The US Congress finally passed a sweeping, debt-financed tax bill titled ‘Tax Cuts and Jobs Act of 2017’. The tax overhaul, the biggest in 30 years, is favoured by the rich, but loathed by the middle class. Policymakers argue the tax reforms are based on trickle-down economics, which critics say is the horse-and-sparrow theory coined by economist John Galbraith: Feed the horses enough oats hoping some will pass through to the road for the sparrows. While the full import of the reforms will be known with time, the changes in the corporate tax structure could have tremendous consequences for emerging economies like India.
Among others, the headline-grabbing element is the reduction of the corporate tax rate to 21 per cent from 35 per cent. The revised rate is lower than the OECD average of 25 per cent and the effective tax rate would be much lower. The move can potentially start an international tax war, sparking competitive rate reductions across the world. At 35 per cent, the US has one of the steepest tax slabs, which is why several firms including Apple and Google created complex structures to retain profits outside the US. The Trump administration’s destination-based tax system is expected to reverse the trend.
If drawn into a tax war, India will be compelled to offer more doles to foreign firms, but the truth is there’s a high cost to low taxes. As it is, India offers tax incentives to MNCs to attract FDI, and further tweaks could lower tax revenue. Two, Indian firms operating in the US (IT, BPO and pharma) may find it attractive to retain profits in the US, as the federal tax outflow drops to the bone. Third, homegrown firms may even prefer to increase investments in US businesses.
Ahead of the budget, the government is seeking industry inputs on the proposed tax reforms. India has vowed to lower the basic corporate tax rate to 25 per cent, but Finance Minister Arun Jaitley needs to further shape the domestic tax policy and ginger the budget horse to attract investments.