On September 20th 2019, domestic stock markets in India skyrocketed with the Sensex index soaring over 2200 points, the steepest intraday rise in more than a decade. The boom came in response to the cuts in corporate income taxes introduced by the Finance Minister in an attempt to steer the Indian economy out of the current slowdown and spur growth.
Under the recent announcements, corporate tax rates for domestic companies have been driven down to 22% from the earlier 30% while for new manufacturing companies, set up after October 1st 2019, the slashed tax rate stands at 15%. The measures form a part of the 1.45 lakh crore fiscal stimulus package introduced by the government to arrest the tumbling GDP and a 45 year high unemployment rate plaguing the economy.
Interestingly, the stunning reduction in corporate taxes has garnered conflicting views with the real impacts of the move being extensively debated. While the proponents of the move believe it to be a masterstroke, which will provide the much needed impetus to the ailing economy by reviving private investments, critics argue that the move fails to address the fundamental reason for the sagging economic growth i.e. weak consumption demand. Before delving deeper into the existing divide of opinions regarding the efficacy of slashing corporate taxes, it’s imperative to understand the backdrop against which the recent announcements were made.
The “WHY” behind the move
Numerous reports have stated that India witnessed its slowest economic growth in the last 6 years in the quarter ended June 2019-20, with the GDP plummeting to 5%. Global uncertainties led primarily by the escalating Sino-US trade tensions have contributed their fair share to the current slump. Besides, struck by a combination of cyclical and structural issues, the current slowdown is visible in many sectors of the Indian economy ranging from manufacturing and financial sector to the real estate sector.
India’s automobile sector, which contributes to 7.1% of the GDP and around half of the nation’s manufacturing output has also been battling with declining sales, mounting inventories due to sluggish consumer demand and production shutdowns, which have all culminated in increased layoffs of temporary workers. While a McKinsey report forecasted India to become the world’s third largest car market by 2021, the present state of the auto industry, which has witnessed a 31% decline in sales, tells a different story. It won’t be far-fetched to say that a multitude of rushed and misdirected government policies, especially the skewed EV roadmap along with a burgeoning GST on the automotive parts has pushed this industry into a crisis.
Moreover, SBI’s latest study, “Root Cause of the Current Demand Slowdown” holds a substantial decline in both urban and rural wages as the main culprit for the existing downturn. It reflects how the agricultural growth slipped in the current fiscal and both rural & urban wages which grew in double digits until a few years back shrunk to single digits as companies adopted extensive deleveraging and cost cutting measures. Declining wage growth propelling the rural financial stress, weak corporate sentiment owing to placid consumption demand and a dismal flow of credit in the midst of the much talked about NBFC crisis are the principal challenges facing the current regime, which set the stage ready for a slew of measures introduced by the government, one of which happens to be the reduction in corporate taxes.
The Conflicting Opinions
In my opinion, the debate surrounding the corporate tax reduction has been wrongly centred around the propriety and far sightedness of the move, instead of questioning the adequacy of the policy. The policy marks the beginning of the much need reforms for India’s economic revival and qualifies as a step in the right direction. However, it can transpire into long term growth only when supported by a bundle of immediate measures to address the core issue fuelling the economic downturn i.e. dwindling consumer demand.
1. One cannot completely condemn the move of the current government as an incompetent temporary prop. It’s undeniable that the announced tax cuts will play an instrumental role in bringing India at par with other Asian economies and can aid the country in leveraging on the deteriorating US-China relations, which is driving many companies to relocate from China. The tax cuts will address the concerns of numerous investors who have been accusing India of tax terrorism and provide a stimulus to foreign investments in the country.
2. Reduced taxation in the manufacturing sector is expected to expand the fiscal room for companies to engage in price cutting and discounting strategies, which can fuel consumer demand.
3. The tax cuts for new manufacturing units will provide a favourable environment for the manufacturing sector and will provide a fillip to the Make in India programme of the government.
Let’s take a look at the flip side now.
1. Merely tax cuts, however, would be ineffectual in ramping up foreign investments. The scepticism among foreign investors regarding the sloth paced judiciary processes (the Vodafone deal case for instance) lies at the heart of a dearth of foreign investments faced by India.
2. Reduced taxation won’t necessarily translate into corporates channelizing the surplus profits towards expansion of operations and capacity utilisation. Given the uncomfortably huge piles of debts many corporates find themselves trapped in, most analysts believe that the surplus generated through this policy move would be channelized towards strengthening their balance sheets, which can render the move futile. With mounting inventories and in the absence of a pick up in demand, the prospect of corporates pumping back the surplus generated to undertake fresh investments seems dismal.
3. The boost given to the manufacturing sector under the new tax rules comes at the cost of increased fiscal risks. The tax sops involve forgoing of 1.45 lakh crores in annual revenue, which will magnify the government’s fiscal deficit by 0.7% of the GDP. Concerns about how the government plans to compensate for the lost revenue have not been sufficiently addressed.
4. The policy brings with itself the possibility of exacerbating income inequality under the mirage of generating higher income and growth.
Recommendations
The government and policy makers need to advance with a systematic approach to battle the cyclical and structural slowdown gripping the economy.
1. Private consumption has long been the catalyst driving India’s growth. There’s a dire need to address the collapse in private consumption. The tax measures announced by the government would fail to dramatically alter the investment patterns in the absence of a rise in consumption demand. Hence, a reduction in personal income taxes would increase consumers’ disposable incomes, enhance their purchasing power and would go a long way in spurring demand.
2. The policymakers need to follow up on the announcement of slashing corporate taxes with land and labour reforms, which will contribute to the ease of doing business. Judicial reforms for securing speedy clearances are crucial towards building a legal environment conducive for foreign investors to step in.
3. There ought to be a reduction in GST rates, especially in the automobile sector, something the industry has been clamouring for long now. In light of the fiscal constraints faced by the government, a phased reduction for certain categories of products in the industry may prove to be a prudent strategy.
4. It’s crucial for the current administration to improve tax collections under the GST regime.
5. The government should focus on boosting exports in an attempt to liquidate the mounting inventories. Given the current US-China tariff wars, India should strategically leverage on the export potential for certain categories of products, which are likely to witness a favourable export climate, particularly textiles.
6. Designing and speedy implementation of policies to boost farmers’ income and thus the rural demand is of paramount importance. Since wages are linked to savings and investment, developing responses to check the sharp decline in wages is imperative to propel growth.
7. Instead of banking on corporate sentiment to revive growth and undertake fresh investments, the government needs to advance towards rural capacity utilisation and rural infrastructure spending to tackle the job crisis at hand and spur rural income and demand.
Ever since its introduction, the slashing of corporate taxes as a policy measure to combat the current economic downturn has sparked discussions among academic and intellectual circles. While we can’t refute the fact that it will assist the economy to uplift it’s growth trajectory and signals the intent of the government to pull the economy out of chaos, the effectiveness of the policy in the absence of concerted efforts to revive demand stands debatable. The tax cuts in the absence of measures to spur demand, will fail miserably in providing a meaningful stimulus to India’s decelerating economy.
WRITTEN BY:
NISHTHA GUPTA
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