Government's spending flexibility now limited
In a bold move to tackle sluggish economic growth, Finance Minister Nirmala Sitharaman slashed the base corporate tax from the earlier 30% to 22%. Corporate groups in banking, capital goods, automobiles and consumer goods will benefit from a high of 11-12%, while those in real estate and logistics will get 5-7%.
The intent of the government is laudable: higher profits for the corporate sector will lead to more investment being ploughed back into the economy thus kick-starting growth and generation of jobs. India, now coming in line on corporate tax rates with its peers, will also improve the inflow of foreign investment.
However, the sharp cut in corporate tax has serious downside concerns. As has been admitted by the finance minister, the reduction in tax rate will knock off as much as Rs 1.45 lakh crore from an estimated tax revenue of `7.7 lakh crore, or a shortfall of nearly 19% of estimated corporate collections.
With the government Budget facing a deficit of 3.3%, the fall in tax collections will increase the fiscal risk from cyclical factors such as rural deprivation, slow credit generation and weak corporate sentiment. These factors may then gang up to pose a drag on near-term growth targets. Moody’s Investors Service bluntly said it did not expect the cut in corporate tax rates to revive growth to the extent that stronger tax buoyancy compensates for the loss of revenue.
The other issue to consider is: planned versus unplanned growth. With tax in its kitty, the government can plan ploughing investments into weak areas like banking and credit growth to shore up the rural economy. With the government’s spending flexibility now becoming limited, the rural economy will be the worst hit.
On the other hand, profits in the hands of corporates do not necessarily translate into growth. The surplus may be used for reducing debt or passing on higher dividends to shareholders.
Perhaps the finance minister should ponder whether such a sharp cut that has drastically reduced the manoeuvrability of government was really necessary.