On September 20, 2019, Finance Minister Nirmala Sitharaman delivered a radical corporate tax cut. Henceforth (and with retrospective effect to April 1, 2019), the tax rate on corporate profits was reduced by eight percentage points from 30 per cent to 22 per cent. For this third calendar quarter (July-September) nominal GDP growth (yoy) has been estimated as 6.1 per cent, the lowest ever experienced for quarterly data in India (a series which started in 1996Q2). The Indian economy was in trouble, and there was a clamour for policy change.
But a large corporate tax cut was not the remedy for the economy as seen by many experts, either in September 2019, or now. Pronab Sen, head of the International Growth Centre and appointed head of a government task force to examine the authenticity of Indian statistics, recently told this newspaper (IE, January 30) that, “Corporate tax cut was a bad idea in the middle of the year… This will add another 0.3-0.5 per cent to your deficit without doing anything. I am afraid what you may actually end up seeing is personal income tax cuts which will send us even further into the trouble.”
Nobel laureates for economics, Abhijit Banerjee and Esther Duflo, have also been very critical. Banerjee has asked for a reversal of the corporate tax cut while Duflo believes corporate tax cuts are no solution to India’s economic woes. But these experts were not alone. They were joined by an international body of experts, who all felt that regardless of the (questionable) long-term benefits of a tax cut, it was “certainly” a bad idea in the midst of a growth slowdown. It would be a reasonable conjecture that many economic experts within the administration felt the same as Sen et. al. The only known exception was perhaps the political leadership.
What was the alternative to a corporate tax cut? The near unanimous judgement among the economic experts was that the government would be well advised to concentrate on expenditure expansion in MGNREGA rather than go for the tax cuts for corporates. Even a 50 per cent expansion in MGNREGA would have meant only an additional Rs 25,000 crore in spending. One percent of GDP is 3 lakh crore, so the “alternate remedy” would have added one-twelfth of 1 per cent of GDP. It is doubtful if this would have helped the economy recover from 6 per cent nominal growth. But this will remain in the realm of the counter-factual because the government did not try out this alternate recommendation.
In an article (‘Tax policy — maximise, not moralise’, IE, July 13, 2019), we said, “The only real growth option for Indian policy makers — cut (corporate) tax rates to internationally competitive levels. And what that might be? Around 22 per cent.” The HLAG report for the Ministry of Commerce, which one of us had chaired, also argued for a 22 per cent corporate tax rate (with exemptions) or preferably an 18 per cent tax rate without exemptions. The new government policy was 22 per cent with no exemptions combined with a lower rate of 18 per cent for new manufacturing firms. All in all, a giant leap in Indian policy making.
The argument for a large corporate tax cut was simple. In a global world, it is the after-tax return that moves companies and investment. India’s competitors, especially in Asia, have effective tax rates in the mid to high teens. And what has not received emphasis in India, or elsewhere, is the likely economic fact that for developing countries tax compliance is the surest route to fiscal discipline. And that increases in tax compliance often accompany non-trivial decreases in tax rates.
Has the Sitharaman tax cut led to an increase in compliance, and/or an increase in private investment? It is too early to tell, but there are pointers. There is some data available in the Budget documents. The Budget contains up-to-date estimates of tax revenues (and other data relating to revenue and expenditure). Since data are available for approximately 10 fiscal months, simple extrapolation gives one a reasonable estimate of actual final revenues. The historical record of these forecasts (called revised estimates in Budget documents) is that, on average, they miss the final actual figure by an average of just 1 per cent.
The 2021 Budget estimates corporate tax collections (excluding surcharges and cess) in fiscal year 2019/20 to be Rs 528 tc (thousand crores). As reference, note that the actual corporate tax collection figure for 2018-19 was a higher Rs 580 tc; and the Ministry of Finance itself had estimated the impact of the tax cut to be a revenue decline of Rs 142 tc. Besides this estimate for 2019-20, we do have government published estimates of tax collection in the first half of this fiscal year (April-September 2019). This estimate was Rs 249 tc and for a period, which recorded the lowest growth in nominal incomes. If the economy had proceeded at the same rate in the second half of 2019-20, tax collections for 2019-20 would have been approximately Rs 500 tc.
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Corporate tax data as published by the RBI also shows a large decline in tax provision by corporates. In 2018Q2 and 2018Q3, tax provision was Rs 65 tc; in the same two quarters in 2019, tax provision had declined to Rs 50 tc. Thus, the best RBI data-based estimate for corporate taxes in FY 2019-20 was a decline of 20 per cent to 25 per cent over the 2018-19 value, which is approximately Rs 460 tc.
If tax collection now is Rs 528 tc (as per the revised estimates), that is an increase of Rs 68 tc made possible by the tax cut. This is our first estimate of the economic gains from the corporate tax cut — an increase in tax revenues of Rs 68 tc or with an average tax rate of 22 per cent, close to a 1 per cent gain in GDP.
The debate whether the corporate tax cut led to increased corporate activity or an increase in tax compliance, or both will be settled only when the actual tax figures for 2019-20 are released. There is good evidence that something positive has happened since September 2019. Monetary policy has remained relatively tight with interest rate cuts equal to the decline in inflation — that is no decline in real rates (except for an onion induced reduction post-September). It is hard to believe that investment increased because onion prices went up. World growth, and world tensions, worsened post-September 2019.
Economic activity in India seems to have bottomed out by September. GST tax collections do provide a clue, a hint of a change in sentiment, an increase in economic activity. Between April-September 2019, GST revenues increased by only 2.2 per cent, yoy. The October-December yoy increase is a (relatively) hefty 7.8 per cent. That is a 5.6 percentage point additional increase in growth, an increase not caused by monetary policy, nor fiscal policy, nor expansion in world growth. And GST tax rates have witnessed a reduction — another factor pointing to a reduction, not increase, in tax revenues.
The corporate tax data provide strong evidence, and especially for highly taxed economies like India, that rationalisation in tax rates is the surest remedy for revenue enhancement and for attacking the scourge of tax avoidance.
If the corporate tax collections are “correct” and if the GST collections persist, then we all need to acknowledge the efficacy of tax cuts for increasing competition, increasing economic activity, and increasing tax revenues. Did the whole class (except the teacher) get it wrong by not accepting the corporate tax cut as a game-changer?
This article first appeared in the print edition on February 8, 2020 under the title ‘Cut tax rates, increase revenue’. Bhalla is executive director, IMF, representing India, Sri Lanka, Bangladesh and Bhutan. Bhasin is an independent economist. Views expressed are personal
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