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Corporate tax cut: Hope for quick trickle-down effect

Will Corporate India share a slice of its windfall with customers, suppliers and employees?

, ET Bureau|
Updated: Sep 21, 2019, 06.10 AM IST
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For a government better known for its daring — and often audacious — political decisions, Friday’s announcements will go down as the most impressive gamble till now on the economic front: bold and long term, sudden yet tenable. It surprised financial markets, which were scrounging for a story and were beginning to believe that a regime, riding on a stunning political mandate, has chosen to disregard the slowdown that is putting off investors and crimping the ability of businesses.

The big questions now are: how soon, how wide will be the trickledown effect? Will Corporate India share a slice of its windfall with customers, suppliers and employees? Rarely, if ever, has New Delhi changed direct tax in the middle of a financial year. And when it did, it refrained from lowering tax on individual income — unless there’s another, though less likely, dose of surprise awaiting in the weeks before Diwali.

Acut in personal income tax (I-T) might have buoyed sagging consumer sentiment in an economy that revolves around the consumer story and is today hit by dwindling demand. For a government witnessing slow tax collections, reducing the tax on individuals is more tempting, as it costs less. But even as it leaves more money in the wallets of consumers, a cut in personal I-T is less enduring & can be reversed when times are good. Compared to this, a corporatetax cut signals a structural step.

It’s evident that Nirmala Sitharaman and her team of advisers are betting on steps that would create economic surplus and boost investment demand, rather than trigger a quick improvement in consumer confidence that they, probably, hope steps like the loan mela would take care of. In fact, the nature and potential of Sitharaman’s latest set of measures are such that they come across more as serious reform, rather than desperate sops thrown by an anxious government to battle job losses and falling growth.

As a medium-term measure, a lower tax rate puts Indian companies on a better footing to compete in the world market against their peers in China, Indonesia, South Korea and Malaysia. Indeed, as the next logical step, advocates of lower corporate I-T would now favour sparing companies of the dividend distribution tax and taxing the entire dividend in the hands of investors — a step that could make Indian companies distinctly more attractive to foreign portfolio managers as well as strategic investors.

But that is a medium-term story. How will the fiscal boost play out over the next few months? What is New Delhi hoping for? Probably higher dividend payment by companies, a softening in the price of goods and services, public sector companies making faster payments to vendors, and new investments by manufacturing companies, even if it means tax arbitrage under a new subsidiary.

Vocal, euphoric stock traders are not only thrilled by higher earnings forecast, particularly of larger companies, due to the tax cut, but are covering their shorts amid a belief that the measures could lead to a recovery cycle. If that sentiment prevails, it would help the FM to pull off some big-ticket disinvestments — money that will be badly needed with government borrowings expected to go up.

Till now, in countering the slowdown, RBI was batting on the front foot — with interest-rate cuts and liquidity injection through open market operations — while GoI, seemingly confident about the economy, was playing second fiddle. Will this change now? Will the monetary authority now go slow on rate reduction and the government go all out to revive growth?

Policymakers are staring at three big truths. The space for further fiscal easing and higher government spending is fast shrinking. Interest rates, as borne out by higher bond yields, may not dip as quickly as it was expected — a phenomenon that would make it tougher for companies to lower debts. And, no one really knows how long the tax bonanza would take to percolate.

Like SBI chairman Rajnish Kumar, who prays every morning for recovery of the bank’s bad loans, his boss Nirmala Sitharaman will be keeping her fingers crossed. She has put her cards on the table: it’s investment over consumption.

Views expressed by the author are his own.

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