The Great Indian Fiscal Give Away

In an effort to jump start the flagging economy, the FM announced, in a surprise move (or should I say knee jerk move?), a big fiscal give away by reducing the Corporate Tax rate to 22% (25% including surcharges and cess), giving up ~$20bn in tax receipts (Rs 1.4lakh crores).  Such a big shift in fiscal plan should be ideally be part of the budget and a matter for parliamentary discussion. This shows that the government has very poor strategic planning and is always on a tactical mode with piecemeal announcements that do not show the larger design of these actions.

Quite expectedly, the market received the news with cheer sending the equity indices up by ~6%. While this is positive, it remains to be seen whether it holds on to these gains or the benefit of the entire initiative is lost if economy continues to flag which could well result in markets giving up these gains.

The move has effectively resulted in frittering more than the special dividend received from the RBI’s (adjusting for the budget dividend assumption of ~Rs 85,000 crores).  This tax rate cut would push the fiscal deficit higher by ~50bps and take it closer to the 4% mark (after considering the RBI special dividend). 

While the Companies are looking for top line growth while the government has handed a bottom line relief.  This Corporate tax rate cut is a right move at the wrong time!

When Trump cut taxes for the Corporates, they did not rush out to invest it in more manufacturing or expanding their business.  They enhanced their earnings per share by either buying back stock or paying down the debt. Increase in corporate profits need not necessarily lead to higher investment unless the economic outlook improves.  Otherwise, it will most likely be used to pay down debt or buyback shares to boost Earnings per share for the shareholders.

And tax rates are not the only reason when investment decisions are made.  Several other factors like, ease of doing business, availability of skilled labour, state policies, land acquisition norms, law enforcement, social harmony, infrastructure etc. amongst other things.

While it is important to maintain the international competitiveness and keep the tax rates in line with regional manufacturing hubs, tax rate is not the only factor that drive investment decisions.  If that was the case, all the tax havens would have been manufacturing hubs.  Be that as it may, the urgent need in the current scenario is to drive demand higher and put more money into the hands of the people. 

Money going to people (instead of Corporates) will help drive consumption which will revive growth and nurse back the manufacturing sector and bring back jobs which will then lead to further earnings for people thereby creating a virtuous cycle.

What could the government have done instead?

This fiscal give away could have been directed better with greater (and perhaps a multiplier effect) on the economy:

·      Raise the minimum slab for income tax and deliver tax relief of Rs 50,000 crores;

·      Invest in market access of farm produce and raise MSP;

·      Reduce / Rationalise GST for specific sectors that are deeply hit to an appropriate level to drive up demand;
·      Cash for clunkers to drive auto demand;

Further actions are required besides the Tax rate cut for Auto like review of BS6 implementation timeline, review of insurance rates, reduction in road taxes etc. to improve automobile demand.

The proposal for real estate sector is unlikely to lead to a revival of the sector as the unfinished development and unsold inventories is not wholesome.

The above suggested actions would have more salutary effect than the headline grabbing Corporate Tax rate cut.

Sequencing of reforms is very important.  When Banks recapitalisation was required, the government gave Demonetisation shock further exacerbating the stress on Banks (as more assets went into NPA, Banks distracted with cash activity etc,). 

Before the economy could recover from that shock, it gave GST, without proper testing of the system and added to the stress on the economy.  Now when direct fiscal stimulus is required, it has come up with the Corporate tax cut that will do precious little to revive growth in the short term. And in the long term we are all dead!  This tax rate cut is a right move at the wrong time!

Unfortunately, this Government continues with its approach of headline management instead of well thought out actions to manage the economy!