The government's Diwali gift to India Inc is one of the most expensive ever - and a clear admission that the Modi Sarkar has finally accepted that the economy needs drastic measures. The only question is whether the rest of us can afford it.
What happened? Well, Union Finance Minister Nirmala Sitharaman finally fulfilled her late predecessor Arun Jaitley's promise five years ago to cut the corporate income tax rate to levels comparable with India's peer economies in Southeast Asia. At one stroke, the corporate tax rate for companies that aren't seeking any sort of exemptions was reduced to 22 per cent - though that is somewhat misleading, as various surcharges also kick in, taking the actual top rate to 25.17 per cent. But that is only marginally over the 25 per cent that Jaitley promised, and which is currently available only to companies with a turnover of below Rs 400 crore.
Essentially, large companies - which we rely on to expand the economy and to hire new employees - have been given a big bonus in the hope that this will spur hiring and investment, thereby reviving growth. The stock markets rose the most in 10 years on the news.
Let's be clear: corporate India needed some drastic measures to help it. It has not had a good decade. Profit growth has been low since the years after the financial crisis. It is not as if India Inc has done as poorly as everyone else - it has, in fact, done worse. Profits, as a ratio of GDP, have gone down sharply from almost eight per cent before the crisis to historic lows of around three per cent. In other words, corporate earnings have not kept up with GDP growth, and if the private sector is hurting for profits, it is not likely to invest. This is a structural problem that needs addressing, and the government is right to focus on it. A corporate income tax cut will directly raise the amount of money that companies can retain and then set aside for investment, if necessary.
The absence of earnings growth and thus of investment and job growth was one of the biggest signs that in spite of government insistence, we have not been in a boom economy since 2014. The first Manmohan Singh term was indeed a boom - profit growth was almost twice GDP growth in that period; that tide lifted all boats. We haven't seen that sort of boom since. The government is now trying to replicate it through this massive tax cut.
Some - especially the opposition Congress party - argue that the underlying problem is one of demand: people aren't buying enough, and that's why companies aren't expanding and investing. This may also be true, but the structural problems with Indian investment go deeper than that. It might have been easy to cut personal income taxes instead (or sales taxes in a pre-GST world, as Pranab Mukherjee did in his post-crisis stimulus, though that option is closed to the centre now.) That would have been politically more palatable perhaps. But a corporate tax cut, which attempts to make Indian companies more globally competitive, is a far more robust and responsible way to go about getting the Indian economy out of the hole that this government has dug for it.
There's only one problem: it will cost us Rs 1.45 lakh crore that we can today ill-afford. Had the prime minister allowed this tax cut to be implemented fully at the time that Jaitley had promised it, then an exchequer boosted by cheap oil could have easily absorbed it and moved on. Instead, it is an economy ravaged by demonetisation and a treasury short of Rs 1.7 lakh crore thanks to a mismanaged GST that will have to bear the burden of this tax cut. Boldness now hurts because of craven timidity earlier.
We now have to start worrying about the fiscal consequences of this sort of stimulus package. Where will the money come from? As it is, the GST is underperforming. Crucial to making up the lakhs of crores that are missing from the tax bill due to a poorly structured GST was an increase in direct taxes. The budget hoped for corporation tax to increase by 14 per cent in fact. How much will the government now mop up? We need to not just look at how much this gives away compared to the takings of the last financial year , but also how much it impacts what the finance minister expected in July we would get this year.
When the euphoria about the tax cut has worn off, I think we will realise that it sets out to solve one problem but creates another. One of the Modi government's few real economic achievements so far has been creating a sense that it is committed to careful fiscal consolidation. But this reputation has been spent like water over the past years, and this mammoth tax cut is the final nail in its coffin. There is little chance that we are still heading towards a deficit of three per cent of GDP, as has been long promised. The chances are that the deficit will now head back towards four per cent of GDP.
In plain terms, this means that the government will borrow more. Which means that more of the country's savings will go to fund government programmes instead of investment. What you gain on the swings you lose on the roundabouts - the question is whether you gain or lose more, and that turns on complicated structural features of the economy, on who tends to spend more and on what.
We couldn't afford this at this point in time; if you don't believe me, then just look at what RBI Governor Shaktikanta Das said a day before the tax cut: there was "little space" for any fiscal expansion like a tax cut, he said. Well, his ex-bosses in New Delhi didn't listen. The government has only itself to blame for rendering necessities like rationalisation of corporate taxes unaffordable, it has decimated small taxpayers with demonetisation, and then produced an overly complex GST, all while expanding its own spending. Had the government wanted to be truly responsible about this tax cut, it would have cut some spending or raised some other taxes to compensate, to ensure that we stayed on a fiscally prudent path.
Don't get me wrong: a reduction in corporate taxes to Southeast Asian levels was overdue. But typically - like with GST - this government has failed to go about it the right way. Don't get swayed by the breathless headlines and the exuberant stock market. The same headlines greeted Pranab's stimulus packages a decade ago. Now we know that the economy is still suffering from those unfunded giveaways. Let's hope we are not paying for this government's fiscal imprudence ten years down the line.
(Mihir Swarup Sharma is a fellow at the Observer Research Foundation.)
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