Fiscal impact of tax sops overstated

In response to concerns about the slowdown in the Indian economy, Finance Minister Nirmala Sitharaman announced a slew of measures, a prominent one among them being a reduction in the corporate income tax rate for existing taxpayers and a sharper reduction for potential new corporates investing in manufacturing. In addition, surcharges on personal income tax introduced in the Budget for FY20 has been withdrawn from capital gains on securities, provided the securities transactions tax has been paid on the underlying asset. The press note announcing these measures also indicates that these measures would be associated with a revenue loss of ₹1.45 lakh crore.

This initiative has been widely welcomed by the corporates in India as well as the range of investment advisers. But, there are two important questions that need to be asked here:

What is the expected impact of a reduction in corporate taxes on the economy? This impact would depend on what the corporates choose to do with the bonanza. They could increase distribution of dividends, buy back shares, pay off their debts or could pass off some of the benefits as lower prices, which in turn could stimulate demand.

Clearly, without some stimulus for demand, there is no incentive for the corporates to use the savings so generated for capital formation. Is there any way to disentangle the likely impact of the reduction in corporate taxes?

If the stock market is the barometer of the economy, clearly, the corporates should either pay more dividends or reduce debt. Further, whichever be the chosen action plan by the corporates, the impact on the economy would depend on the size of the stimulus — which, as the press note indicates, is pegged at ₹1.45 lakh crore.

Following from the above is the question — what is the impact on the fisc? Any estimate is based on some assumptions. To state some assumptions upfront: since information on the effective tax rate for returns corresponding to financial year 2018-19 is not available, we assume that the effective tax rates reported for 2017-18 would be the effective taxes rates in 2019-20 before the proposed change in tax rates.

Estimating the loss

The revenue foregone statement of the Budget (Annex 7 of the Receipts Budget, 2019-20) provides a statement of the effective tax rates for corporate taxpayers classified by the size of profit before tax (PBT) reported. The table presents an estimate of the likely loss of revenue from these measures.

This table also provides information on the share of taxes paid by each of these groups of taxpayers. In particular, one considers two of the proposals for analysis — the reduction in the corporate tax rate for all existing taxpayers and the reduction in the MAT.

For the purposes of this exercise, it is assumed that the change in corporate tax rate affects taxpayers who report positive PBT, while the change in MAT affects taxpayers who report zero or less than zero PBT. The reduction in the tax rate and the elimination of exemptions for the former set would, as suggested by the Finance Minister, result in an effective tax rate of 25.17 per cent on PBT. In other words, for the different categories of taxpayers with PBT greater than zero, the effective tax rate will reduce from 26-29 per cent to a uniform 25.17 per cent.

Assuming that all the taxpayers choose to move to the new regime, one can generate an estimate of the potential revenue loss. (See table). The table suggests that reduction in the effective rate of corporate tax would be to the tune of ₹51,400 crore. The reduction in MAT on the other hand should result in a reduction of ₹11,500 crore, together amounting to ₹63,000 crore.

These estimates correspond to the Budget estimate for corporate tax for 2019-20. With a decline in the rate of growth of the economy, these benchmark numbers themselves could be lower, and corresponding revenue loss on account of reduced tax rates too would be lower.

Revenue assumptions

This estimate is considerably lower than the revenue loss reported in the press statement. It is fair to argue that these were not the only changes proposed. That said, the impact of the incentive proposed for new corporate investment in manufacturing, which is a prospective levy, cannot be expected to kick in during the current financial year.

Now on to the elimination of the surcharge on capital gains transactions in securities subject to the payment of the securities transaction tax. Since the overall revenue expected from the enhanced surcharge is only ₹2,723 crore (the difference between surcharge reported for 2018-19 and that budgeted for 2019-20), the withdrawal of surcharges on these transactions can’t have a significant effect on the overall figure of revenue loss.

The estimates are based on the assumption that corporates’ level of profit or the uses to which it is put do not change. Depending on how they choose to use these resources, the impact on the Exchequer would vary. For instance, if the resources are used to pay higher amounts of dividends, the net tax revenue lost would be lower, since some revenues would be recovered through the dividend distribution tax.

On the other hand, if the corporate chooses to reduce the price of goods/services provided, the profit itself could be smaller and the revenue loss might be larger.

Overall, it appears that the concerns of revenue loss are exaggerated. This assessment can be a source of comfort since the impact on the fisc would be smaller — both for the Centre and the State Governments. But this would mean that the stimulus from such a move too would be smaller than expected.

So, what are the assumptions underlying the considerably higher estimates put out by the Finance Ministry? Clearly, we missing some crucial bit of information — wonder what it is.

The writer is Professor, National Institute of Public Finance and Policy

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