The government has issued an ordinance to reduce the corporate tax rate for domestic firms and new manufacturing units by 10 to 12 percentage points, effectively bringing India’s tax rates on par with its competing Asian peers. Key Details of the Announcement:

  • Finance ministry in its boldest step announced a significant cut in corporate tax rates, thus bringing down the effective tax rate (including various cesses and surcharges) on corporations from 35% to 25%.
  • Under the new tax regime, new companies that set up manufacturing facilities in India starting in October and commence production before the end of March 2023 will be taxed at an effective rate of 17%.

The Analysis:

  • Background: 

The Indian economy is going through a slowdown and the recent data shows, the economic activity in the various sectors has been worsening due to many factors. The latest measure is a step to revive the Indian economy, which until recently, was feted as a global growth engine. The primary objective of the measures is to turn India into an investors’ hub, greater economic management, restore investors' confidence and boost sentiments and demand. Changes in Tax Rate: 

  • The government has cut the corporate income tax rate from 30 percent to 22 percent for all companies. 
  • Newer companies, which are set up after October 1, 2019, will be subjected to an even lower effective tax rate of 17 percent.
  • The new corporate income tax rates in India will be lower than the USA (27 percent), Japan (30.62 percent), Brazil (34 percent), and Germany (30 percent) and is similar to China (25 percent) and Korea (25 percent).

Why the lowering of Corporate tax?

  • Tackling the Economic slowdown: This initiative is objected to tackle the slowdown in economic growth and stir up the economy to a certain level.
  • Skewed Economic Growth: According to the data collected from various sources, economic growth has dropped for five consecutive quarters to 5% in June itself.
  • Value of New Investment Project is low: The value of new investment projects announced during April to June 2019 was the lowest in 15 years. 
  • Strange behavior of the corporate houses to the law: The immediate reason for the tax cut inherent on the issue that various corporate houses have shown against the government policies on taxes.
  • Attracting more investors: The government believes that a lower tax rate will attract more investments into the economy and will help in reviving the domestic manufacturing sector which has seen lackluster growth.

How the decision will have an impact on the economy?

  • More Money to the hands of Private players: Experts believe that lowering the tax rate will leave more money to the hands of the private sector which can offer people more incentive to produce and contribute to the economy.
  • Widening the Economic Base: Corporate tax rate is the major determinant which defines the economic activity of the private sector. Thus, the present tax cut can help the wider economic growth.
  • Capital Inflow to the Economy: Corporate tax rate is also a major determinant of how investors allocate capital across various economies. Offering a lower tax rate will attract more investors to the economy that will further raise capital inflow into the economy.
  • Competitive Economy: The present cut in taxes can make India more competitive on the global stage by making Indian corporate tax rates comparable to that of rates in East Asia.

  • Greater Tax Collections: At the same time, the present tax cut can help boost tax collections and compensate for the loss of revenue.
  • Expansion of the Corporate Footnote: The benefit is immense as it might expand the corporate universe as new firms will now be taxed at 15 percent.
  • More Employment to the Economy: Attracting investors by lowering the tax rate will generate more employment and will help increase the purchasing power of the people.
  • Flip to the Government Programme: The move will also give thrust to government initiatives like Make in India, Startup India, etc. which had taken a hit in the past couple of years.
  • Why India has not initiated to lower the Personal income tax?
    • The consumer demand in India is very low and there is a major collapse in consumer demand. In this situation, it is more important to revive consumer demand. And the only possible way to revive consumer demand is a reduction in personal income tax rates.
But, the Indian government believes that many people in India do not pay income tax. More than 90 million individuals will file income tax returns in the current assessment year.
    • Earlier the government has pointed out that the number of tax filers for the assessment year 2018-19 (or financial year 2017-18) was 84.4 million.
    • In the scenario of income tax returns, around 57% of those who filed returns also paid income tax for assessment years 2017-18.
  • Statistics on Direct Tax Collection in India:
    • There is a constant growth in the direct tax-GDP ratio over the last three years, and the ratio of 5.98% in FY 2017-18 is the best DT-GDP ratio in the last ten years.
    • There is a growth of more than 80% in the number of returns filed in the last four financial years from 3.79 crores in FY 2013-14 (base year) to 6.85 crores in FY 2017-18.
    • The number of persons filing a return of income has also increased by about 65% during this period from 3.31 crore in FY 2013-14 to 5.44 crore in FY 2017-18.
  • Current Scenario: 
    • The net direct tax collections represent 64.7 percent of the total budget estimates of direct taxes for the financial year 2018-19 (Rs 11.50 lakh crore).
    • The gross collections for corporate tax are 14.8 percent while that for personal income tax is 17.2 percent.
    • After adjustment of refunds, the net growth in corporate tax collections is 16 percent and that in personal income tax collections is 14.8 percent.
  • Challenges Ahead:
    • Revenue loss for the government: The tax cut is expected to cause a yearly revenue loss of Rs. 1.45 lakh crores to the government.
    • Widening Fiscal Deficit: The initiative may cater to the fiscal cost to the economy as the move can increase the fiscal deficit on borrowing costs.
    • Government spending to be difficult: Government spending will be difficult due to the rising fiscal deficit so that the government cannot rely on a tax cut alone.
    • Need for Effective Monitoring Mechanism: Increasing Tax base but at the same time increasing tax refunds indicates the probable loopholes in the Tax regime. The government needs effective and efficient tracking and monitoring mechanism.
    • Bringing Everyone in the Base: There is still a large section of small industries which has been exempted from the tax regime. Thus, the government needs to reform the policy and try to bring everyone under the tax regime.
    • Proper Implementation of Policies: Despite constant efforts by the government regarding financial inclusion, there is a need for proper implementation of government schemes and policies.
  • What Needs to be done?
  • Greater public Spending: In spite of lowering the corporate tax, the government must focus on greater public spending to boost economic growth.
  • Supply-side Reforms: Tax cuts and supply-side reforms can help the economy recover from its slump and attract investors to raise capital.
  • Reducing the Entry Barriers: The government also needs to reduce entry barriers in the economy and make the marketplace more competitive.
  • Structural Reforms: Along with the tax cut initiative, the government also should enact policy for structural reforms in order to get rid of the economic slowdown.
  • Extension of the tax cut: Along with the corporate tax cut, the government also needs to extend the tax cuts to smaller businesses.
  • Boosting the investor's Confidence: The investor confidence is slightly low in the country due to the strict law. The government should make law investors friendly.

Way Forward: The current economic slowdown is due to the problem of insufficient demand which cannot be addressed just through tax cuts.  Many experts believe that lackluster demand faced by sectors like automobiles is merely a symptom of supply-side shocks such as the goods and services tax. The present tax cut simply as a concession to corporate houses rather than as a structural reform that could boost the wider economy. India is also going through a major collapse in consumer demand. Car sales, motorcycle sales, scooter sales have collapsed since the beginning of this year.  In this situation, it is more important to revive consumer demand. One possible way to do this could have been a reduction in personal income tax rates.  Further, cutting income tax rates is the quickest way possible to put money into the hands of people. Lower taxes would mean a higher income and that, in turn, could lead to increased consumer demand.  Also read: Corporate Tax Rate Cut India Inc. Hails Corporate Tax Reduction