Some gain, some pain

The reduction in corporate tax is unlikely to give any gains to consumers

PTI8_30_2019_000122A Big move: Finance Minister Nirmala Sitharaman hopes the tax cuts will spur growth | PTI

For a thirsty traveller in a desert, an oasis can be a life-saving sight. It could also be a mirage—the desert light playing tricks with your eyes, creating an optical illusion when there is actually nothing but endless expanse of sand. The question many have been asking over the past few days is whether the ‘mini budget’ bonanza of the Union government is a panacea to the ills plaguing the Indian economy, or just optics.

The tax cuts also mean India wants to position itself as an alternative to China, or at least countries like Vietnam that are currently the alternative.

On September 20, Finance Minister Nirmala Sitharaman, in her latest slew of measures to reinvigorate the Indian economy, unleashed what some termed a ‘silver bullet’—a dramatic cut in corporate tax from 30 to 22 per cent. This meant that after adding cess and surcharges, the effective tax an Indian company would have to pay dropped from 34 per cent to 25.17 per cent. Additionally, the series of amendments to the Income Tax Act 1961 and this year’s Union budget through an ordinance the same day saw the effective tax payable by a new company (set up from next month and starting production within end-March of 2023) at 17.01 per cent (15 per cent tax plus surcharge and cess).

While there have been significant cuts in corporate tax earlier—P. Chidambaram cut it down to 35 per cent in his ‘dream budget’ of 1997, spurring the economy to robust growth in the ensuing years—the significance this time is perhaps more, with consumer spending dropping to a trickle, manufacturing sector slowing down and tax revenues showing a shortfall.

Though the loss of an estimated Rs1.45 lakh crore of revenue because of this tax cut will add to the government’s overall fiscal deficit, Sitharaman was quick to allay fears, saying that she hoped the measures would offer a fillip to growth and thereby make up for this loss.

India Inc went into raptures praising the move. Kumar Mangalam Birla, chairman of Aditya Birla group, said the move would ‘revive animal spirits’, and Bharti Airtel chief Sunil Mittal described it “a gust of fresh air to resurrect the economy”. Confederation of Indian Industry’s president Vikram Kirloskar said it would “boost investor sentiments and encourage manufacturing”.

While the three earlier rounds of stimulus were aimed at helping specific sectors, this one encompasses the entire gamut. The government hopes the tax savings will be ploughed back into fresh business investments, and, in the case of consumer goods companies, the price reductions will prompt consumers to spend more. “This is a huge act of faith on corporate India,” said Hitesh D. Gajaria, partner and co-head of tax at KPMG India. “The government has made the first move to attract investment into manufacturing, and is trusting corporates to make appropriate capital allocation to this sector.”

According to Shreekant Somany, chaiman and managing director of Somany Ceramics, and chairman of the CII National MSME Council, “15 per cent tax on new businesses is a great boon, an opportunity for companies both inside the country and from abroad to look at manufacturing in India.”

The tax cuts also mean India wants to position itself as an alternative to China, or at least countries like Vietnam that are currently the alternative, or a ‘plus one’ to China in the outsourcing scheme of things. India’s tax now on new businesses, at an effective 17 per cent, is lower than competitors like China (25 per cent), Vietnam (20 per cent), Thailand (35 per cent) and Indonesia (25 per cent).

It will also help India as it negotiates its way into the Regional Comprehensive Economic Partnership, a planned free-trade bloc comprising of ASEAN countries as well as China, South Korea and Australia. “Advantages of trade arising out of India joining RCEP can be fully secured when domestic taxation laws are as competitive as those prevailing in other member countries,” according to A.K. Bhattacharya, distinguished fellow at the Delhi-based think-tank Ananta Centre.

Not everyone, however, is going gaga over the ‘silver bullet’. “It is a long-term structural positive; it will result in an increase in fiscal stress in the short term,” said Aditi Nayar, principal economist at the rating agency ICRA. “We do not expect a broad-based pickup in capacity expansion by the private sector until there is greater visibility of a sustained uptick in domestic consumption demand.”

That could be a problem. “These measures are supply-side involvements, but the economy is facing demand-related challenges,” said Avneesh Sood, director of Eros, a real estate company. “The trickle-down effect will be marginal to immediately spur consumption demand in the economy.” There is also the possibility of companies using the extra money they save in taxes to clear up debt or give dividend to shareholders, instead of investing in fresh businesses in a slow market to spur growth. It also remains to be seen if consumer companies, like biscuit makers, will pass on their savings by cutting prices to make consumers spend more. The track record of Indian businesses is not much inspiring, either—when GST on restaurant food was cut from 18 per cent to 5 per cent, most restaurants either increased prices or added a 10 per cent service charge.

There is another big loser in all these—states. While Sitharaman estimated a revenue loss of Rs1.45 lakh crore, the truth is that about 42 per cent of it would have gone to the states. “The Centre will relatively lose less as a result of the tax cuts than the states,” argued Bhattacharya. “States are already seeing a slower rise in taxes that are transferred to them. That unhealthy trend continues.”

While the Centre can make up for its own revenue loss with the transfer of Rs1.76 crore surplus funds from the Reserve Bank of India and expediting disinvestment of public sector companies, state governments will have no such buffer. This may force them to reduce expenditure, which, in turn, could lead to a decline in spending. “State governments’ financial health may come under considerable stress,” said Nayar. “The likely cuts to productive and capital expenditure at the state level pose a key risk to the economic growth outlook.” KPMG’s Gajaria, though, is reassuring. “There is no worst-case scenario,” he said. “We were where we were. There can only be a positive upside.”

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