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Will the corporate tax cut widen the country’s fiscal deficit?

By Finserv MARKETS - Dec 25,2019
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Will the corporate tax cut widen the country’s fiscal deficit?

India Inc. is gung-ho about the prospects of a windfall since Finance Minister Nirmala Sitharaman slashed down the corporate tax to 25.17% on September 20, 2019 . But this concession also means that the government will take an annual revenue hit of Rs. 1.45 lakh crore.

According to a survey of economists, the corporate tax rate will further widen the fiscal deficit. They expect the fiscal deficit to increase to 3.9% – 4.1% of the GDP by the end of March 2020. Thus, it will overshoot the fiscal deficit target of 3.3% of the GDP for FY2019-20 by at least 70 basis points.

A fiscal deficit means that the government is spending more than its earnings. Though not a very negative thing as even the United States have been straddling with fiscal deficits since World War II, a balanced budgetary policy is a good thing for the overall health of the economy.

Contradictory viewpoints

A day after the corporate tax cut announcement by the Finance Minister, Niti Aayog Vice Chairman, Rajiv Kumar tried to allay fears by saying that the tax cuts will not increase the fiscal deficit as higher growth and increased tax collection will balance the shortfall.

However, just a few days ago RBI Governor Shaktikanta Das had stated that the government was in no position to stretch the fiscal deficit any further since GST, direct tax and indirect tax collection (read government earnings) was way below target for 2018-19.

The Niti Aayog VC is optimistic that direct and indirect revenues will grow post the tax cut. He also stated that the government will be able to collect an additional 1.05 lakh crore through disinvestments and additional Rs. 50,000 crore from RBI, which was not included in the Budget.

The not-so-good news

According to the Controller General of Accounts (CGA), the government saw a shortfall of Rs. 74,774 crore and Rs. 93,198 crore in direct and indirect taxes, respectively in FY 2018-19. The figures above are a reason for concern because taxes accounts for 85% of government revenue.

The effect of rising fiscal deficit is compounded in an emerging economy such as India because of dwindling household savings. Average household savings as a percentage of total savings was 10-12% during the early 2000s, today that rate has come down to just 7%.

In a time when both household savings and direct and indirect taxes collection are moving southwards, stretching the fiscal deficit can be risky. The finance minister may have taken a calculated risk but it’s a risk nonetheless and things can go either way. S&P Global, an international rating agency, has commented to the corporate tax cut as a “credit negative development.” That means S&P will immediately downgrade India’s credit rating if the stimulus doesn’t work or the fiscal deficit widens further by the end of FY 2019-20.

Will the corporate tax cut widen the country’s fiscal deficit?

No reduction in government spending

Usually, governments reduce spending to reduce the fiscal deficit gap rather than reducing its income, which the corporate tax cut has done. On the contrary, the finance minister has clearly stated that the government is not planning for spending cuts at this stage.

The corporate tax cut has effectively reduced the government’s annual revenue by Rs. 1.45 lakh crore. However, with the current economic slowdown, the government has no option but to take some drastic measures to boost growth, increase consumption and improve market sentiments.

Conclusion

The corporate tax cut announcement had a very positive impact on the equity markets and it witnessed the highest surge in a single day over a decade. However, experts are sceptical about this new measure by the finance minister. They feel that it only looks at boosting business growth while doing nothing to raise consumer demand and consumption which is a more serious problem at this stage. Moreover, the positive impact of the corporate tax rate cut will only be seen after 2-3 years, they say.

Though the intent is to clearly boost the flagging economy, the country’s widening fiscal deficit can be a serious source of concern if the corporate tax cut fails to spur growth and increase the government’s revenue. All experts opinion aside, when an individual lives beyond his means and falls in debt, it can ruin his financial condition. The same holds true for a nation; a rising fiscal deficit doesn’t augur well for a country’s economy.

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