Bold tax move needs matching reforms

Venky Vembu | Updated on September 23, 2019 Published on September 22, 2019

Policy consistency and other enabling supply-side measures can build on corporate tax breaks

In the first flush of over-the-top corporate and stock-market euphoria following the dramatic announcement on Friday of sweeping cuts in corporate taxes, it is easy to forget that barely a month earlier, Finance Minister Nirmala Sitharaman had, in effect, been arguing against herself. A 25 per cent tax rate for all corporates, she had said as recently as in early August, must await a time when there was “revenue buoyancy”.

Her articulation of such a dampening sentiment — that the government would be unable anytime soon to deliver on its promise of lower corporate taxes — had done such a masterly job of ‘expectation management’ that heads of industry had reconciled themselves to the inevitability of high taxes and been reduced to petitioning her for lowly tweaks of GST rates.

But even the government’s steady dribble of ‘stimulus’ measures in recent weeks had proved largely ineffectual in arresting the downward spiral of business sentiment. In fact, a certain surliness of spirit had begun creeping into industry-government interface, with one outspoken corporate titan even suggesting — erroneously — that Sitharaman was perhaps holding forth on matters beyond her Ministry’s ken.

Which is when, in the proximate context of Prime Minister Narendra Modi’s high-profile visit to the US, the government went ‘all in’ with the dramatic announcement of corporate tax cuts, bringing them down to levels that are competitive with other jurisdictions.

There is never a bad time to do the right thing, of course. And consistency of outlook is sometimes an overrated virtue, particularly if that original outlook placed a premium on heavy-handed tax extraction.

So, if a Minister who had metaphorically waded into ‘paddy fields’ and trampled on business sentiments therein (to invoke the imagery of the Sangam poetry she had cited in her Budget speech) changes course and is awakened to the wisdom of judicious taxation, it is surely a consummation devoutly to be desired.

Even though nothing had changed materially over the past month in terms of improved ‘revenue buoyancy’, the government has evidently advanced the implementation of the Direct Tax Code recommendations in respect of corporate taxes in order to give Modi a talking point beyond a cheery ‘Howdy’ greeting in Houston.

A calculated gamble

And in taking a ₹1.45-lakh crore hit in terms of forgone revenue from corporate taxes for the full year, the government is taking a calculated gamble that the measure will unshackle the corporate ‘animal spirits’ that had, even until last week, thrown in the towel.

Friday’s surge in the stock market is, in one sense, entirely rational. The lower taxes will add to the bottomline of many corporate entities for the full year, which automatically warrants a re-rating of their respective stocks.

And yet, for all the merits of the lower corporate taxes, the measure may have the intended effect of bringing in sufficiently high fresh investments only if it is complemented by other efforts to enhance the ease of doing business. India’s recent record of vaulting up the charts of that index, while admirable in itself, is hard to reconcile with the real-life experiences of businesses at the provincial level, which still grapple with bureaucratic cussedness and corruption.

Lower taxes are, of course, a persuasive consideration for businesses to scale up investments, but in the absence of other supply-side initiatives that make it easier for them to operate optimally, they will count for only so much.

Given the government’s record — until recently — of its incapacity to acknowledge the gravity of the economic slowdown, the fear is not entirely unwarranted. Having won today’s headlines with a truly momentous announcement, the government must overcome the temptation to downplay the criticality of pro-active policy-making.

Policy coherence

When it comes to such policy-making, businesses also look for coherence insofar as it impacts on their interests, but in recent times that commodity has been in short supply. The recent succession of trial-and-error tweaks of policy minutiae may have been suggestive of a government that is responsive to the pain-points felt by the industry, but they also represent a failure to get the big picture right.

Even at the macro level, financial markets will be wary of the government’s evident reprioritising of its fidelity to fiscal prudence, which it had all along upheld as a virtue it was committed to.

Indicatively, the recent announcement that the government would look to public sector banks to facilitate ‘loan melas’ would arguably have sounded off more alarm bells, had it not been drowned out by the thunder that accompanied the corporate tax cuts. Although the announcement came laden with caveats, there is a very real risk that it will sow the seeds for profligacy in lending — and for tomorrow’s crises — even before PSU banks have fully emerged from the NPA mess.

Desperate situations sure merit desperate responses, but it wouldn’t hurt for the government to chart out a roadmap to getting back on the path of rectitude on that front. Of options, it has plenty; it is the political will to implement them that thus far been somewhat deficient.

Even so, there is cause for cheer in some of the changes in the government’s recent responses. The emphasis until now that a fiscally constrained government would look to monetary policy to reverse the slide has mercifully been abandoned. Beyond a point, lowering interest rates is akin to pushing on a string, and doesn’t provide sufficient traction. The bold move to lower corporate taxes represents a welcome change.

But far more important is the underlying principle that governs the government’s tax move. By giving corporates the option to avail themselves of far lower taxes — on condition that they forgo deductions and incentives — the government has signalled its willingness to abide by a simpler tax regime, and a less cumbersome tax administration process.

If that same principle is extended to individual taxpayers — as seems very likely whenever the Direct Tax Code recommendations are implemented in their entirety — it should enhance the ‘wealth effect’ of taxpayers (beyond just stock market investors) and provide a more material boost for consumption than any number of GST tweaks.

Published on September 22, 2019
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