Corporate Tax Reduction In India
Corporate Tax Reduction In India
Written by: Priyan Purohit
On 20thSeptember 2019, Finance Minister of India Mrs. Nirmala Sitharaman revealed the biggest corporate tax reduction that the country had seen in 28 years. This move was taken in light of the recent stagnation of the Indian economy, which recently noticed five quarters of slow growth and lost its status as the fastest expanding major economy to China. The Finance Ministry issued a statement saying that the new rates are now comparable with one of the lowest tax rates in the South Asia and South-East Asia region. Equity markets cheered this decision and the SENSEX skyrocketed by over 1900 points. This is bound to improve business and investor sentiment and confidence. Companies making more corporate profit will also result in higher inflows into equities and outflows from the debt segment.
Base corporate tax has now been reduced to as low as 22% from 30% for companies willing to sacrifice other exemptions. For new manufacturing firms incorporated after 1st October 2019 that are able to start their operations before 31st March 2023, corporate tax has been slashed to as low as 15%. The government aims to see a boost in the investments being made in the Make in India initiative, increasing employment and economic activity, ultimately leading to an increase in revenue in the long run. This reduction in tax comes with its own implications on the fiscal deficit. In this case, the government is sacrificing 20 billion dollars’ worth of annual revenue, which amounts to 0.7% of India’s GDP. To assist the government in compensating for this immediate loss in revenue, the Reserve Bank of India has decided to transfer 25 billion dollars to the government for this fiscal cycle.
THE PROBLEM OF LOW PURCHASING POWER
However, questions are now beginning to arise on the actual effectiveness of this step. For instance, Nobel laureate Abhijit Banerjee has said that the government should focus more on the demand-sided measures such as putting money directly into the hands of the people rather than going for any more corporate tax reduction. Research has shown that there is a concern about the lack of purchasing power in the country, especially since for the past many years, economic growth has been fueled by domestic consumption. Household savings in India are at a 20-year low. Hence, economic growth in the last 2 decades has been as a result of debt borrowings and not due to surplus money in the hands of people. This shows that the root cause of all these problems is the lack of demand in the market. Since income inequality is increasing, the current tax rate cuts are more likely to impact distribution of income, rather than economic growth or an increase in employment. Lower tax rate can stimulate growth, depending upon what the firms choose to do with their excess profit.
IMPLICATIONS OF THIS TAX REDUCTION
There are three ways in which companies can now spend this excess profit:
1) Pump the cash back into business by giving employment to more people and going for expansions.
2) Rewarding company shareholders with higher dividends.
3) Passing on benefits to consumers in the form of discounts and reduced prices which would lead to customers shopping more.
An increase in the fiscal deficit doesn’t necessarily entail economic growth. Given the nature of the current economic slowdown which is mainly due to weak consumer demand, there is no reason for private companies to invest more if tax outgo decreases. Since there is high unemployment and income inequality in the country, consumers are not spending in the first place, thus, additional investments by companies become risky. For example, there is no reason for an automobile company to reduce its prices or opt for expansion to try and create more jobs since the demand for automobiles itself in the market is very low. A person need not have in depth knowledge of economics to appreciate this flow. Companies will go for expansion only when there is a demand for their product in the market. Demand will arise through consumption and consumption will happen only when the consumer is willing to spend. Which in turn can happen only if he has extra money in his pocket to spend.
In conclusion, the stock market is cheering this move since now that companies are making more profits, their share prices will also increase. So, investors in the share market are going to benefit. It is a huge boost for startups too as they can focus a greater proportion of their capital towards setting up production since their tax burden has been reduced to as low as 15%. However, if the government aims at making this move as effective as possible then it should focus on the more crucial problem of increasing market demand. One of the ways through which this can be achieved is by increasing the customer’s disposable income through a direct injection of investment instead of maximizing private sector profits. A reduction in the taxes on consumer goods is also anticipated in the annual fiscal budget which is to be presented shortly in February, 2020. This combination of a reduction in both consumer and corporate tax can be effective in increasing demand and nudging the companies to spend their excess corporate profit in a consumer-friendly manner.