The government’s corporate tax move is bold. But there is a fiscal risk | Opinion
Private consumption, the engine of the economy that had been firing most consistently in recent years, is losing steam. Two other engines — investments and exports — seem to be slowing down again after a brief period of robust activity. The result is 5% growth.
To boost growth, the government, on Friday, decided to risk the only engine of the tax system that has performed lately — corporate tax. In 2018-19, the actual collection (provisional) of corporate tax was Rs 6.63 lakh crore, against the budgeted Rs 6.21 lakh crore. The collections under other major taxes were much lower than budgeted.
The government’s finances have been under pressure. Tax collections have not grown at expected rates. To meet the fiscal deficit target, the government has pushed a lot of borrowing off-budget, making government agencies borrow more. It has also allowed the National Small Savings Fund to lend to a number of government agencies. Most of household financial savings in India now go towards financing the government and its agencies.
In this context, cutting corporate tax rate is a very bold move. It is a fiscal risk — as the government will forego Rs 1.45 lakh crore in possible revenues — being taken to boost growth by way of increased private investment.
The new structure of corporate tax rates leaves more money for investors to save and invest in a manner of their choosing (corporate tax incidence is mainly on capital or investors); it can help Indian firms become more competitive globally (corporate tax rates were higher than most countries); and it can boost consumption by lowering prices.
The nature and scale of impact of this move will, however, depend on four factors.
First, will the decision trigger a deeper change in tax policy and administration vis-à-vis businesses? It is puzzling that corporate tax collections have been growing rapidly in a difficult economic situation. Interestingly, the corporate tax collection under dispute increased from Rs 3.07 lakh crore in 2016-17 to Rs 3.99 lakh crore in 2017-18. No other type of tax saw a comparable rise in amounts under dispute. It seems the department is collecting more from firms than is due, even if a lot of it goes into dispute and is eventually not realised. The tax cuts must be accompanied by a rationalisation of the revenue department’s approach to businesses, otherwise it could nullify some of the benefits.
Second, how will the government pay for these tax cuts? It can cut expenditure, monetise assets (land, operational infrastructure assets), privatise government firms, or increase borrowing. India has considerable capital controls, especially on debt instruments. Government borrowing in domestic markets makes private sector borrowing more expensive. This tax cut will lead to lower tax collection in the short to medium-term. If the government then borrows to bridge the gap (on-budget or off-budget), it would limit the benefits for firms. The government must try to pay for most of these tax cuts by reducing unproductive expenditure, monetising assets and privatising government firms.
Third, the benefits will depend on which firms really benefit from this reform and how.
The existing incentives on corporate tax, which included incentives for accelerated depreciation, exports from special economic zones, expenditure on scientific research, investment in the power sector, were projected to be Rs 1.4 lakh crore in 2018-19. After adjusting for Minimum Alternate Tax, these were Rs 1.09 lakh crore. Firms will have to choose between availing such incentives and going for the lower tax rate. At present, on an average, the larger firms are financially more comfortable, but might benefit less. In 2017-18, the effective tax rate for firms with more than Rs 500 crore in profit was only 26.3%. So, for them, the net effect will be smaller. Smaller firms are financially more stressed at present. They will get a breather, but whether and when they will start investing is to be seen. This move will benefit existing firms that face effective tax rates higher than the now reduced rates (including the lower MAT), and all new domestic firms in manufacturing. In the coming months, we will see firms making these choices, which will determine the overall economic impact.
Fourth, the impact will also depend on what else the government does to improve the investment climate in India, in terms of financial sector reforms, land and labour market reforms, opening access to foreign capital, solving problems of public sector banking, easing infrastructure constraints, improving contract enforcement, and so on. Evidence suggests that even firms in relatively sound financial condition are hesitating to make fresh investments. There may be a variety of reasons for this hesitation. Structural issues will continue to affect investment decisions, and even such a big tax cut is not a substitute for addressing those through reforms.
Foreign firms, which are basically defined as firms that do not pay dividends in India, but do business here, have been excluded from this reform. If the objective is to encourage firms to invest more in India, this complete exclusion should be reconsidered. Even if the firm is foreign but is investing in India, having a lower tax rate might encourage it to invest more here, and may even lead to more taxes for the country. Being a capital-starved country, India needs to attract investment by foreign firms. It also needs technology from foreign countries. Integration with the global economy is essential for our future growth. The government should consider reforming the tax treatment of foreign firms as well.
The move to cut corporate tax rate is consistent with the Indian government’s tendency to reform from crisis to crisis. Due to the context, this reform also presents a big fiscal risk. Its overall impact will depend on certain choices that the government and firms will make in the next few months.