On 20 September, Finance Minister Nirmala Sitharaman announced a booster dose for the corporate sector of India ahead of the Prime Minister’s visit to the US.
The Indian finance minister declared a reduction in the nation’s corporate tax rate from about 35 to 25 per cent. For the entities that do not want to enjoy any other incentive or commission, the effective tax rate would be just 22 per cent. Also, such companies are exempted from paying Minimum Alternate Tax. It was a cheerful moment for everyone including the representatives of different media groups from New Delhi waiting for the press briefing. The markets cheered pushing the index up by close to 3000 points in two trading days.
Liberal tax cuts….
To attract new investment the finance minister also pronounced that new manufacturing companies, which start operations after October 2019, will pay tax rate of only 15 per cent which transforms to a little over 17 per cent after taking into account cesses and surcharges. However, the companies should start manufacturing activities on or before 31 March 2023 and sacrifice exemption or incentives to avail this benefit of lower tax rate. This is a gorgeous incentive for global companies too. In the present times of US-China trade war, this stimulus can help many foreign companies to formulate their business and investment strategies afresh. This places Indian tax regime at the identical echelon as several East Asian countries including Singapore.
According to Philip Capital, a finance house having presence in 15 countries across the world, the new corporate tax structure will result in earnings benefit for several sectors. It also mentioned that there is a negligible impact on pharmaceutical and information technology sectors.
Incidentally the corporate tax cuts makes India competitive amongst other nations in terms of taxation (see graph).
Flip side of the cut
According to the Union Budget presented in July 2019, total corporate tax revenue was estimated at Rs 7.7 trillion. Now the ministry of finance estimates the revenue loss due to reducing the corporate tax at around Rs 1.45 trillion. This will definitely increase the government’s fiscal deficit from the present target of 3.3 per cent to around 4 per cent of GDP. A surge in fiscal deficit does not essentially entail growth. A good part of the money will be funded by the 1.78 trillion rupees drawn from the reserves of the RBI.
Aurthur Laffer’s quote, “When you tax something, you get less of it and when you tax something less, you get more of it,” may not ways yield desired output. A handful of nations succeeded, but many suffered from billion-dollar deficits! In 2012 the US State of Kansas resorted to drastic tax cuts, but ultimately dumped it having lost 700 million dollars in tax revenue a year and the supply-side theory nose-dived, leaving enough evidence that tax cuts are not always advantageous.
In times of economic crisis, corporate entities will invest if their tax outgo reduces drastically. They will also analyse the spending power of consumers. When consumers are not spending due to high-pitched unemployment and low income, companies hesitate to invest. The more worrying factor is corporate tax rate cuts are more likely to influence the distribution of income than growth. The economy will travel on the slow track although companies get a larger share of profits. This will intensify inequality. Thus, although decrease in corporate tax revenue is balanced against the windfall from the transfer of reserves by the Reserve Bank of India, this narrows fiscal room for finesse. This may damage our image in the eyes of global rating agencies.
Other shots of powerplay
In August 2019 the finance minister declared a mega consolidation plan for 10 public sector banks that will be merged into four. The government also mentioned capital infusion plan totaling over Rs 70,000 crore. In 2018 the government favoured the merged Vijaya Bank and Dena Bank with Bank of Baroda and in 2017 the State Bank of India absorbed five of its subsidiaries and the Bharatiya Mahila Bank.
The merger strategy can have mixed views. One view is that we need to consolidate in times of crisis. If we want to wield the willow we must cut out the loss making banks instead of merging it with profit making banks. The other option is to privatise them. But the government’s hands are tied in the light of strong trade unions. People say that in the long run there will be employee cuts in the sense of no replacement for retiring employees.
GST rate cuts…
When the economy was showing signs of drying, up, GST Council meeting was held in Goa recently. The finance minister made several announcements pertaining to compliance and tax rates. New Return filing to be introduced from April 2020 although earlier it was planned to implement it from October 2019. GST rates relating to some segments have been rationalised: Hotel tariffs of Rs 7500 and above will be liable for 18 per cent rate, tariffs between Rs 1000 to Rs 7500 will be liable for 12 per cent rate and no tax will be levied for tariffs below Rs.1000. GST rate has been reduced from 18 per cent to 5 per cent on outside catering without input tax credit. Slashed from 5 per cent to 1.5 per cent on diamond job work and from 18 per cent to 12 per cent on other job works.
Exemption has been given to storage and warehousing services with reference to certain agricultural products, BSB Crop insurance of West Bengal and Life Insurance services by Central Armed Paramilitary Forces and to intermediary services where both supplier and recipient is outside India. Export freight exemption further extended till 30 September 2020.
Reliefs to exporters, house builders…
Indian exports have been stagnant at around $300 billion. The Finance Minister has announced measures to stimulate exports that include improved credit flows from banks, prompt transmission of interest rate cuts by banks and a scheme for remission of duties and taxes on export products replacing the existing merchandise and export incentives. These are estimated to provide relief of around Rs 50,000 crore. The fully electronic refund scheme on input taxes for exports will address the issue of delayed input tax credit refunds for exporters. The revised priority sector lending norms for export credit is expected to release up to an additional Rs 68,000 crore. On the lines of Dubai Shopping Festival, the ministry will also hold annual mega shopping festivals to boost exports.
The Finance Minister also announced use of technology to cut the turn around time in ports (these average in excess of four days in Indian ports in contrast to less than a day in major ports across the world).
For the realty sector a major problem relates to last mile funding leading to accumulation of unfinished units. A special Rs 10,000 crore window to extend funding incomplete housing projects should be of value to the housing sector.
The government has attempted to provide a ‘supply side’ solution when robust ‘demand side’ solution is needed. Fixing the consumer side of the dilemma will give birth to new investment opportunities.