Corporate income tax: a slippery slope
In the Union Budget 2018-19, the finance minister has extended the benefit of a reduced corporate income tax (CIT) rate of 25% to companies with revenue of up to Rs250 crore, from the limit of Rs50 crore announced in the previous budget. With a number of state polls this year and the general election next year, the finance minister has perhaps been conscious of the political ramifications of being branded a pro-corporate government, therefore stopping just short of an across-the-board reduction in CIT, and noting that the benefits will accrue primarily to small and medium enterprises. Justifying the cut, he has argued that higher tax savings by the corporate sector will lead to more investment and job creation. The step and the claims, however, need to be assessed critically.
First, it is unclear why reducing the CIT, which resulted in an additional revenue foregone of Rs7,000 crore in this fiscal, and Rs14,200 crore cumulatively in the last two years, was considered necessary at this juncture. There has been fiscal slippage in the current financial year, and the budgeted deficit numbers for the next financial year suggest a clear deviation from the path of fiscal prudence. The revised fiscal deficit for 2017-18 stood at 3.5% of GDP (gross domestic product), the same as in 2016-17. The budgeted deficit for 2018-19, at 3.3% of GDP, is significantly higher than the target rate of 3% of GDP, recommended by the fiscal responsibility and budget management (FRBM) committee, in the years up to 31 March 2020.
Rising fiscal deficit could eventually prove damaging as it could squeeze the loanable funds available to firms, resulting in even higher cost of borrowing. Given that there was no fiscal headroom to enact the tax cut, the perceived benefit of a larger investible surplus could be eroded soon by an increase in the cost of capital, thus making the exercise counterproductive. Further, sacrificing fiscal prudence can send wrong signals to the international community, including sovereign rating agencies and investors.
Second, the presumption that lower CIT would result in higher investments is contentious. International evidence suggests that investments are influenced more by non-tax incentives than tax incentives. In our current taxation system, as interest paid on debt is tax deductible, we effectively subsidize debt-financed investments. Combined with depreciation rules and a plethora of tax exemptions available for companies, the government’s strategy appears to be predominantly on lowering after-tax costs, to stimulate investments. This, when it is widely acknowledged that the impediments to domestic investments emanate from a poor investment climate, bottlenecks in the labour market, and an unpredictable and discriminatory legal and regulatory framework. The budget has failed to provide any reform direction in this regard.
Third, we need to be circumspect while assuming that corporate tax cuts will automatically mean more money to invest, which in turn will boost employment and raise wages. Any credible fiscal policy will have to offset the tax cut either with spending cuts or increases in other taxes, both of which can be contractionary in nature, as the incidence of such measures is likely to fall disproportionately on households. On the other hand, global empirical evidence suggests that corporate tax rate cuts mainly benefit shareholders and chief executive officers, not workers.
Fourth, if we look at the average corporate tax rate (a measure of a company’s income-tax burden relative to income earned) and the effective corporate tax rate (a measure of a company’s corporate income-tax burden on returns from a marginal investment), the country stands at a very competitive footing compared to other emerging and developed countries. The Congressional Budget Office (CBO) of the US, in its report titled “International Comparisons Of Corporate Income Tax Rates”, published in March 2017, estimates the average corporate tax rate in India at 25.6%, which compares favourably with countries like Argentina (37.3%), Indonesia (36.4%), Japan (27.9%) and Italy (26.8%). The effective corporate tax rate for India, estimated at 13.6%, is even lower, and renders it more competitive than countries like Argentina (22.6%), Japan (21.7%), the UK (18.7%), Brazil (17%) and Germany (15.5%). Reductions motivated by comparisons of only the top statutory tax rates of global peers, without concomitant reduction in the large number of exemptions, cannot be justified on economic grounds. Given that corporate tax rates were competitive by international standards, the fiscal costs of extending further benefits could have been avoided.
Finally, though not explicitly expressed in his budget speech, the finance minister appears to have been influenced by a global corporate-tax cut war unfolding currently, since the US announced a 40% cut in its corporate tax rate late last year. A host of countries, including Australia, Argentina, France, the UK, South Korea, Mexico and Chile, have announced aggressive corporate tax cuts to counter the US move. India needs to be cautious and avoid herd behaviour. A race to the bottom will be unsustainable, and could worsen our already precarious fiscal health.
The government should focus on improving India’s business environment and initiating reforms to reduce the cost of capital, in order to attract investments and create jobs. Joining the global tax war will not yield real benefits for the economy as a whole—certainly not at the cost of jeopardizing the credibility of our fiscal policy.
Amarendu Nandy and Abhisek Sur are, respectively, assistant professor and doctoral candidate at IIM, Ranchi.
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