting services from the ambit of the 17% tax rate. There is no rationale for excluding services from the corporate tax rate that now compares with Singapore’s and other Asian competitors’.
Of course, India should encourage manufacturing. A 17% tax on manufacturing would encourage fresh investment in manufacturing, provided there are competitive manufacturing opportunities in India. For that, India needs efficient infrastructure, competitive wages, supportive administration and functional contract enforcement and arbitration procedures. Some patches in India do have efficient infrastructure, but chaos rules in most parts, precluding inclusion in global manufacturing value chains. Thanks to dysfunctional schools, workers available at low wages are mostly unemployable in modern manufacturing. Lower-level bureaucracy remains hidebound in most parts and the courts are tardy. Most detrimental are high and variable import tariffs, which make downstream value addition non-competitive.
India’s comparative advantage lies in services. India is a part of global value chains in services, thanks to a thriving business process outsourcing industry and captive R&D by many Fortune 500 companies. It makes sense to incentivise yet more organised, high-end services, to create jobs for educated job seekers. Services like tourism can absorb less-skilled workers in far greater numbers than modern manufacturing can. A worker in a modern factory will need specialised skills, unless he is simply moving things around in a fully automated facility that hardly needs workers. Encourage manufacturing, but do not discriminate against services.