For last few months, almost everyone in the country seems to be worried about the slowdown in economy. Even those who don’t understand anything about it seem concerned. They may not know the nitty-gritty but know that the country is going through a bad economic phase. People are losing jobs, the auto sector is in a mess and companies are announcing production holidays, they say.
It is in the light of these common conversations that finance minister Nirmala Sitharaman decided to accept the demand of industry bodies in pre-budget memorandums and cut the corporate tax rates for domestic manufacturers from 30% to 22%, while for new manufacturing companies, the rate was reduced from 25% to 15% provided they do not claim any exemptions. The 15% tax rate is among the lowest in South East Asia.
The revenue secretary, the top civil servant behind the implementation of the decision, has called it the biggest tax reforms ever undertaken by India. Prime Minister Narendra Modi called it “historic”. “It will give a great stimulus to Make in India, attract private investment from across the globe, improve competitiveness of our private sector, create more jobs and result in a win-win for 130 crore Indians,” he said before embarking on the high-octane US visit.
Corporate tax is a direct tax that the corporate pay – like individuals pay income tax. These two direct taxes are a great source of revenue for the government. For instance, for the current fiscal, the target for these two taxes is Rs 13.35 lakh crore. But in the first six months, tax collection has been below target. Government has been able to collect only Rs 5.5 lakh crore so far.
The tax cut will mean the government will mop further lower revenue. It is expected that the tax cut will cost the government Rs 1.45 lakh crore, which is 18.92% of the target. By simple logic, that is a wrong move to make – why should government want to decrease its revenue collection by close to 19%?
But after the Rs 1.76 lakh crore from the Reserve Bank of India, the government is in a position to take that risk for larger goals of reviving the economy through new investments.
Earlier, the government announced export incentives and scrapped the super-rich surcharge on foreign and domestic portfolio investors. The government hopes to increase the tax base by attracting more economic activity in the wake of these decisions. Wider tax base will mean more tax even at lower rate, and that’s how the government hopes to make up for the tax bonanza that is estimated to be 0.7% of the GDP.
There’s also fear of missing the fiscal deficit target of 3.4%, especially due to the slowdown, but the government seems to have decided to focus on the immediate need to revive investment and create jobs, over bridging the gap between spending and revenue.
Industry associations, such as Confederation of Indian Industry (CII), Federation of Indian Chambers of Commerce & Industry (FICCI) and the Associated Chambers of Commerce and Industry of India (ASOCHAM), have long been demanding a cut in corporate tax. Last week, when Sitharaman announced the cut of 8 percentage points, the markets jumped in glee.
The stimulus package has already excited the industry.
Investors, traders and speculators rushed to buy, and Sensex rallied 1,921 points – its second-biggest single-day gain ever – to close at 38,015 points on Friday, the 20th.
This was the initial indication that the decision will have a positive impact on economy. Stocks of infrastructure and auto companies and banks witnessed an unprecedented rally. This means that investors got the confidence that these sectors will improve. The corporate tax cut will give companies money to make new investments, which will eventually create jobs and improve the gross domestic product (GDP) growth rate, which decelerated to 5% in the quarter ending June, slowest in last six years.
The tax cut is intended at improving the market sentiment as the short-term goal and aims to see an increase in investments, both from within the country and outside. After the trade war between the US and China, many companies want to exit China and are looking for a new destination to invest in manufacturing units. Some of them have flocked to Vietnam, which offers attractive tax rates and good quality infrastructure.
The corporate tax cut bring many of them to India, believes India Inc. “The tax rate is now similar to emerging countries, which are out competitors. Companies like Apple which are looking at setting up manufacturing units in India will definitely take a decision because of low tax rates,” said HDFC chairman Deepak Parekh.
Earlier, the government has also eased norms of foreign direct investment (FDI). So the government first made it easier for foreign companies to invest here and now given them a reason why they should invest in India.
The government believes that flow of investment will revive the economy. That’s a long-term goal and we will have to wait and watch whether that happens or not. But the initial response of market indicates that it is likely to revive business and market sentiment.
After the NPA crisis in India, banks tightened their norms to provide credit to companies for new projects. There was pressure on the government to up the public investment.
After announcing the corporate tax cut, the finance minister met heads of public sectors banks and directed them to hold camps in 400 districts from September 24 to 29 to improve credit supply to private investors.
The money that companies will save because of lower corporate tax rate will further add to capital for investment.