Corporate tax cut a bad gamble
Everywhere, governments are acting to minimise the economic damage due to Covid-19. The Narendra Modi government has also announced a package amounting to 10% of India’s GDP, including past fiscal and monetary measures .
The Indian economy, like the rest of the world, is facing an unprecedented disruption because of the Covid-19 pandemic. Everywhere, governments are acting to minimise the economic damage. The Narendra Modi government has also announced a package amounting to 10% of India’s GDP, including past fiscal and monetary measures . To be sure, fiscal stimulus in this package is just 1% of India’s gross domestic product (GDP). This is lower than what most major economies have committed. Why did India hold back on the fiscal paddle? The Indian economy had been caught in a slowdown even before the pandemic hit. This made the case for a fiscal push even stronger.
Statistics released by the ministry of finance give a hint to this otherwise perplexing question. India’s revenue projection and collection abilities are facing an unprecedented crisis. Gross tax collections in 2019-20 were less than those in 2018-19. This is only the second instance since 1961-62 of tax collections having declined on a year- on-year basis. This is largely the result of what can be described as a bad gamble on corporation tax cuts to revive economic growth.
What makes it even worse is that the government did not see this coming until February. These figures raise serious questions on the government’s tax buoyancy assumptions. Tax buoyancy is the additional revenue generated per unit increase in GDP. If tax collections went down when the economy was growing, they could suffer a huge fall when it is headed for a contraction. This also raises serious questions on assertions about decisions such as demonetisation and the Goods and Services Tax (GST) leading to a widening of the tax base.
On May 29, the Controller General of Accounts, which works under the ministry of finance, released provisional figures for 2019-20. They put gross tax collections in 2019-20 at Rs 20.09 lakh crore. This is lower than the Rs 20.8 lakh crore collected in 2018-19. The Centre for Monitoring Indian Economy (CMIE) database shows that it is only the second instance (after 2001-02) since 1961-62 that tax collection had fallen on a year-on-year basis. The 2019-20 provisional collections are just 81.7% of the Budget Estimates (BE) presented in July 2019. One quarter of the year was already over when the government presented its budget. They are 7% less than the Revised Estimate (RE) figures given in the 2020-21 Budget.
A look at tax buoyancy numbers paints a grimmer picture. In 2019-20 India’s tax buoyancy was -0.05, the lowest since 1962-63. In 2001-02, this value was -0.01. The data also shows that this is not an aberration. Tax buoyancy has been falling since 2016-17 onwards.
What explains the fall in tax collections? The government announced a reduction in corporation tax rates in September last year. It slashed corporate tax rates for domestic manufacturers from 30% to 22%, while for new manufacturing companies; the rate was reduced from 25% to 15% provided they do not claim any exemptions. This was expected to lead to a revenue loss of Rs 1.45 lakh crore. This was justified on the grounds that the move will revive the economy. The then revenue secretary Ajay Bhushan Pandey had said that the decision was “one of the biggest tax reforms ever undertaken by India — one that would not only encourage new investments by domestic as well as foreign investors but also motivate them to reinvest their profit” (see https://bit.ly/2zI80lb) for details).
The gamble seems to have backfired badly. The revenue loss is bigger than expected. BE for corporate tax collection was Rs 7.66 lakh crore in 2019-20. The provisional figures are just Rs 5.56 lakh crore, a shortfall of Rs 2.09 lakh crore. The investment scenario actually became worse. Gross fixed capital formation, which measures new investment activity, contracted 3.9% on a year on year basis in the quarter ending September 2019. It contracted at 5.2% and 6.5% in the quarters ending December 2019 and March 2020.
Even this does not explain the entire shortfall. Other major tax heads such as income tax and GST have also fallen significantly short of the 2019-20 BE figures. However, they are not less than the 2018-19 collections, unlike corporation tax.
CMIE data shows that income tax collection figures have been missing BE figures by an increasing margin since 2017-18. This raises serious questions about the efficacy of demonetisation in widening the direct tax base. GST collections have not been able to meet BE figures until now. In fact, the only major revenue head which had over performed vis-a-vis BE targets in both 2017-18 and 2018-19 was corporation tax. Thanks to September’s tax cuts, this item had the biggest shortfall in 2019-20.
Because of the pandemic, both growth and tax collections will face very strong headwinds. At a time when a fiscal push was most needed, the government has a huge tax crisis on its hands. And it has nobody but itself to blame for sacrificing the golden goose of corporation taxes in the false hope of boosting economic growth.