The corporate tax cuts are the Modi 2.0 government’s first structural reform

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Last month, in an interview to the Economic Times, Prime Minister Narendra Modi gave us a glimpse of his economic vision for the next five years. He said, ‘We are focused on improving our competitiveness through long-term reform measures.’ Driving the point home, he said his aim is investment-led growth and that tax cuts would be part of realising that objective. And best of all, he said, ‘We are willing to go as far as needed to ensure that ‘animal spirits’ are revived and our entire private sector is bullish.’ The corporate tax bonanza announced last Friday is a giant step towards fulfilling that promise.

True, it hasn’t taken long for the doubts to start creeping in. Several commentators said the slowdown in the economy is because of low private consumption demand and it’s far from certain that corporate tax cuts will boost consumption. Others have been quick to point out that the stimulus would have been more immediate and more equitable if it was given via cuts in personal income taxes, or through lower indirect taxes, or even by more government spending. Nor is it certain that companies would start investing, given spare capacity and tepid sales growth. And finally, questions are being asked about whether the bloated fiscal deficit will lead to inflation and higher interest rates, thereby offsetting part of the gains from the tax cuts.

There is much truth in all these views. It’s true that the government has taken a big risk. It is also possible that the tax cuts may not boost growth all that much, nor will its effects be felt anytime soon.

But it doesn’t really matter. The reduction in corporate taxes is a structural reform and if it provides a cyclical boost, that will be an added bonus. The tax cuts were absolutely essential. Simply put, if India is to have any chance at all of improving its competitiveness, both of its domestic corporate sector and as a destination for global capital, its corporate tax rates too have to be competitive. Indeed, a case could be made out that they should be lower than the average, given our well-known problems in infrastructure, land acquisition, high power costs, creaking contract enforcement system et al.

But is the timing of the announcement right, with the economy in a slowdown? What better time than now, when the all-important ‘animal spirits’ are down in the dumps and business is sorely in need of a pick-me-up? What better time than now, when inflation is tame and the impact of a higher fiscal deficit will therefore be muted? What better time than now, when a bit of inflation may be just what the doctor ordered? But more importantly, it’s the first genuine structural reform of the Modi 2.0 government.

Why should the government prefer a corporate tax cut to other kinds of stimulus? Because it has the long-term effect of making the Indian economy more competitive and of making India a more attractive destination for global firms seeking an alternative to China. But it also has another aim -- that of signalling the government will continue to pursue business-friendly policies. Faith in the government had faltered lately because, in spite of the prime minister’s assurances, the lack of follow-up measures had raised some niggling doubts. This was particularly true of stock market players, many of whom have been the ruling party’s biggest supporters. The tax cuts show that the government firmly believes it is the private corporate sector that is the engine of economic growth. And the government’s faith in trickle-down economics is very reassuring for the markets. Indeed, after the announcement last Friday, the government would be perfectly justified in turning around and telling the doubters: ‘Why are ye fearful, O ye of little faith?’

To be sure, a wary eye needs to be kept on the fiscal deficit. Experts have pointed out that total borrowings of the central and state governments together with that of public sector enterprises amount to 8-9 percent of GDP, eating up most of household financial savings and leaving little for private sector investment. And that’s before the latest giveaways.

Indeed, RBI governor Shaktikanta Das had said just a couple of days ago that the government has limited fiscal space to support growth. Of course, he might have changed his mind since then.

If the rating agencies don’t take too much umbrage at the tax giveaways and the repercussions on the fiscal deficit, the sovereign borrowing option could keep local interest rates in check, although that route is far from risk-free. And if necessary, the government could always go slow on the sops for the masses, without the corporate sector or the stock markets batting an eyelid.

The government’s emphasis on investment rather than consumption-led growth is encouraging. The long-term development of the economy is critically dependent on capital accumulation -- the East Asian miracle economies had very high investment levels during their growth spurts and India’s investment to GDP ratio has slipped woefully in the last few years. As Hyman Minsky, a much-neglected economist resurrected after his theories proved prophetic during the great financial crisis said, “it is investment that calls the tune”. For India, the only hope of finding decent jobs for the millions of young people fleeing unviable farms is higher investment in industry.

That said, there are many other requirements besides competitive tax rates to attract investment. Our competitors are not sitting idle -- there is no dearth of countries that are offering sops to multinational firms looking to shift their supply chains out of China. In this rat race, we have to keep raising our game. The next reform on the government’s radar should be repealing the troublesome land acquisition rules, which have become a fetter on investment growth.