Tax cuts alone don't drive growth

The world economy is in a state of flux. So is the global supply chain. What economies/firms had expected was, with the progressive liberalisation of cross-border transactions, advances in production technology and information services, and improved transport logistics and services, firms would have experienced overall higher production and trade that would have led to better world output.

But the reality has been different. Truncated trade policies at the behest of US President Donald Trump, unavailability of easy credit loan, decreasing consumption demand and lack of liquidity in markets — all combined together across economies have contributed to the deceleration of India’s as well as the world’s GDP.

What was needed was perhaps boosters that would stimulate the economy in particular. The recent announcement of a substantial reduction in corporate tax can be counted as one such booster to ease the economy out of this morass, with two quarters of negative growth, provided it is well-accompanied by administrative and labour reforms.

Time is possibly opportune to encash upon the dynamics of the global supply chain as China is losing its steam. Competitive cost of China is fading out as China’s labour cost is going up, debts of small and medium enterprises are increasing, resulting in a debilitating effect on production as well as overall expenses in running the firms.

Lowering of consumption demand in China is also adding to the current woes of the economy. More importantly, the China-US trade war has jeopardised the situation further by disrupting the existing global supply chain arrangements. Many MNCs and companies of different hues are scouting to set up plants elsewhere in the emerging economies. India can find a prominent place on their list of possible destinations.

It is a part of the narrative already that domestic risk factors, trust in the market and financial system due to emergence of NPAs and a high-cost environment are rendering manufacturing relatively uncompetitive globally and therefore India is proving to be unattractive.

However, the substantial reduction in the corporate tax rate to 25.17% for large companies, announced recently can evoke positive feeling for trade and industry. What is important is that new manufacturing firms will be taxed at an even lower concessional rate of 17%, inclusive of all surcharge and cess. This will gear up the investment sentiment among the Indian businessmen and foreign investors.

Corporate tax being a direct tax, its reduction no doubt will garner less overall revenue for the government, but can also help consumption demand to go up. Newer products and services because of fresh investment will further entice the consumers to increase the consumption, and the economy will notice higher growth.

A major tax cut like this should also significantly alter the return on equity for new investment. Such policy should also put India at par with other emerging and competitive nations like Vietnam, Indonesia, Thailand and other ASEAN countries.

The tax cut for new manufacturing companies should also be seen in the context of other significant moves that can make this work — such as administrative and labour reforms. As a part of the global value chain, India’s informal sector is also greatly attached to this.

A large amount of contractual labour is employed in this sector. These contractual labourers are at the mercy of the owners and can be hired and fired at any time. This would disrupt the continuous participation of MSME sector as they would not be able to meet the supply of intermediate or final products in the global supply chain.

Child labour

Many of them involve child labour which is opposed in the WTO platform. Hence, administrative and trade reforms have to go along this corporate tax cut to make the entire investment process more holistic for India to benefit. Labour laws need to be liberalised to make contractual labour a means of continuous employment, and it needs to be articulated in international fora not as a trade barrier.

Administrative reforms over refund of the input tax credit, promised when the GST was slowly implemented, is still an area of concern for the industry. Manufacturers and exporters are not getting its full benefit. This needs to be processed in a time-bound manner. Once this is taken care of, credit-constrained export-oriented units will benefit from bank lending.

Thus, just reducing the corporate tax will not trigger increased investment demand and growth. How this financial capital can effectively participate in the production process is the issue. It is important to remove fears from the minds of domestic and foreign investors.

What needs to be done now is a comprehensive land law and labour reform that would facilitate trade and industry to aim for more economic activity. This has been a long demand of industry and can’t be postponed anymore.

Lastly, it is necessary to provide relief from regulatory risk to the investors, with access to international arbitration, advance tax rulings etc. Holistic reforms inclusive of corporate tax, administrative, land and labour reforms can boost the confidence of investors and drive the economy.