Tax Cuts, or Deficit Much? - The Public Economist

The harrowingly low growth estimates of the Indian economy have been making headlines for long. While there is no doubt that the pandemic has had destructive effects on all sectors of the economy, a few pre-pandemic policies have not only missed their mark by a long shot, but also added to the economic woes of the country still recovering from the aftermaths of the first wave. To recap, the economy was not particularly blooming well before the coronavirus took the reins of the imminent slowdown. The gross domestic product for the September 2019 quarter had slipped to 4.5%, the lowest since 2013. Demand and investment were at a six-year low, manufacturing at a 15-month low, exports were slagging, banks were saddled with non-performing assets, and investments had taken a hit due to the lowering confidence in the Indian capital market and precarious macroeconomic conditions. All of this contributed to a series of policy changes that the government counted on to stabilise the situation, the most controversial of which were the corporate tax cuts. The government announced corporate base tax rate cut from the then 30% to 22% and simultaneously reduced the tax on new manufacturing companies from 25% to 15%, essentially making it one of the lowest corporate tax in the world. The motive behind this move was to invite investments, increase competitiveness, and on the back of it all, generate employment. And with this, the government sacrificed Rs.1.5 lakh crores in the hope of improved economic performance, enough to offset the large revenue loss incurred.

It has been almost two years since that calculated decision and it’s fair to say that the tax cuts have done more harm than good in the economic revival of the country, or at least that is what the data shows; the total FDI inflows in the first two quarters of 2019 was $26.1 billion as compared to the FDI equity inflows stood of $23 billion in the last two quarters of 2019, FDI in manufacturing has also not observed any significant changes. As of the employment generation, rural unemployment has reached an unprecedented level of 9.7% while urban employment has witnessed some sporadic rises. Despite all the data pointing at the foundering nature of tax cuts, the slabs have been kept unchanged in the budget of 2021. It could be attributable to the rebranding motive of the budgeters in the face of country’s growing international reputation as an unstable tax regime.

The outcome of this constancy is a depressing tax kitty and rising inequality.

The corporate income tax collection for FY21 stood at Rs 4.57 lakh crore, while total personal income tax was at Rs 4.69 lakh crore. Income tax collections surpassed corporate tax returns for the first time in 12 years. Though, both corporate and personal income tax collections shrunk in the financial year 2020-21 by 18 percent and 2.3 percent respectively. It should be emphasized that corporate taxes account for 55% for government’s tax revenue, making this information all the more disparaging. In addition, the loss incurred is not evenly spread among all stakeholders. According to the economic survey, 2019-20, the tax cuts have largely benefitted big enterprises while leaving small companies unaffected if not worse off. It reported that nearly 99% of the companies had a turnout of less than Rs.400cr. and hence already paid the lowered amount of 25-26% in taxes. It is the creamy layer of top 1% of companies that could substantially increase their profits by reducing tax returns from the earlier 30% to 22%. Somewhere between the policy’s pro-business intentions to its pro-big businesses approach, the principles of equality has been lost. The cuts have been further criticized for boring a massive hole in the potential relief package released by the government owing to the fiscal turbulence caused by the revenue losses. In hindsight, the lost revenue would have better been spent on stimulating demand via lowering of indirect taxes, regulating subsidies, and exploring direct transfer schemes.

In view of the macroeconomic conditions, it can easily be established that a tax cut alone, without commensurate infusion of capital in infrastructure and skill development cannot bring about the desired results. In 2019 itself, all major nation states were inclined towards corporate tax reduction, including the U.S. which happens to be the second highest investor in India’s FDI pool. The U.S. has been successful is bringing its corporate tax down to 21% during the republican rule, not only is it below India’s after cut rates, it is also below the world average rate of 23.79%. Similarly, Canada and Japan have also brought down their tax rates from the earlier to 26.5% and 30.62% in 2019. This effectively eroded the competitive edge that the policy makers advocated in favour of the corporate tax rates in the first place.

On the other hand, the various policy lessons that can be drawn from from tax stringent countries like the UAE, Brazil, and Venezuela with exorbitant rates of 55%, 34%, and 34% respectively, are also replete with the same conclusion. A hike in tax rates, much like a dip, is not a sufficient measure to ensure prosperity. Both, Brazil and Venezuela, have fragile economic systems with inflation, instability, and predictions of a collapse running high. In the UAE, however, the system is more robust and carefully constructed such that the tax slabs change proportionally with marginal increase in profit, and aim to diversify occupational distribution. India could adapt such a framework to ensure that the benefits of the tax cuts seep down to beneath the top 1% of companies and develop a ‘business friendly’ environment, instead of a ‘corporate friendly’ system. If you know the difference, you know the difference!

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Rishika Singh

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Rishika's research interests include labour economics, public finance, and financial innovations. As an independent researcher, she has previously written for renowned journals, blogs, and a national periodical. In addition to being an ardent contributor to the solutions of various social and economic issues, she enjoys cracking econ puns, baking, and a good game of badminton.

Rishika Singh

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