11 July 2020

Editor's Space

de Tax Caveat



On September 20, Finance Minister Nirmala Sitharaman announced a reduction in India’s effective corporate tax rate, from around 35% to 25%. For companies that do not avail of any other incentive or commission, the effective tax rate would be just 22%. Although the bourses cheered the decision, the bond market went flat on fears that government would now be forced to borrow more to meet its expenses. Lowering corporate tax involves forgoing Rs.1.45 lakh crore in annual revenue, which will widen fiscal from the current target of 3.3% to 4% of GDP this financial year.


But there is a serious caveat in this reasoning.


While rigid fiscal deficit targets can be constraining, as it forces the government to cap expenditure and squeeze out more tax from companies, an increase in fiscal deficit does not necessarily entail growth. Lower corporate taxes can stimulate growth, depending on what the companies do with the taxes they’ve saved. But considering nature of the current slowdown, which is mainly due to weak consumer demand, there is no reason to think that private sector will invest more if their tax outgo decreases. If consumers are not spending in the first place due to high unemployment and diminishing wages, then additional investments become risky.


The Finance Minister has grasped the fact that India’s structural failures are more important than the current cyclical downswing in GDP. Keynesians would have advocated a cut in indirect taxes and rise in government spending to give an anti-cyclical boost to a slowing economy. But that would have been a one-off effort, to be reversed soon. By contrast, the cut in corporate tax is a structural reform with long-term effects.


She has shown guts in sacrificing a whopping Rs.1,45,000 crore (0.7% of GDP) of tax revenue to make India’s corporate tax rate competitive with that of Asian neighbours. Since this announcement, our competitors have cut their rates further. Critics say she abandoned fiscal prudence altogether, but she did not do it for populist spending. Structural change will ultimately induce faster growth, best recipe for raising incomes for all. And quality of fiscal deficits matters. Deficits for increasing productive investment are entirely defensible.


With a lot happening and set to happen, this month’s issue is full of reading material and we are certain that you will have a wonderful read!

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