Corporate Tax Reduction: An Impulsive Move or a Permanent Remedy?

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.

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