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Will the Corporate Tax Cuts have a Trickle-Down Effect?

By Finserv MARKETS - Dec 19,2019
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Will the Corporate Tax Cuts Have a Trickle-Down Effect?

Last month, finance minister Nirmala Sitharaman announced that the tax rate for companies was brought down to 22% (effectively 25.17% with cess and surcharge). This is a significant cut from the old rate, which stood at 30% (effectively 34.94% with cess and surcharge). This decision will cost the government 1.45 lakh crore rupees a year.

Nevertheless, if the trickle-down effect comes into play as intended, these corporate tax cuts might just be able to salvage the country’s economy. When corporates pass on the benefit to the end user, it can boost consumption by improving the purchasing capacity of the consumers. With more money in hand, people can choose to spend it or to invest it in fixed deposits, mutual funds, or back in corporate shares.

The top-rated mutual funds available on Finserv MARKETS are a great option and come with professional fund managers who keep their finger on the pulse of the market. You can take your pick from equity, debt, or hybrid funds spanning across various sub-categories like small cap, multi cap, large cap, and even international.

Will the Corporate Tax Cuts Have a Trickle-Down Effect

Source: The Economist

On the other hand, if you choose to invest in fixed deposits, Finserv MARKETS offers some excellent options for this kind of investment as well. With flexible FD tenures ranging from 12 months to 5 years, competitive interest rates as high as 8.7%, and an additional 0.35% over the regular interest rate for senior citizens, this is clearly a place where money goes to grow.Corporate tax cuts have an impact on the supply side as well as the demand side. Here’s how.

The impact on the supply side

The recent reduction in corporate taxes will have a guaranteed positive impact on companies in India. Owing to corporate tax cuts, companies need to pay lower taxes. So, they’re left with a higher post-tax income, which can be invested in better infrastructure, in newer technologies, or even in conventional investment vehicles like fixed deposits to improve future revenues.

The impact on the demand side

Consumer demand in India has been consistently dropping in recent months. Despite the festive season, consumer confidence has fallen by 3.5 percentage points for the fourth month in a row. This goes to show that the real problem in the Indian economy isn’t that its expensive to do business, but that public consumption is plummeting. As a result, while supply continues to increase for the most part, demand is suffering.

To fuel economic revival, it’s essential to ensure that the benefits of corporate tax cuts eventually make their way to the end user. There are two ways in which demand can be restored. The first is by reducing expenditure. The second is by raising the inflow of money to the public.

Fortunately, companies can pass on the benefits of corporate tax cuts using both these strategies.

Here’s how it can be done.

  1. Option 1: Reduction in the prices of goods and services

With companies having greater PAT (profit after tax), the scenario is ripe for a reduction in the prices of goods and services. A reduction like this would kickstart public demand and boost consumption. Companies can bring price reduction into effect without suffering cutbacks in their profit margins, because the slash in tax rates will make up for the difference. Consumers, can then, in turn

How realistic is this strategy?

Theoretically, this may seem like the perfect move to encourage higher demand for goods and services. However, in practice, there’s a very real possibility that it may not be implemented. This is because when companies are left with higher post-tax profits, they generally prefer to keep those gains for themselves instead of passing it on to the public.

  1. Option 2: Increasing inflow of money to the public

Higher post-tax profits can also be passed on to the end user in the form of dividends or by hiking the salaries of corporate employees. Essentially a distribution of corporate profits, a dividend is a payment made by the company to its shareholders. With more money coming in as dividends or as higher salary, the end user will have more funds to spend. This essentially increases purchasing power and boosts demand.

How realistic is this strategy?

Payout of profits as dividends is more probable than price reduction, primarily because dividend payouts also encourage FDI in the companies that take this step. Since the corporates also stand to benefit from paying dividends, they have a higher incentive to adopt this strategy. However, dividends aren’t likely to boost consumption as much as price cuts would. This is because only a small segment of consumers, who have invested in companies and are shareholders therein, may actually stand to benefit from this move.

Hiking salary of corporate employees will also only positively impact a certain segment of consumers. Additionally, since this move has no immediate or extended benefits for the companies themselves, they’re unlikely to do this.

Will the Corporate Tax Cuts Have a Trickle-Down Effect

Source: blog.investyadnya.in

What happens if companies don’t pass on the benefits of corporate tax cuts?

Rating agency Crisil conducted a survey, which revealed that only 10% of companies intend to pass on the benefits of tax cuts to the consumer. If corporates fail to pass on the benefits of higher post-tax income to the consumers, the trickle-down effect doesn’t come into play. As a result, the long-awaited boost in public consumption will be delayed further. This means that people’s purchasing power might continue to drop, which will, in turn, hurt the business of the corporate sector because people will no longer buy goods and services unless absolutely necessary.

So, if companies retain their higher PAT and enjoy the benefits of this bonus revenue themselves, it will be a short-lived victory for corporates. Only by putting the money back into circulation can the country’s economy be revived. And the quickest way to bridge the widening gap between supply and demand is by increasing people’s purchasing power to boost consumption.

If this does come into play, you might find yourself with a little extra cash in hand. One way to utilize this is to spend it. However, if you’d rather save up or invest the money, it’s advisable to compare various options like fixed deposits, mutual funds, or retirement plans, so your future is secure. If you decide to invest in mutual funds on Finserv MARKETS, you would get to enjoy added benefits like tax exemptions on your investments, professional fund management, and zero brokerage fees.

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