2 min read.Updated: 24 Sep 2019, 10:37 PM ISTPuja Mehra
Corp tax cut is being seen as an application of the theoretical approach known as supply-side economics for countering the slowdown in GDP growth. Mint explains why this may be an inaccurate interpretation
The government last week cut tax rates on corporate incomes. This is being seen as an application of the theoretical approach known as supply-side economics for countering the slowdown in GDP growth. Mint explains why this may be an inaccurate interpretation.
Supply-side economics holds that the economy grows when more goods and services are produced. Supply-side economists argue that businesses and corporates must produce more to stimulate an economy. They assume that the rich are the real drivers of growth. The central tenet is governments can boost production and, hence, growth by cutting taxes on the incomes and capital gains accruing to the rich. Increased savings, consumption and investments by the rich would create new jobs and, thus, new incomes. This will push up the government’s tax revenue, making up for the tax revenue lost due to rate cuts.
What is trickle-down economics?
The supply-side theory is often pejoratively called the “trickle-down" approach to economic policy. Critics say it leaves the non-rich at the mercy of the trickle-down effects of growth. It inspired the Reagan administration’s tax rate cuts aimed at combating stagflation in the US in the 1980s. The top marginal tax rate for income was cut from 70% to 28% and for corporate income from 46% to 40%. It was earlier known as the “horse-and-sparrow theory": Feed a horse enough oats and some will be left behind for the sparrows. It assumes that tax rates are all that keep the rich from productive economic activity.
What does the demand-side approach say?
The opposing theory to the supply-side approach is demand-side or Keynesian economics. It focuses on ensuring that consumers buy more. When demand for goods and services weaken, Keynesians advocate stimulating GDP growth through increased public spending. As the economy grows, tax revenues will increase again.
The recent corporate tax rate cuts don’t seem to be an application of supply-side economics, rather an attempt to reform the corporate tax structure. Expert panels had found the corporate income tax system to be in need of reform and advised rate cuts, simplification and removal of provisions that introduced structural distortions in the economy. The rate cuts pave the way for phasing out various tax exemptions for corporate taxpayers. The exemptions have complicated the tax system and increased compliance costs.
What is the way forward now?
India’s corporate tax structure has hampered resource allocation and competitiveness of companies in foreign markets. The flaws give rise to waste and inefficiency, distort financial and investment decisions and encourage tax executives to hunt for loopholes. The high rates have induced firms to move profits abroad. Last week’s changes do not fully tidy up the mess and will have to be followed up with other recommendations.
Puja Mehra is a Delhi-based journalist and the author of The Lost Decade (2008-18).
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