Corporate tax cut: Is it half full or half empty?

The corporate world revels in great glory ever since the corporate tax cut announcements made by finance minister Nirmala Sitharaman in what could be called the ‘mini-budget’. The government slashed the corporate tax rate from 30 per cent to 22 per cent for all companies so that their effective rate came down to 25.17 per cent. Earlier in July, the government had reduced the tax rates to 25 per cent for companies having turnover less than Rs 400 crore. This budget proposal has become irrelevant by the new tax cuts for all companies. The new base rate, 22 per cent, is less than that of US, China, Japan and Korea.

When we consider the recent fiscal announcements of the government, perhaps none are as important as this corporate tax cut because of its huge cost. The revenue forgone on account of this decision is Rs 1.45 lakh crore which is equal to one fifth of the projected corporate tax collections. This will increase the fiscal pressure of the government enormously. The government’s fiscal deficit target of 3.3 per cent was mainly based on tax buoyancy and high corporate tax growth. The projected corporate tax collection was Rs 7,70,000 crore and a 20 per cent reduction in it will magnify the fiscal risks of the government.

There is no doubt over the fact that the tax cut will increase the after tax profits of the companies so that their net economic efficiency will improve. This makes the lenders happier to give loans to finance the fixed and working capital needs of the firms. Further, the cut will increase the net income of the company and shareholders may get a higher dividend, if the firms keep a higher payout ratio. However, the underlying principle behind the tax cut-investment hypothesis is “low tax rate, low dividend payout, reinvestment of earnings and economic growth”. But the incongruity lies in the fact that the capacity utilisation is stagnant in Indian manufacturing sector for a series of quarters. A survey report of Federation of Indian Chamber of Commerce and Industry (FICCI) at the beginning of the year showed that the capacity utilisation is only 75 per cent. The major reasons for this capacity under-utilisation are the poor demand scenario in the country and the low purchasing power of households.

It clearly shows that unless the demand scenario is changed, the future investment outlook will remain the same. The main issues confronted by the Indian manufacturing sector constitute high cost of inputs and uncertainty in demand. In order to make the companies to re-invest their extra earnings generated by tax cut, the demand environment should change. Otherwise, the companies will pass the benefits to shareholders in the form of dividends or bonus shares.

The RBI’s consumer Confidence Index in July fell by 4 points on account of low income assessment of households. In order to boost consumer demand in the market, the government should take necessary steps to reduce the cost of inputs used in the production process. In addition to this, there should be adequate measures to improve the disposable income of the rural households so that their purchasing power will improve.

There is growing consensus among the economists that there should be an economic stimulus to revive the domestic demand and to promote fresh investment cycle. However, the route chosen by the government will reduce the government spending in future as the corporate tax kitty is weakened. At the same time, there exists an uncertainty regarding the reinvestment decisions of the companies. Further, in the current scenario, companies in many sectors may not pass on the benefits of tax cut to the consumers due to their liquidity issues. Since the basic problem is poor demand caused by the low household income, a favourable change in the GST or personal income tax would have created more benefits. The corporate tax cuts will not generate adequate cash inflows in the market immediately.

(The writer is assistant professor at postgraduate and research department of commerce, Nirmala College, Muvattupuzha)