Pros & Cons of Corporate Tax Rate Cut

Corporate Tax Rate Cut – Good Move or Bad Move?

Introduction

In this article, we are going to discuss the pros and cons of Corporate Tax Rate Cut announced recently by Finance Minister Nirmala Sitharaman in an attempt to boost the Indian economy. Let’s analyse whether the Corporate tax rate cut is a good move or bad move?

Pros & Cons of Corporate Tax Rate Cut | Good Move or Bad Move?

Corporates in India will be taxed at 22% from 30% earlier rate and an effective rate of 25.17% including surcharge and cess. The tax cut came as Indian Prime Minister Narendra Modi’s government attempts to spur the country’s slowing economy.

So lets analyse the pros and cons of corporate tax rate cut in detail.

Pros of Corporate Tax Rate Cut

1.Support to Indian Corporates (Increased Earnings)

• The move of corporate tax rate cuts will provide a big support to corporates in India. With the tax cuts, the post-tax earnings (PAT) of the companies is going to rise considerably.
• For Example :
  • HDFC Bank earlier used to pay 35% tax on Profit before Tax earnings (PBT). So, its post-tax earnings was 65% of PBT. However, now due to corporate tax rate cuts by the government, HDFC Bank now need to pay only 25.17% effective tax (including surcharge and cess) on its PBT earnings.
  • So, the resultant post-tax earnings left with the bank is 74.83% of PBT v/s earlier 65%. So, there is increase of 9.83% which will play a considerable role in the overall profitability of the bank.

2. Multiplier Effect on GDP – Supply Side Measure

• Tax Multiplier Effect
  • One way to assess the growth impact of the corporate tax cuts is to look at the tax multiplier of growth. The measure is used to capture the impact of an increase or a reduction in tax on GDP of the country.
  • Thus, a change in tax rates results in a multiplier effect. The tax multiplier tells that how big of a change you will see in GDP as a result of a change in tax rates.
  • According to the economists, the corporate tax multiplier has been estimated at approximately -1. The value of about -1 implies that a fall of about Rs.1.45 Lakh crore in corporate tax collections by the government could raise the GDP by about Rs.1.45 Lakh crore by the end of the year, where both are measured in nominal terms.
• Expenditure Multiplier Effect
  • The expenditure multiplier effect tells the magnitude of how much real GDP will change in response to an autonomous change in aggregate spending. The capital expenditure effect on GDP is the highest at about 2.5 times.
  • The boost to bottom-line for companies is likely to manifest in the form of
  • Higher Investments and Capital Expenditure (Capex) : It will improve productivity and increase output. In turn, results in lower product prices charged to the customers.
  • Higher Returns to Stakeholder :
    1. Dividend Payouts to Shareholders
    2. Higher Incentives to Employees
• This is likely to boost investments and consumption as well as demand in the economy over the long term. Thus, the increased consumption and expenditure will have a cascading impact over the long term and will contribute to increase in the GDP growth rate of the country.

3. Support to Capital Market

• After the announcement of corporate tax rate cut on Friday, 20th September, there was a big positive momentum seen in the capital markets. Sensex have shown a big rally of 3300 points in just 2 days (Friday and Monday).
• Domestic Institutional Investors (DIIs) and Foreign Institutional Investors (FIIs) were the key active participants. The total net buying of DIIs and FIIs was Rs.6,013.1 Cr in these 2 days. (Please refer above table for details).
• This shows how big is the support offered to the capital markets by government’s corporate tax rate cut move.

4. Competitive Tax Rates Compared to Asian Peers

• With the rate cut in corporate tax, India now came closer to the rates prevalent in many of the emerging and industrialized countries.
• The new corporate income tax rates in India will be lower than USA (27%), Japan (30.62%), Germany (30%), Brazil (34%), Philippines (30%), SriLanka (28%) and is similar to China (25%) and Korea (25%).
• The government hopes it will make India more appealing to multinational manufacturers that are preferring countries such as Vietnam, Taiwan, Thailand (20%) and Malaysia(24%).

Cons of Corporate Tax Rate Cut

A cloud of questions hovers above the real impact of the corporate tax rate cut announced by the Indian government. There are many cons of this move.

1. Fiscal Deficit May Increase

• The primary concern is how the tax cut will make up for the lost revenue? The tax rate cut measure involves forgoing Rs.1.45 lakh crore ($20.45 billion) in annual revenue.
• This tax revenue lost is about 0.7% of India’s GDP. It means the tax cut move will cost the government about 0.7% of GDP each year.
• The corporate tax rate cut will widen the government’s fiscal deficit from the current target of 3.3% to 4% of GDP this financial year.

2. Government May Decrease Spending to Manage Fiscal Deficit

• In order to cater the widened fiscal deficit, there might be a constraint on government spending. Government may decrease spending to manage the fiscal deficit targets.
• However, reduced government spending on infrastructure and other needful measures would hamper the further growth and job opportunities in the economy. So, reducing government spending would not be a correct way to tackle widened fiscal deficit numbers.
• Government can use the surplus received from RBI to manage the gap. Also, the divestment would provide the necessary funds support to the government. Selling the stake in BPCL, Container Corporation and Air India would be a key upcoming step by the government.

3. Corporates May Use Increased Earnings in Debt Repayment

• Given the nature of the current slowdown, which is mainly due to weak consumer demand, there is no reason to imagine that private companies will invest more if their tax outgo decreases.
• If consumers are not spending in the first place due to high unemployment and diminishing wages, then additional investments become risky.
• So, there might be possibility of using the increased earnings of the corporates in repayment of their existing debts instead of more investments.

4. Demand Side Measures Requirement May Rise

• The real problem India facing is not that it is too expensive to do business but the fact that there is no demand. So, the demand side measures requirement may rise.
• Key Demand Side Measures are :
  • GST Rate Cut
    • Cutting goods and services taxes which would reduce prices, would be a more effective way to boost consumer demand.
    • Because, to boost consumption, the prices of goods and services that the consumers are buying should be reduced.
  • Personal Income Tax Rate Cut
    • Cut in personal income tax would have had a wider impact on consumption and demand improvement.
    • That is why an effective solution is to increase consumers’ disposable incomes by a direct injection of investment.