Media has touted the Corporate Tax Rate Cut by FM Nirmala Sitharaman as monumental, but former Finance Minister P Chidambaram did the same on two separate occasions. Will the move revive the economy?
- FM Nirmala Sitharaman’s latest booster gave a Corporate Tax Rate cut of more than one-fourth, from 30% to 22%.
- Consequently, the stock markets spun into delight and recorded their highest bull run in ten years.
- But the move is not unprecedented, former FM P Chidambaram did the same on two separate occasions in 1997-98 and 2004-05.
- The move is expected to give impetus to private investments but adds to the fiscal risks.
In a much-lauded, and touted ‘historic’ move, India’s Finance Minister Nirmala Sitharaman made a substantial cut on the Corporate Tax on domestic companies. The announcement slashed more than one-fourth of the percentage, from 30% to 22%. Consequently, the markets spun into delight and recorded their highest bull run in ten years.
The move was touted as the beginning of a new regime for India Inc., with a much-needed wave of optimism spreading through the country. But will the significant rate cut result in making India an investment hub? Former finance minister P Chidambaram did the same during his tenure. And we can take clues from then.
Is the Corporate Tax Rate Cut really an unprecedented move?
The announcement comes with Rs. 1.45 lack crore blow to the economy in future tax shortfall. An amount that is a full percentage point of India’s GDP, and one which no future government will be able to recover. But that doesn’t deny the monumental significance of the move.
This is the biggest single corporate tax rate cut in India’s history, and 15 years after a similar cut last took place.
Before FM Nirmala Sitharaman, it was the former Finance Minister P Chidambaram (now under investigation in a 2008 alleged case of corruption). In 1997-98, holding the Finance Ministry portfolio in the Deve Gowda government, Chidambaram won all the praise media had to shower.
In what was christened ‘Dream Budget’, the FM slashed the corporate tax rate from 40% to 35% (one-eighth). Seven years after that, it was again P Chidambaram as UPA Finance Minister who slashed the rate from 35% to 30% (one-seventh) in 2005. Thus, this is the third time since the opening up of the economy in 1991, that the corporate relief has been undertaken by a government.
What will be the positive outcomes of the move?
The news of the tax cut sparked an ‘Early Diwali’ for the stock markets. BSE and NSE climbed and climbed like nothing we’ve seen in the last decade. The news has brought in fresh enthusiasm. And it also coincides with the Howdy Modi event where the Prime Minister will look to use his tact and public skills to encourage investment in India.
Lowering of tax also increases the profitability of Indian companies. They will be able to use the extra cash for R&D or other purposes. Also, it gives India Inc. the backing of the government. It makes corporate a stakeholder in the USD 5 trillion economy dream.
Consequently, re-investment will be high. Moreover, companies shutting down factories in China will have increased interest in enhanced infrastructure on the Indian soil. Make in India initiative may finally be successful.
The Fiscal Blow to the Economy – The other side of the story
Every action has a reaction. The announcement had an immensely positive reaction from the market. But there are consequences too. The move where India stands to lose 1.45 lakh crore, further downgrades the fiscal position. There’s a target set for a USD 5 trillion economy. And that is 14-15% growth per year. Today, the Indian economy growth rate stands at 5%.
Moreover, this may have some social welfare-related repercussions. With the state government’s the beneficiary of 42% of the collected Union Taxes, cumulatively they stand to lose around Rs. 61,000 crores. This means that they would have a much-shaved budget to dive into expanding their targeted social welfare or infrastructure enhancement schemes.
The structural reforms still unaddressed
In the last 90 days, Finance Minister Sitharaman has blown away media, analysts and experts alike with a slew of measures aimed at reviving the stagnating economy. From mega bank-mergers to reduced taxation on foreign investments, capital infusions and new SOPs to auto and real estate sectors.
However, the measures ignore some major structural reforms that remain unaddressed.
India needs land and labour reforms. And with it, making products and services more affordable to the common man i.e. middle- and lower-income groups. A stable economy has two main pillar – private investment and consumption. The announcement did stir up the markets but if it will translate into private investments overtime is not certain.
Most sectors haven’t been able to achieve even 75% of their capacity utilization. So an immediate exponential increase in private investment is highly unlikely. Furthermore, the indirect taxes are still adding stress on the consumer and in turn hurting demand in the market. Unfortunately, none of the boosters specifically address this issue.
- The announcement coincides with the Howdy Modi event where the PM will use his tact and public skills to encourage investment in India.
- Less tax will increase the profitability of companies operating in India and result in extra cash flow that can be reinvested.
- However, the government takes a blow of INR 1.45 lakh crores, in other words, almost a full percentage point of the GDP.
- The booster does not address the much-needed structural reforms and the decreasing consumption. Private investment spur is unlikely in the short term.