The government's move to reduce corporate tax rate is being hailed as a huge game changer for India's economy, as it would boost corporate earnings and drive in more private sector investment, which has been missing for some time now.
However, it has also raised the specter of rising fiscal deficit given that the tax collections, be it direct taxes or GST collections, have already been lower than expected.
India's economy has slowed down significantly; GDP growth in the April-June quarter came in just at 5 per cent, its slowest pace in more than 6 years. This has forced the Narendra Modi-led government to announce a slew of measures over the last few weeks to lift the economy.
Among the boldest measures yet, finance minister Nirmala Sitharaman on Friday proposed reduction in basic corporate tax rate to 22 per cent from 30 per cent for domestic companies. For new manufacturing companies, the tax rate will be reduced to 15 per cent from 25 per cent. With this, India now has one of the lowest levels of corporate tax among developing and emerging economies, noted Soumya Kanti Ghosh, group chief economic adviser at State Bank of India. Corporate savings could jump by Rs 50,000 crore.
However, Ghosh sees fiscal deficit in the year ending March 2020 rising to 3.75 per cent of GDP. The fiscal deficit had been targeted at 3.3 per cent in the Union Budget presented by Sitharaman in July this year.
"The government has estimated Rs 1,45,000 crore forgone owing to the current measures announced. If we take into account the expected tax revenue shortfall, decline in nominal GDP growth, expenditure rationalisation initiatives and RBI surplus, the net impact on fiscal deficit will amount to Rs 82,000 crore or 0.40 per cent of GDP," Ghosh said.
Apart from the cut in corporate tax rate, the finance minister also rolled-back enhanced surcharge on capital gains on sale of equity and tax relief on share buyback of listed companies.
All these concessions constitute what is known as Keynesian prescription, noted S Rajasulochana, assistant professor, area of finance and strategy at TAPMI (TA Pai Management Institute). British economist JM Keynes was among the first to suggest in the 1930s that the government should spend more and cut taxes to fuel the economy. But that may bring other challenges too.
"Experiences from other economies show Keynesian economics is the cause of fiscal indiscipline and inflation. India may not be able to keep up its fiscal deficit at 3.3 per cent of GDP and supply side constraints are likely to flare inflation in the country," said Rajasulochana.
The cut in corporate tax will improve corporate profitability in the coming quarters, but that will also be contingent to improvement in demand, feels Kavita Chacko, senior economist at CARE Ratings.
"The corporate tax rate cut can be viewed as a fiscal stimulus given the revenue foregone, which in turn would pressure the government's already stressed fiscal position further. It would lead to a widening in the fiscal deficit surpassing the set target of 3.3 per cent of GDP," said Chacko.
She expects the fiscal deficit to widen to around 3.8 per cent this year.
