On September 20th 2019, domestic stock markets in India skyrocketed with the Sensex soaring over 2200 points, the steepest intraday rise in more than a decade. The boom came in response to the cuts in corporate taxes introduced by the Finance Minister to arrest the current economic slowdown.
Under the recent announcements, corporate tax rates for domestic companies have been reduced to 22% from the earlier 30% while for new manufacturing companies, set up after October 1st 2019, the slashed tax rate stands at 15%. The measures form part of the 1.45 lakh crore fiscal stimulus package introduced by the government to arrest the tumbling GDP and a 45-year-high unemployment rate plaguing the economy.
The real impacts of the move are being extensively debated. While the proponents believe that the move will provide the much needed impetus to India’s ailing economy by reviving private investments, critics argue that it fails to address the fundamental reason behind the sagging economic growth i.e. weak consumption demand. Before delving deeper into the debate surrounding the efficacy of slashing corporate taxes, let’s understand the backdrop against which the announcement was made.
The “WHY” behind the move
Numerous reports have stated that India witnessed its slowest economic growth in the last 6 years in the quarter ended June 2019-20, with the GDP plummeting to 5%. Global uncertainties led primarily by the escalating Sino-US trade tensions have contributed their fair share to the current slump. Besides, struck by a combination of cyclical and structural issues, the current slowdown is visible in many sectors of the Indian economy. India’s automobile sector, which contributes to 7.1% of the GDP and around half of the nation’s manufacturing output has been facing declining sales and mounting inventories, which have all culminated in production shutdowns and increased layoffs.
A study by SBI holds a substantial decline in both urban and rural wages responsible for the existing downturn. Agricultural growth declined dramatically in the current fiscal and both rural & urban wages shrunk to single digits as companies adopted extensive deleveraging and cost cutting measures. Declining wage growth propelling the rural financial stress, weak corporate sentiment due to sluggish consumption demand and a dismal flow of credit in the midst of the NBFC crisis are the principal challenges facing the current regime, which led to the tax cuts.
The Conflicting Opinions
In my opinion, the debate surrounding tax cuts has been wrongly centred around the propriety of the policy instead of questioning its adequacy. The policy marks the beginning of the much needed reforms for India’s economic revival. However, it can transpire into long term growth only when supported by a bundle of immediate measures to address the core issue of dwindling consumer demand.
- One cannot completely condemn the move as an incompetent temporary prop. The announced tax cuts will bring India at par with other Asian economies and can aid the country in leveraging on the deteriorating US-China relations, which is driving many companies to relocate from China.
- Reduced taxation in the manufacturing sector will provide a fillip to the Make in India programme and is expected to expand the fiscal room for companies to engage in price cutting and discounting strategies, which can fuel consumer demand.
Let’s take a look at the flip side now.
- 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) lies at the heart of a dearth of foreign investments faced by India.
- Tax cuts won’t necessarily translate into corporates channelizing the surplus profits towards expansion of operations. Most analysts believe that the surplus generated through this move would be channelized towards strengthening the balance sheets, rendering the move futile.
- The boost given to the manufacturing sector comes at the cost of increased fiscal risks. The tax sops given 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.
The government needs to advance with a systematic approach to battle the cyclical and structural slowdown gripping the economy.
- Private consumption has long been the catalyst driving India’s growth. The tax measures announced by the government would fail to dramatically alter the investment patterns in the absence of a rise in consumption demand. A reduction in personal income taxes would increase consumers’ disposable incomes, enhance their purchasing power and therefore go a long way in spurring demand.
- The tax cuts need to be supported 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.
- Tax collections under the current GST regime need to be improved. 5. There ought to be a reduction in GST rates, especially in the automobile sector. A phased reduction for certain categories of products in the industry may prove to be a prudent strategy.
- The government should focus on boosting exports 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. 7. Instead of banking on corporate sentiment to 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.
The slashing of corporate taxes as a measure to combat the current economic downturn has sparked discussions among academic and intellectual circles. While it will assist the economy to uplift its 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.
Only a fresh reform impetus addressing the core issue of shrinking domestic consumption demand will prove fully effective in unlocking the nation’s growth potential in the long term.
Nishtha Gupta is a student at Hindu College, Delhi University
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