Finance Minister Nirmala Sitharaman has recently reduced the income tax payable by large companies. The Corporate Tax has been reduced from about 30 per cent to 25 per cent, hoping companies will invest more lured by this concession. She is right that reduction in Corporate Tax will make available larger amounts of surplus to the Companies for investment.
But will this be made in India or abroad? Most companies today have global contacts, and even rich individuals are investing a large part of their incomes in foreign countries. Our capital is flowing out because they do not have confidence in our economy.
A farmer having surplus available for investment but is unsure if he can depend on the rains will be discouraged to invest in agriculture. But, if he was assured of irrigation, he may go to the extent of borrowing to invest in agriculture.
The decision to invest is dependent more on the expected profits and less on the availability of surplus. Similarly, when presented with a decision to invest in India or elsewhere, both Indian and multinational companies appear to be transferring part of their incomes abroad.
They are making outward foreign investment, inflating import bills and deflating export bills. Money is also going abroad in the purchase of gold and foreign goods like Swiss chocolates.
These trends indicate that companies may not invest in India due to the recent tax cuts. If one did not find it profitable to invest Rs 100 crores here, Rs 200 crores is just a greater risk .
The reduction in Corporate Tax may, therefore, have exactly the opposite of the intended result. The additional surplus made available to companies by lowering taxes can lead to an increase in outflow and push India into a deeper recession.
A better solution would have been to give incentives in purchase of land, GST and, maybe, direct subsidies to labour intensive sectors. This would generate employment and demand and, in turn, lead to more investment.
The FM has also made a steep reduction in Corporate Tax payable by companies making new investments in the manufacturing sector. This has been reduced to 15 per cent—much lower than the reduced rate of Corporate Tax of 25 per cent as described above. However, the this is unlikely to bring in investments.
The main reason being that the comparative advantage enjoyed by developing countries like India and Vietnam due to low wages has become irrelevant because of the use of robots and automatic machines. Earleir when the robots were used sparingly, multinational companies found it profitable to manufacture in India due to lower wages.
Consequently, the number of workers required has declined and manufacturing is returning to the developed countries. A factory has reportedly been established in China where there is not a single worker on the assembly line, and all the work of unloading raw material, handling the machines, packing and warehousing are done by robots.
It is more profitable to establish such factories in the developed countries with the easy availability of cutting-edge technologies. The FM should instead consider extending these incentives to the services sector which has immense growth potential.
The rates of Capital Gains Tax have been reduced. These are payable by Foreign Institutional Investors who invest monies in our share markets. The decision algorithm of the foreign investors involves not only the income tax rates but also the currency rates.
Let us say, an investor has invested one US Dollar/Rs 70 in India in 2018 and as its value increased to Rs 72 in 2019, a profit of Rs 2 was made. However, let us say, the value of the rupee declined in this period from Rs 70 to 74.
Having sold the share at Rs 72, the investor would only get a profit of 98 cents because the value of the rupee has declined in this period. The low growth rate of the Indian economy does not inspire confidence in the rupee.
The FM should have considered placing restrictions on outflow of our own capital instead of trying to attract foreign investors. The reduction of revenue due to these concessions is expected to be Rs 145 thousand crores per year.
In the present year, this loss can be made up by the transfer of about Rs 170 thousand crores from the RBI. This constitutes of annual profit of about Rs 120 thousand crores and a one-time transfer of reserves of about Rs 50 thousand crores.
The RBI may transfer the profits in the coming years as well but it is unlikely to make more transfers from the depleting reserves. The revenue foregone, therefore, will necessarily have to be made up by disinvestment of public sector or by increasing the tax burden on the common man. The consequence of the latter will have a disastrous result.
The purchasing power of the common man will reduce, there will be less demand in the market, and hence less investment. The FM should have considered taking steps to increase the purchasing power of the common man.
For example, highways could be made using more labour and less excavators and JCBs. The steps taken by the FM are good in intention but ignore the ground realities, which may lead to results opposite of those intended.
Bharat Jhunjhunwala is former professor of Economics at IIM Bangalore.