Should Narendra Modi follow Donald Trump's strategy on tax rate cuts?

Both India and US have followed similar trajectories in tax rates since the 1970s

Trump’s radical tax plan that seeks to reduce tax rates across the board has many parallels to India. In post 1970s India fraught with droughts, malnutrition and grinding poverty it was a sin to be rich. Americans meanwhile have always worshipped money and idolised those who make money. Both nations seem to have followed similar trajectories in the manner in which tax rates have moved since the 1970s

The swinging 60s and taxing times for the rich

In the 1960s, India's individual tax rates were lower than those in the US. For corporate tax rates we were higher than the US. During the 1960s, India had 7 tax rates. The highest income taxed during the time was Rs 20,000. Those earning this amount and more had to pay a tax rate of 26.25%. In the US, the peak tax rate in 1960 stood at 91%. Corporates meanwhile were taxed at a much lower rate of 52% in the hope that better profits would drive business growth and generate employment. There were wild growth fluctuations in the American growth story in the 1960s ranging from a low of 2.1% in 1960 to a high of 6.55% in 1966. However, during Lyndon Johnson’s presidency, the income tax rates for individuals was slashed to 70% while corporate taxes were reduced more modestly to 48%.

The wild 70s and Indira Gandhi’s tax shock

In 1970, Indira Gandhi India’s prime minister who also held the finance portfolio increased the peak tax rate to 93.5%. This was applicable to those earning an income of Rs 2 lakh or more a year.  The aggressive peak rate tax would leave anyone earning Rs 2 lakh with Rs 13,000 in their pocket. The move was a precursor to Indira Gandhi’s ‘Garibi Hatao’ slogan that helped the Congress sweep the general elections the very next year. The per capita income of India at the time was $110. With most of the electorate poor and a middle class yet to completely take shape, Indira Gandhi’s move to tax a minuscule section of India’s super-rich paid rich dividends at the hustings. But Indira Gandhi also reduced the corporate tax from 80% to 55% in the hope that more profits with industrialists would create more jobs for India’s poor. The US meanwhile continued to enjoy a decade of tax stability after the John F Kennedy inspired tax cut executed by Lyndon Johnson in 1964. 

Both peak income tax rates and corporate tax rates remained around 70% and 48% respectively. The tax rate stability doesn’t seem to have rubbed much on economic growth. The US economy contracted for two years during the 1970s and GDP growth continued to fluctuate wildly. Indira Gandhi meanwhile reduced the peak income tax rate to 77% in the year she declared emergency while corporate tax rates were left unchanged.

The 1980s and emergence of the fiscal deficit dilemma

The decade marked one of the most significant cut in tax rates in both nations since the aggressive taxation of the 1960s. VP Singh who was the Indian finance minister in the Rajiv Gandhi cabinet halved the number of tax slabs from 8 during Indira Gandhi’s time to 4. The peak tax rate was slashed to 50%. However, Singh raised the entry tax rate to 25% which hovered at 13% during Indira Gandhi’s tenure. The icing on the cake for India’s newly emerging middle class was a hike in exemption limit to Rs 18,000. Indira Gandhi had fixed the limit at Rs 5,000 in 1970 which was hiked only marginally in the following years.  For the first time since the 1960s peak income tax rates and corporate tax rates were almost identical. Meanwhile the Ronald Reagan administration in the US also reduced the peak income tax rate for individuals to 50% from a high of 70% in 1985. 

Corporate tax rates were left relatively untouched and were almost at their 1960 levels. This was also the time America’s economic growth was at its highest levels in decades touching a high of 7.25% in 1984. In India lower taxes didn’t help the country shift gears from the sluggish ‘Hindu rate of growth.’ Instead it contributed partly to the ballooning of the fiscal deficit to 7.55% in 1985. The high fiscal deficit would continue to plague India well into the next decade as well.

The 1990s and the new tax normal

The decade saw not just political turmoil in India but a downward movement in both income and corporate tax rates. This was the beginning of the establishment of a new normal for tax rates in India, a trend which continues till date. Finance minister Manmohan Singh reduced the number of tax slabs to 3 in 1995. The entry tax rate was fixed at 20%. In 1997-98 finance minister P Chidambaram further reduced the entry tax rate to 10%, which Jaitley made 5% in the latest Budget, while the peak rate stands at 30%. In the middle of the decade the corporate tax rate also fell 40. A new normal was emerging half around the world in the US too. Peak income tax rates and corporate tax rates were reduced to 39.6% and 35% respectively. Both rates continue to be almost the same till date. At the start of the 21st century, India’s corporate tax rates were down to 35%.

INDIA & US: A TALE OF SIMILAR TAX HISTORIES
	India GNI per capita current ($)	India Peak Income Tax Rates %	India Corporate Tax Rate %	US GNI per capita current ($)	US Peak Income Tax Rate %	US Corporate Tax Rate %
1960-61	90	26.25	20	3024	91	52
1965-66	110	26.25	80	3855	70	48
1970-71	120	93.5	55	5252	71.75	49.2
1975-76	190	77	55	7819	70	48
1980-81	280	66	60	12,555	70	46
1985-86	300	50	55	18,161	50	46
1990-91	390	56	50	23,727	28	34
1995-96	380	40	40	28,550	39.6	35
2000-01	450	35.1	35	36,934	39.6	35
2005-06	730	30	35	44,741	35	35
2010-11	1220	30	35	48,881	35	35
2015-16	1590	30	35	57,555	39.6	35
Source: University of Michigan World Tax Database; World Bank; Ministry of Finance India