Corporate Tax Reduction: Will it revive the economy?

Last Updated on September 21, 2019 at 12:50 pm

The reduction in corporate tax to 25.17% with no minimum alternate tax (MAT) for domestic companies (that are not incentivised) and 17.01% (plus no MAT) for new companies announced on 20th Sep 2019 is indeed a huge announcement. However, one should not confuse the zoom in market indices as a  sign of economic revival or start of a bull run. The road to economic recovery is long and hard.

The market zoomed up – Sensex by 5.32% and BSE Midcap by 6.28% – on 20th Sep because companies would now have more profits. This will reflect in the stock movement and dividends. This has nothing to do with economic revival.

Before we move forward, a question that has been troubling me for the past few weeks is – are we over-reacting to this economic slowdown? I am no expert and so only have questions. The economy, by its very nature, is cyclic – subject to growth and slowdowns. The underlying reasons differ war/peace, technological changes, climate, political stability etc. play a role in moving the economy up or down, and this cannot be prevented.

So my question is (it is only a question) will the economy not revive without the need for any drastic change in policy from the government? Yes, it needs a nudge here and there to promote borrowing, to ensure inflation is in check etc. The slash in corporate tax is a step in the direction but has come at a massive cost for the government. Was it necessary?

I have nothing against the reduction. My point being, (1) is this enough? (2) Is ease of manufacturing in India enticing enough for corporations to take the leap? The government wants to promote production in India. Hence any new domestic company incorporated on or after 1^st October 2019 making fresh investment in manufacturing get to pay about 10% lower tax.

Lower tax is only one aspect of nurturing new businesses. According to the Ease of doing business index created by the World Bank, there are nine other factors like ease of registration, paying taxes, associated paperwork, getting credit etc. that are key. If the other nine factors are already in place then the lower tax would make a big difference to new companies.

Although ease of doing business has improved significantly – 77th in the World leaves a lot of room for improvement. Those aware of ground realities would probably think of this as an overestimate. The big problem with manufacturing is quality control and labour costs.

India is no longer the land of cheap labour. The rapid urbanization of second and third-tier cities implies no one will work for peanuts. Blame it on our inherent lack of rigour and discipline if you will, our manufacturing quality control standards are quite poor. I speak from my experience as a user of scientific equipment.

So excuse me for not being particularly gung-ho about the lower tax benefit for new manufacturing companies. It is one step in the right direction. We need to wait for the other step to join and that will take time.

As regards the reducting in tax for existing companies, yes it will attract investment. At the very least the move could save the jobs of many. Will it make a significant difference in creating new jobs? I wonder. Again, I am no expert or tracker to offer data, so kindly allow me to speculate and feel free to correct me.

Instead of listing reasons for the slowdown or lesser profits, companies have no choice but to reinvent themselves to grow again. Will the profits saved by paying lesser tax (plus an increase in investment) be enough to do this?

Borrowing is essential to business expansion and growth and thanks to higher NPAs, weak NBFCs, increasing defaults and PSU mergers, commercial lending has taken a backseat in India.

It is a vicious cycle: Lenders need to see credibility (they seemed to have messed it up in the past). Credibility requires profitability. Profits require demand. Demand requires consumption. Consumption requires money. Money comes employment. Employment requires profitability!

Assuming that the higher fiscal deficit will not make a big difference to the GDP growth, interest rates will be lowered a bit to attract borrowing. Let us hope there is no major spike in petrol and gold price, no disruptive 4 am a tweet from a certain president and everybody keeps believing the music will not stop so that rates can be kept low.

A lower interest rate regime will hit the “savers” hard. See: Why have we not seen a retirement crisis in India? Let us hope the government does not decrease small savings rates too much in Oct 2019. Will all these cuts, they need the national small savings fund to hold things together.

In essence, I think other aspects of a business, in particular, borrowing should favourable for an extended period of time for at least some businesses to revive. So let us not get carried away by Friday’s market movement. I expect (and this is not a prediction) the market to move sideways and wait for earnings to catch up. However, if there is any bad news in the meanwhile, it will spell trouble.

What do you think?