In Budget Today, A Major Catch-22 For PM Modi

In his last full budget before 2019 elections, PM Modi is facing a revenue squeeze that may make it difficult to deliver on a promise to lower the basic corporate tax rate over time to 25 percent from 30 percent.

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In Budget Today, A Major Catch-22 For PM Modi

PM Modi pledged in 2015 to bring down corporate taxes over four years

Highlights

  1. Businesses are expecting government to cut corporate tax in Budget
  2. PM Modi pledged in 2015 to bring down corporate taxes over 4 years
  3. Government has signaled it may slow the pace of fiscal consolidation
Businesses waiting for Prime Minister Narendra Modi to follow through on a pledge to cut corporate taxes may need to wait a bit longer.

In his last full budget before 2019 elections, PM Modi is facing a revenue squeeze that may make it difficult to deliver on a promise to lower the basic corporate tax rate over time to 25 percent from 30 percent. It's a catch-22 situation for the premier, who is also trying to lure foreign investors at a time when the U.S., U.K. and other countries are lowering business taxes.

Here's a look at PM Modi's challenge ahead of the government's budget on Thursday.

Why Cut?

PM Modi pledged in 2015 to bring down corporate taxes over four years, but businesses are still waiting for a roadmap on how that will happen. It's part of his mission to improve the country's investment climate: he is also reducing red-tape, spurring the liquidation of assets to speed-up the recovery of bad loans, and introduced a national sales tax last year to cut down business costs. India is ranked 119 out of 190 countries when it comes to ease of paying taxes, according to the World Bank's Doing Business index.
corporate tax bloomberg
While those reforms have helped India win a credit rating upgrade and record foreign direct inflows last year, PM Modi needs to keep investment going to help support an economy that's set to expand at its slowest pace in four years.

Tax competition around the world is heating up. The U.S. lowered corporate taxes by 14 percentage points to 21 percent, with companies like Apple Inc., Wal-Mart Stores Inc. and JPMorgan Chase & Co. announcing plans to raise investment, hiring or wages.

"The U.S. has made corporate tax rates competitive and India needs to respond," said Jayesh Sanghvi, a tax partner at EY in Hyderabad. If it doesn't, companies will examine arbitrage opportunities given the 10-15 percentage point difference, he said.

After reducing the rate last year to 25 percent for small companies with a turnover of up to Rs 50 crore ($7.9 million), businesses are expecting Finance Minister Arun Jaitley to move again this week. Half of the 120 professionals surveyed by Deloitte expect the rate to be cut to 25 percent for all companies. Rakesh Nangia, head of tax advisory firm Nangia & Co., warned of a "flight of capital" if tax rates aren't reduced.

Can India Afford It?

PM Modi is in a fiscal bind. Revenue collection remains under pressure following the chaotic roll-out of a national sales tax, and with an eye on next year's election, his spending priorities may turn to the distressed rural sector, putting pressure on the budget deficit.

The government signaled on Monday it may slow the pace of fiscal consolidation after pledging to narrow the budget gap to 3 percent of gross domestic product in the year beginning April 1 from an estimated 3.2 percent this year. Chief Economic Adviser Arvind Subramanian told lawmakers that setting "overly ambitious targets" may undermine the credibility of fiscal policy.

Abhishek Gupta, a Mumbai-based analyst with Bloomberg Economics, expects the budget deficit to come in at 3.4 percent of GDP this year. The median estimate in a Bloomberg survey of 18 economists is for 3.5 percent this year and 3.2 percent next year.

Political considerations may also prevent PM Modi from reducing corporate taxes now, said Shailesh Kumar, a senior analyst at Eurasia Group in Washington.

"In addition to concerns that a reduction will further widen the deficit, a move by Modi to cut corporate rates ahead of next year's election would expose him to opposition criticism that he is a crony capitalist who only wants to help friends in the business sector," he said.

What Are Others Doing?

Japan has begun phasing in a cut in corporate taxes to get companies to spend their cash on boosting wages and investment. Hungary is bringing the rate down to 9 percent, France plans to lower it to 25 percent by 2022, and the U.K. is aiming for 17 percent by 2020.

China will offer a tax exemption to foreign investors if they re-invest their dividends in projects encouraged by the government.

Comments
Aside from the corporate tax cut, the U.S. government is also discouraging offshore payment for services in a move that may hurt India's pharmaceutical, research and development and software companies.

"U.S. multinationals operating in India would want to look at the profits they are leaving here," said Rajesh H. Gandhi, a partner at Deloitte India. "Similarly, Indian multinationals operating in the U.S. could be encouraged to increase the depth of their U.S. operations and allocate more profits at the U.S. level."

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