Designing Mechanisms for Policy

Abstract

As part of its efforts to revive the economy, the Government of India recently announced a major cut in corporate taxes – from 30% to 22% for older companies, and from 25% to 15% for new manufacturers. A motivating factor for the lower bracket for new manufacturers was presumably the desire to court supply chains forced to relocate under the heat of the US-China trade war; most of the east Asian countries have tax rates below 20%. The broad cuts were welcomed widely; however, an unintended consequence in the short term seems to be a pause in big capital expenditure projects from older companies. It might after all be more lucrative for such older companies to incorporate new units to take advantage of the 22% versus 15% arbitrage opportunity, if the rules could provide wiggle room for it, and firms are not ready to take the leap until they are sure. The unequivocal winners seem to be the tax lawyers who have been employed in their hordes to pore over the fine-prints of the announcements. Economists have been troubled by the law of unintended consequences for a long time. In fact, such concerns figure prominently in the writings of the forefathers of modern economics like John Locke and Adam Smith in the 17th and 18th centuries. Yet, it was only with the inauguration of the modern field of mechanism design and implementation theory in the latter half of the 20th century that we finally managed to get a technical glimpse at how this law operates. Even then, our understanding remains limited at best, and many of the best minds in economics in recent years have been working on pushing the frontiers of this field.