Corporate Tax Cut
No short term benefits.
Hi Vivek,
Nice piece on the Apple lock-in. Interesting though that it’s the people that cause the lock-in and not the tech ecosystem itself. Let me give you some MBA gyaan, Porter’s five forces framework offers a good framework to do the analysis you did. I know you are not a fan of frameworks but just telling. This week I look at the corporate tax cut that was announced a couple of weeks back.
The FM recently announced a reduction in the corporate tax rate. The effective tax companies will pay has reduced from 35% to a little over 25%. The tax paid by new manufacturing companies has been reduced to 15%. The markets cheered the move, with the Sensex index gained over 3500 points in two trading sessions.
The fiscal deficit for FY20 as estimated by the government to be around 7.03 lakh crore which would be at 3.3% of the GDP. The GDP estimate itself was a bit of a stretch, expecting the nominal GDP to grow at 12% (was 8.18 % for Q1).
In the budget presented for FY20, the govt projected corporate tax collections to be Rs 7.66 lakh crore, which would mean an increase of over 14% from the last year’s collection. Even this is unlikely given the current slowdown as the revenue also have to increase proportionality for the estimates to materialise. But let's assume that the government calculations on GDP and Corporate tax collection actually will materialise. In that case, the current tax cut will reduce 1.45 lakh crore of tax receipts for the govt. This is almost 2.5 times the budget that the government is spending on the MNREGA scheme this year. This will add about 0.7 percentage points to the fiscal deficit.
But what impact will this additional money with the corporates have on the entire economy?
This reminds me of the multiplier effect. Research suggests that the multiple for corporate tax in the Indian context is about ~ 1 (one). This indicates an addition of Rs. 1.45 Lakh crore worth of economic activity can be realised by giving a Rs. 1.45 lakh crore corporate tax break. Typically, the multiplier effect should be higher for it to be an effective investment. This corporate tax cut seems to be an inefficient step to boost demand or to immediately stimulate our economy.
The following chart shows India’s corporate tax rate over the last few years.
With a tax cut, the companies will have more of the profits to keep. So, what will they do with it?
Typically govt expects companies to invest in their expansion,
This raises demand for credit,
Creates more jobs
New jobs will increase consumption thus stimulating the economy
It also increases the taxes collections for the government, thus setting off some of the deficit the govt incurred due to corporate rate cut.
But will this materialise?
The RBI in its recent OBICUS survey on the manufacturing sector found that the current capacity utilisation is at 74%. This Indicates at least manufacturing companies may not invest in their capacity expansion, at least not in the immediate future. Also, expansion plans for companies are not just about capital but should make business sense and are subject to the many clearances that one has to receive at various levels of the government. Thus this tax cut will not have an immediate impact on investment by the industry.
What companies will mostly do
What companies can immediately do to help the economy is either reduce the prices of their goods or increase the wages of employees. Given the recent report that unemployment is at a record high, I doubt if increasing wages is something companies will do as they have access to labour willing to work at lower pay. The laying off of contractual employees might reduce thanks to the corporate tax cut. The transmission of the corporate tax cut to benefit the general public is therefore slow and limited, in the short term.
Any other tax cuts?
Would a cut in personal tax have been a better option?
A personal tax rate cut could result in a faster spike in demand. But the problem with reducing personal tax rates is that in India it is only about 50 million people that pay income tax. A move to cut the income tax may have only benefited them. Also, it would have increased income inequality, which is already among the highest in the world. I think even a personal tax rate cut for a low-income economy like India would not bear many results as already over 95% of the population does not pay income tax. There is only so much consumption 5% of the population can do.
Reduction of GST rates
It’s the indirect tax that is paid for goods and services that both the rich and the poor pay alike. And about half the tax collections of the country are indirect. The share of indirect tax collection of the total tax collections by the government has increased over the last few years from about 40% to nearly 48%.
The GST impacts everyone who buys any product. It is the GST council, represented by all the states that take a call on these tax rates. The union FM had hoped to get a tax cut on automobiles, but could not convince the council in the meeting held last week. It will directly benefit consumers because of the reduced prices of G&S and increase demand and this will benefit every consumer. Cutting on the GST rates is something that the council, in my view, should consider at the earliest.
Becoming a Manufacturing Hub: Make in India Takeoff?
As discussed above, a reduction in corporate tax may not immediately result in adding capacity, but what are its implications in the medium to long run. There is much talk of an increase in the FDI in India following the reduction in corporate taxes.
Also, the latest tax is among the lowest in India and has become more competitive in Asia, which suggests that India can see improved FDI. But as said before, many clearances are needed for a company to set up shop in India. Let me draw some broad strokes here: Labour law reforms, respecting contracts awarded and a mature jurisprudence in the Bankruptcy Code are some important conditions to invite greater FDI.
India had missed the bus in becoming a manufacturing hub like China. China grew exponentially by lifting millions out of poverty by these manufacturing jobs. Today we see China investing hugely in building their capacity to provide opportunities in the knowledge economy. An average Chinese is better off than an Indian and so the wages have gone up in China. This may be an opening that India can take advantage of only if the broader reforms also are done.
Though in my view, manufacturing as an industry has passed the time when it could provide thousands of jobs in gigantic economic zones. We live in a global knowledge economy, where it’s the human capital over machinery that is vital for the product. So, I am a little circumspect about the future of the quality and the number of manufacturing jobs that can be created. Instead of playing the catch-up game, India can leap forward to the digital age. To invite FDI in such sectors, investment in human capital becomes a priority.
Regards,
Bheem
Disclaimer: All the views expressed above belong solely to the author, and do not represent those of the organisation he works in.
The Duologue is an effort by Vivek and Bheem to have a dialogue about varying topics.
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