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 Rs 250 crore, from the limit of Rs 50 crore announced in the previous budget. He has argued that such a move will spur investments and help in job creation.
Why cut in corporate income tax rates is counterproductive?
- First, it is unclear why reducing the CIT, which resulted in an increased budget deficit for 2018-19, at 3.3% of GDP, 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. 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. There are a plethora of tax exemptions available for companies for them to explore and increase investments. Actually, 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. Successive governments have failed to address this.
- Third, we need to be think closely before assuming that corporate tax cuts will automatically mean more money to invest to 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 and thereby, contracting their income.
- Fourth, if we look at the average corporate tax rate and the effective corporate tax rate, 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%). 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, 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.
Way forward –
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 jeopardising the credibility of our fiscal policy.
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