In a bid to benefit from the disruption to global supply chains resulting from the US-China trade war, some Asian economies are resorting to tax sops to attract foreign investments. Recently, India reduced its effective corporate tax rate from 35% to 25%. Thailand, too, trimmed its corporate tax. Indonesia is expected to follow suit in 2021.
However, the impact of a US attempt in 2017 to spur demand by trimming corporate taxes was underwhelming. Of course, the US was then in a different phase of growth and so was the global economic backdrop. Even so, the tax cuts were a sentiment boost at best.
“(The US tax cut) was bigger (from 35% to 21%), and was on the back of a strong economy, high market multiples and low interest rates. This drove the US markets initially, and also earnings and economic recovery for a couple of quarters. But 21 months on, it’s more sobering—GDP growth has moderated (down 100bps from peak), markets are only up 5% post initial euphoria, corporate/consumer expectations are modest, investment momentum has slowed sharply, and the fiscal deficit is up," analysts at Edelweiss Securities Ltd said in a note to clients.
“India may well have been at the bottom of the cycle vis-a-vis the top for the US. That might shape up a different medium-term response/story, but should not be a reason to ignore the US experience," they added.
Given that capacity utilization across many sectors in India is still below optimum levels, companies are unlikely to invest immediately in expansions. Some capital-intensive firms are expected to retain tax savings to improve their balance sheets. Unless demand meaningfully improves, corporates may opt for using tax savings for purposes other than expansion.
Analysts at UBS Securities India Pvt. Ltd say that lowering of taxes may not boost near-term growth.
But, importantly, they see it as a major reform that may aid realizing medium-term growth, as it boosts India’s competitiveness. “With an effective tax rate of 17% for new manufacturers, India has the lowest tax rate among its peers, adding to its competitiveness. A lot of other issues (land, labour, infrastructure, ease of doing business, etc.) may not be as negative as widely believed, in our view.
Nevertheless, it may take time to make these competitive and change perceptions—a shift of manufacturing from China may not wait for these to happen. The tax cut possibly is an attempt to overcome these by making it compelling now. This is unlike, say, temporary GST cuts, which may boost near-term demand but are unlikely to solve the structural issue or create a sustainable growth cycle," they said in a note to clients.