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Corporate Tax Cuts: Is it enough to reverse our slowing economy?

The government of India slashed down the corporate tax rates significantly this Friday in the GST Council Meet held at Goa.

The government of India slashed down the corporate tax rates significantly this Friday in the GST Council Meet held at Goa. The corporate tax rate was reduced to 25% from 30% for the domestic companies as well as a tax reduction from 25% to 15% was proposed for new manufacturing units to boost investments. However, will this cut be kind enough to jumpstart the economy?

The Indian economic growth hit a six-year low of 5% this June quarter. Several reasons were responsible for a slowing economy, including delayed or paused of purchases of goods by the Indian consumers. The lowering of taxes has immense benefits for the companies as well as the consumers. The firms can either invest their profits or pass on to the customers in the form of price cuts.

The big boost to the shareholder value is unquestionable, which marked its appreciation by surging the highest in a single day in over a decade. The Sensex rose above 1700 points, and Nifty crossed 11,000 points with a cut in corporate taxes. The companies welcomed the decision, with some even stating that it would help boost investment.

According to reports, the revenue generated from corporate tax was 3.56% of GDP in India for FY’ 18-19. The share of direct taxes that include personal income tax was 6.4% of GDP. Still, the regressive indirect taxes account for over 60% of all tax collections in India, including by the states.

Declining growth reasons

Weak investments acted as a trigger for the declining growth, and tax cut partly fixes this supply-side problem. However, the center cannot solely rely on the tax cut and needs a monetary boost via further policy rate cuts and, perhaps, even increase spending. Analysts at Edelweiss Securities wrote in a note that the fiscal boost in 2008-2009 proved to be quite useful in lifting aggregate demand as it was led both by tax cuts and expenditure ramp-up, followed by massive monetary easing and coinciding with global fiscal stimulus.

Investors expect RBI to cut policy rates again in October with retail headline inflation assumed to stay below the formal target of 4% and slowing growth. Shilan Shah, a senior Indian economist at London-based research company Capital Economics, said that the relaxing fiscal measures might influence the size of future rate cuts, but probably won’t take them off the table altogether. Their best guess would be that the Monetary Policy Committee would revert to a more traditional 25bp cut at the upcoming meeting in October.

While the government has already reduced spending to an extent only because it didn’t get adequate money through tax revenues, it might tighten up the regulations a bit more. Nevertheless, the economists still estimate the fiscal deficit to swell to 3.8-4% against the budgeted 3.3% of GDP.

Savings versus Investments

Comparing the situation with the fact that public sector borrowings requirements which include borrowings of the central government, state governments and PSEs like the Food Corporation of India are at nearly 9% of GDP, there is no money left for the government to spend. Currently, even the household savings have been absorbed by the public sector almost in entirety. No doubt that the tax cut announcements on Friday spooked the bond markets.

Analysts worry that much of the tax cuts would go into savings rather than investments which would bring us full circle to the demand side of the economy. Additionally, in a depressed economy, when the inflation is low, there is barely any incentive for the producer to invest in the fixed assets or create capacity.

The lower spending power amongst Indians has come partly due to stagnant wages and higher living cost. The falling economy has shown a more profound impact on the rural parts. To reverse the slowdown, the companies need to cut prices of products or share their profits through wage hikes with increased public spending. Only time would define the success of the proposals for the Indian economy.