The Economic Times on October 10 reported that the Narendra Modi government plans to simplify the direct tax code by pruning tax exemptions. If the government does act on this plan, it would have a positive impact on the economy as a tax code cluttered with exemptions results in economic distortions, encourages companies to lobby the government for more exemptions and keeps the headline tax rate high.

The aim of direct tax reforms has been to simplify the code by removing exemptions. One measure of the cost borne by the economy on account of tax exemptions is provided by a statement in the budget which details the extent of revenue foregone.

For instance, in 2013-14, revenue foregone on account of exemptions for corporates was Rs 57,793 crore.
The fallout of these exemptions nudged finance minister Arun Jaitley to promise reforms in the direct tax code. In his last budget speech, he laid out a roadmap of the reform path.

“The basic rate of corporate tax in India at 30% is higher than the rates prevalent in the other major Asian economies, making our domestic industry non-competitive. Moreover, the effective collection of corporate tax is about 23%. We lose out on both counts, i.e. we are considered as having a high corporate tax regime but we do not get that tax due to excessive exemptions.

A regime of exemptions has led to pressure groups, litigation and loss of revenue. It also gives room for avoidable discretion. I, therefore, propose to reduce the rate of corporate tax from 30% to 25% over the next 4 years. This will lead to higher level of investment, higher growth and more jobs. This process of reduction has to be necessarily accompanied by rationalization and removal of various kinds of tax exemptions and incentives for corporate taxpayers, which incidentally account for a large number of tax disputes,” said Jaitley.