Corporate Tax Cut

What Happened?

Corporates will have a new tax rate of 22% that used to be 30%. Finance Minister Nirmala Sitharaman on September 20th announced a reduction in the country’s effective corporate tax rate from around 35% to 25%. The actual point of comparison is the effective tax rate since this is the tax that corporates actually pay, after claiming exemptions and adding surcharges, cess, etc. The effective tax rate paid by corporates was about 29% for the year 2018-2019.

So, it’s a gain of 4%, but if you are a corporate, there’s one condition you need to meet in order to claim the new tax rate: you need to drop all the exemptions you are claiming right now that bring your effective tax rate down. Also, new manufacturing firms incorporated after October will be taxed at 15% instead of 25%. Notably, 99.3% of all companies in India have a turnover of less than Rs 400 crore (~$60mn).

The Effects

On People

The tax cut is aimed at boosting the commercial scenario in India. The move is especially a ray of hope for India Inc., who had been longing for such a reform. The cut is expected to improve the condition of the manufacturing industry, and it seems employees will be getting a piece of it. To revamp, companies will spend more on hiring and boost production. This is possible only if the companies are able to benefit from the new tax rate and allow the amount that they save to trickle down.

A major determinant for foreign and domestic investors when allocating capital across various industries is the corporate tax rate. Global investors are vital for the economy and a low corporate tax rate can significantly boost investor confidence. This puts India on a global competitive scale, but more importantly, becomes an influential inviting force in the East Asian economies.

On the Government

For the Government, the tax cut means an estimated annual loss of approximately ₹1.45 lakh crore, which it plans to compensate for after the economy starts to revive. All this while the Center struggles to meet its fiscal deficit target. The slowing growth rate puts the regulator in a situation where easing corporate structures will lead to healthy cash flow. 

Effectively the reduction is a huge gamble that the Finance Minister is playing. Not only does this cost the government quite a lot, but it also is only deliverable if the government is able to deliver on the rest of its reforms. The government faces problems in creating demand and a high purchasing power parity.

Criticism

The move has been criticized as an effort to increase production while the demand remains stagnant. Consumption has fallen considerably with no direct action on income taxes. Vivek Kaul, an Indian economist, pointed out that if the government was looking for a change in the tax structure income should have been the way to go. 

Some argue that the slowdown cannot be solved by corporate tax reforms and require heavier government spending. The lack of sufficient demand has led to serious supply-side shocks. While still recovering from the effects of the goods and services tax such as mass loss of jobs there are bigger issues that need to be addressed to revive the economy.

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