Competitive Corporate Taxation: Answer to India's Economic Meltdown

As the Indian economy continues to struggle and nears the entrance of the ICU wing, Finance Minister Nirmala Sitharaman has come out with a long-awaited direct tax cut slated to bring some relief to investors and business owners.

On Friday, 20th September, 2019, Sitharaman informed the press and the public that her government was slashing corporate taxes by a significant margin

A move clearly designed to raise the spirits of industries grappling with the upsetting reality of the latest economic meltdown.

While such a tax cut leaves India at a pleasantly competitive position vis-à-vis other South East Asian economies, and makes good on the promise Sitharaman's predecessor Jaitley had long envisaged, it continues to raise some questions about the feasibility of this move in rescuing the Indian economy once and for all.

From the initial looks of it, this sharp corporate tax cut seems to have landed like the perfect early Diwali gift for businesses in India.

With the Centre having introduced the Taxation Laws (Amendment) Ordinance 2019 to modify the provisions of the Income Tax Act of 1961 and the Finance (No.2) Act of 2019

Government of India

Corporates from this financial year onwards will have to pay just 22% as tax instead of the earlier 30%.

While the effective tax rate ultimately goes up to 25.17%, it is still a rather drastic drop from the earlier effective tax rate, which was firmly to the north of 30%.

Moreover, new domestic companies incorporated on or after the 1st of October this year (with production beginning before March 2023) will enjoy a tax slab of 15%, slashed from the earlier 25%. Of course, these benefits will only be available to those businesses that do not already avail of tax exemptions and incentives. The others can jump on to the bandwagon once their incentives expire.

All in all, this clearly sounds like Santa has come calling for corporates and their investors, both of whom are likely to reap a great deal of money as a result of the tax rate having been slashed.

The market itself has responded extremely favourably to the news, with both Nifty and Sensex rising by over 5 percent each, clocking up the largest rally in an entire decade.

The banking sector saw major upswings in share prices and the crisis-stricken auto industry seemed to be sharing in the bounty. Even though some of the companies that were left off the purview of the tax cuts saw a downward trend, the general sentiment of the market seemed to have been soaring.

The reaction of the market is quite reflective of the cheer this decision has brought to companies.

This move is also likely to encourage the establishment of new startups and give an impetus to the manufacturing industry by lowering the entry barrier for those wishing to start out.

As for existing corporate entities, they will be able to save more and either reinvest that leftover money for further capacity building and generation of employment or for introducing price cuts to boost sales and salvage the demand side of the economy.

Moreover, the tax cut makes India a destination more feasible than even China for investors and foreign firms looking to set up shop on the Asian soil.

The lowered tax rate makes the country's corporate taxation quite comparable to the likes of Hong Kong & Singapore, and can potentially cause investors to throng to the Indian market, and revive its faltering industries.

Source: KPMG’s corporate tax table provides a view of corporate tax rates around the world.

All these possibilities paint a rather rosy picture, and while at least some of these point to attainable milestones, some of us can't help but wonder how the government will be able to afford the 1.45 lac crores that it is due to lose out because of this tax cut.

While Sitharaman has repeatedly harped on the fact that the government is not planning to slash government expenditures to make up for the beating its coffers will take, it is a reasonable concern to worry about whether it is debt or minting more money that government plans to resort to for balancing its account books and arresting the deficit rate.

While the government's decision to address the structural problems that led corporates to earn lower profits and withhold investments over the past decade is quite appropriate, the timing of this move can be called into question.

Had the government chosen to implement this during the Jaitley era when the treasury was in a better position to afford this major monetary haemorrhage, it just might have been the perfect solution for taking the economy to the promised land.

However, in 2019, when the demand side of the economy is still hurting from the whiplash of the poorly implemented scheme of demonetisation, and the supply side is grappling with a messy #GST system, it might prove too costly to pass over a whopping 1.45 lac crores.

Answer to India's Economic Meltdown?

Moreover, as many have already pointed out, the tax cut itself, or in fact any of Sitharaman's emergency measures, seem to have done little to revive the demand side of the economy: to flush the pockets of those who will actually buy goods and services and keep the industries in business.

While the tax cut may incline some corporates to introduce lowered prices to boost sales, it cannot force them, and therein lies a fundamental problem of balance in this grand plan of a glorious revival.

To survive the shortfall triggered by the tax cut and an inadequately managed GST system, the government will be pushed to its back foot and forced to borrow.

This is likely to take away a lion's share of India's savings, to be poured directly into existing government programmes, instead of promoting higher investments. Thus, while corporates enjoy a new lease of life, and move to reinvest their profits, the country's remaining savings will meet a perilous fate. That is not to say that the balance of it all will not churn out a positive effect in the long run, but the pendulum could really swing either way as it stands now, and it would all depend on how Sitharaman's Ministry moves to ensure prudent fiscal management in the days to come.

While the exuberance of the stock market calls for a heady concoction of jubilation and relief, it is perhaps worthwhile to bear in mind, that the tax cut, while solving some problems, also creates some new ones for the government to wrestle with. We are yet to know if that scuffle will leave our economy bleeding and hurtling down a collapsing road, or if it will truly accomplish the benefits it had set out to, with this policy change.

For now, perhaps it is best to content ourselves with the fact that industry insiders across India are welcoming the move with open arms, and the country is effectively competing with several peer economies when it comes to attracting foreign investments. If anything, it will definitely send the cash registers of corporates ringing, and make it easier for startups to set out on a new path of resurgence and hope.