Tax Rate Cuts: Will It Change Growth Curve

In a bold move, Finance Minister, Nirmala Sitharaman has surprised the markets by announcing mega cuts in corporate taxes on September 20 in the hope of fanning animal spirits of the economy: reduced the tax rate for all companies that do not avail any exemption from the present 30% to 22%, and inclusive of Cess and surcharge, the effective tax rate for such firms stands reduced from 34.94% to 25.17%. Secondly, tax for companies getting incorporated on or after October 1 this year and commencing production by March 31, 2023 stands reduced to 15% from the present 25% and inclusive of Cess and surcharge the tax rate comes to 17%. Thirdly, the minimum alternate tax paid by zero tax companies has been reduced from the current 25% to 15%. There were also some less significant changes such as removal of surcharge on capital gains on buying and selling of equities and changes made in applicable tax on share buyback program of companies.

According to a Crisil report, these tax cuts are likely to enable around 1,000 companies to save about Rs 37,000 cr. These cuts are however likely to benefit large companies such as Reliance, Tata, Vedanta and Adani more than the mid-sized firms. It is also felt that firms from the consumer segment will benefit more by these cuts, for their current effective tax rates are a little over 30%, while exports-linked sectors such as IT and Pharma would benefit the least for they are already enjoying low effective tax rates. The benefits are thus not uniform across the board.

On the down side, the government has to forgo revenues worth Rs 1.45 lakh cr during the current fiscal itself. Nevertheless, it is gung-ho about the cuts, for it believes it is an all-cure pill for the current ailments of the economy. Even the industry Moghuls appear to be superb-excited about the cuts, for in one stroke these changes have made our tax-structure comparable with the best of the lot. No doubt it will boost Corporate India’s confidence as it makes their production more competitive in the global markets. And all this cumulatively well reflected when the investors from the Dalal Street—perhaps, treating the tax-breaks as a Diwali-gift—simply lifted the benchmark indices with a historic one day rise of 5.32%.

Now the big question is: Will the tax-cuts translate into higher consumer incomes thereby giving boost to domestic demand, the much desired fuel for lifting the growth? An honest answer is, perhaps: ‘No’ (in the short run), but ‘Yes’ in the long run. For, although the tax cuts are certain to swell the profits of companies and make them more bullish than before, it may not drive companies go for fresh investments, unless demand picks up. And demand for consumption would not grow unless greater purchasing power is put in the hands of the less privileged of the society—who unfortunately constitutes about 60% of the population—through public spending.

That aside, even if corporates come forward to invest in new projects, banks, being shy of taking fresh exposure to business groups with whom they are still litigating about recovering bad loans, may not be enthusiastic enough to lend fresh credit. Secondly, banks’ balance sheets are not that strong enough to go all out to increase their credit portfolio. Thus, it is evident that the rate cuts cannot by themselves change the near-term growth prospects.

Nevertheless, the big talking point from these cuts is 15% tax on new companies setting up new manufacturing units. This certainly makes India an attractive destination for a host of foreign firms, particularly those who are moving out of China in search of greener pastures. Even here again, all this happens with a lag effect.

But what is certain to happen immediately is: rise in fiscal deficit unless, investments intensify and growth picks up and the resulting tax-buoyancy reduces this figure. The tax rate cuts along with exports- and housing-incentives announced earlier put together are estimated to come to 0.5% of GDP. Of which having got 86,000 cr from the RBI in excess of what it has budgeted, the government is likely to end up with a hole of 59,000 cr and thus be able to contain the fiscal deficit at around 3.4 to 3.8% of GDP—a tad higher than what was budgeted for.

That said, one must hail the government for making big bets to give a boost to the economy, albeit in the long run. Now that the government has pulled the fiscal and monetary levers simultaneously, let us hope that Corporates catch up government’s expectation and nudge GDP to grow if not in the near-term, at least in the long run.