By Surjit S Bhalla & Karan Bhasin
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 to 22 %. For this third calendar quarter (July-September), nominal GDP growth (y-o-y) has been estimated as 6.1 %, 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 Center and appointed head of a government task-force to examine the authenticity of Indian statistics, recently stated that “corporate tax cut was a bad idea in the middle of the year…This will add another 0.3-0.5% 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 (bit.ly/2OAxKnP).
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? In unison, the near unanimous judgement among the economic experts—the government would be well advised to concentrate on expenditure expansion in NREGA rather than go for the tax cuts for corporates. Even a 50% expansion in NREGA would have meant only an additional Rs 25,000 crores in spending. 1% of GDP is Rs3 lakh crores, so the “alternate remedy” would have added one-twelfth of 1% of GDP. It is doubtful this would have helped the economy recover from 6% 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 titled “Tax Policy—Maximize, not Moralize” (bit.ly/373aaGN), we stated, “The only real growth option for Indian policy makers—cut (corporate) tax rates to internationally competitive levels. And, what that might be? Around 22 %”. The HLAG report for the ministry of commerce, which one of us had chaired, had also argued for a 22 % corporate tax rate (with exemptions), or preferably, an 18% tax rate without exemptions. The new government policy was 22%, with no exemptions, combined with a lower rate of 18% for new manufacturing firms. All in all, a giant leap in Indian policymaking.
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 lead to an increase in compliance, and/or an increase in private investment? It is too early to tell, but there are pointers. It is a subject worthy of examination even today, just five months after the tax cut. There is some hard data available, and it is contained in the data accompanying the Budget speech. The Budget contains up-to-date estimates of tax revenues (and other data relating to revenue, and expenditure). Since data are available for approximately ten 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%.
The Budget for FY21 estimates corporate tax collections (excluding surcharges and cess) in FY20 to be Rs5.28 lakh crore. As reference, note that the actual corporate tax collection figure for FY19 was a higher Rs5.8 lakh crore; and the ministry of finance itself had estimated the impact of the tax cut to be a revenue decline of Rs1.42 lakh crore.
Besides this estimate for FY20, we do have government-published estimates of tax collection in the first half of FY20 (April-September 2019). This estimate was Rs2.49 lakh crore, 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 FY20, tax collections for FY20 would have been approximately Rs5lakh crore.
Corporate tax data, as published by RBI, also show a large decline in tax provision by corporates. In 2018Q2 and 2018Q3, tax provision was Rs65,000 crore; in the same two quarters in 2019, tax provision had declined to Rs50,000 crore. Thus, the best RBI data-based estimate for corporate taxes in FY20 was a decline of 20% to 25% over the FY19 value, which is approximately Rs4.6 lakh crore.
If the reality is now a tax collection of Rs5.28 lakh crore (as per the revised estimates), that is an increase of Rs68,000 crore 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 Rs68,000 crore, or with an average tax rate of 22%, close to a 1% gain in GDP.
Only release of the actual tax figures for FY20 will settle the debate about whether the corporate tax cut led to increased corporate activity or an increase in tax compliance, or both. 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, i.e., 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%, y-o-y. The October-December y-o-y increase is a (relatively) hefty 7.8%. 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?
Bhalla is Executive Director, IMF & Bhasin is an independent economist. Views are personal