In an earlier column, I wrote about OECD's analysis of our failure to develop industry. It also took a close look at our taxation system, and suggested how it could be improved.

The corporation tax rate is 30 per cent for Indian companies and 40 per cent for foreign companies. There is a further tax of 15 per cent on dividends; if all untaxed profits were distributed, the total tax would come to 40.5 per cent. There are various 'cesses' to complicate matters. Altogether, they bring the taxes to 45.92 per cent for Indian companies and 43.26 per cent for foreign companies. There are various rebates for depreciation, research and development and so on; as a result, the average tax rate varies between 41.9 and 50.3 per cent, and the marginal effective tax rate between 26.2 and 58.1 per cent. In comparison, the BRICS average is 28 per cent, and the OECD average is 25 per cent.

India has the highest corporate tax rate in comparison to similar countries: 46 per cent against 34 per cent in Brazil, 28 per cent in South Africa, 25 per cent in China and Indonesia, and 20 per cent in Russia. In other countries, it generally varies between 20 and 35 per cent. One reason is that India does not levy a dividend distribution tax, which is an easy way of passing on tax to the country of origin of the foreign investor. The high tax rate also provides a higher incentive to foreign companies to shift the tax base - understate profits made in India and transfer them to countries with lower taxes. India still received foreign investment despite high taxes because Indira Gandhi had signed an agreement under which investment channelled through Mauritius was tax free. Now the government has foolishly rescinded the agreement, and even this reason for investing in India has been removed. Apart from this, one of the greatest disincentives to foreign investment in India is its legal practices: court cases take ages in India, and the Indian government keeps appealing every time it loses in court. A foreign investor has no chance, legally, despite a fair judicial system.

The actual tax paid is greatly reduced below the tax rates by rebates. The average tax paid in 2013-14 was only 23.2 per cent. Strangely, it was 26 per cent on companies earning less than Rs 10 million, and went down to 21 per cent on the biggest companies earning over Rs 500 million. It was 19 per cent on public companies, and 24 per cent on private companies. Companies in energy paid 19 per cent; hotels and trading companies, at the other end, paid 31 per cent. Rebates and concessions cost 21.8 per cent of the revenue; 8 per cent was recovered through minimum alternate tax. Of the 21.8 per cent of tax revenue that was lost from rebates, 6.2 per cent was lost on account of accelerated depreciation, which subsidized capital-intensive industries at the expense of everyone else. Another 6.2 per cent was lost from regional concessions, mostly related to special economic zones. Another 5 per cent was lost from concessions given to infrastructure industries - electricity, oil, natural gas, telecommunications and so on. About a third of the revenue was offset by the minimum alternate tax; but it had no other rationale. It was just a disincentive to making profits.

The higher the tax rate, the greater the incentive to evade the tax, for instance by transfer pricing. India is tough with transfer pricing, but is quite oblivious of the fact that it makes transfer pricing lucrative. The high tax rates are accompanied by high rates of depreciation which vary considerably between various assets. The idea is to encourage investment, but that is doubtful; the immediate effect is to create a lot of surplus capacity. Low tax rates, combined with realistic depreciation rates, would have a stronger incentive effect. The effective tax rates are raised by inflation, which is traditionally high, in two ways. First, no allowance is made for the fact that profits lose value over time because of inflation. Second, businesses are allowed to write off only the historical cost of assets in depreciation. When the assets are replaced, they will cost a lot more because of inflation; most of their cost will not be covered by allowed depreciation. In the case of debt, on the other hand, inflation raises the rate of interest, and interest is fully written off against profits. So debt gets better tax treatment. This leads to the chronically high debt-equity ratios of Indian companies which make them more vulnerable to economic ups and downs.

Special economic zones get generous tax incentives. A business located in a SEZ pays no corporate income tax on its profits in the first five years. In the next five, it gets a 50 per cent exemption; in the third five years, its reinvested profits are exempted. Developers of SEZs are exempt from income taxation in ten years of their choice out of the first 15 years of operation.

India used to give tax concessions on export profits; they were removed in 2000. A recent study showed that the profits of beneficiary firms fell to a half after the removal - obviously because of tax evasion. The same economist showed that firms made much better profits in their factories in SEZs than in their units outside; obviously, they were concealing profits in the latter. Similarly, research has shown that tax concessions to investment in backward areas had led to greater investment in only some of those areas, which were better administered. So giving concessions to states without insisting on good administration is a waste of resources.

It makes sense to let off small and medium enterprises lightly, because they deserve to be encouraged, and because they are so many of them that pursuing them would increase the administrative burden without commensurate returns. But it is also a good idea to cover them, so that they are taxed when they grow. SMEs currently pay a presumptive tax of 8 per cent on sales. It should be made to vary with the profit margin. The presumptive tax gives an incentive to keep sales below the taxable limit; this can be reduced by basing the tax on the average of past three years' sales. There is also a case for taxing new entrants at a reduced rate for the first few years, as in Mexico.

Indian tax administration is not popular. But OECD shows that it is not because it is excessive. In fact, it employs fewer people per head of population, India spends a much smaller proportion of GDP on them relatively to comparable countries, and it spends a smaller proportion of expenditure on tax officers. They are too few, poorly educated and trained, and have no capacity for tax policy analysis. The result is poor tax administration. It is evidenced by the number of tax disputes - over 3,50,000 in India, against 2,00,000 in Brazil, and less than 50,000 on the average in both OECD and non-OECD countries. The tax authorities spend too little on themselves; this affects their quality of functioning, and is reflected in public view of them.