Corporate tax concessions and the stimulus

Corporate India, or atleast major parts of it, appears to think that fiscal stimulus equals tax cuts. Accordingly, the build up to the budget saw very loud campaigning for lower corporate taxes, lowering of indirect taxes and tax concessions to exporters. In fact, by now, as evidenced from the previous two rounds of fiscal stimulus, the government too appear to have been forced into this belief.

I have already blogged here as to why such stimulus spending is more likely to end up as corporate welfare than any meaningful stimulus on the aggregate demand. This blog is no fan of lower direct taxes in India and has written extensively here, here, and here. The effects of lowering indirect taxes (they rarely end up getting passed on to the consumers) have been discussed here, here, and here. I have also discussed earlier the relative merits and demerits of tax cuts and government spending as fiscal stimulus alternatives and why the latter delivers the greater bang for the buck. This would be all the more so in the more structurally distorted developing economies like India.

As the budget figures indicate, the effective tax rate of the corporate sector for 2008-09 was 22.24%, substantially lower than the statutory rate of 33.99%, translating into a total revenues foregone from corporate tax payers of Rs. 68,914 Cr (or 17% of the fiscal deficit).



And of them too, ITES and BPO service providers and software development agencies had a tax liability of just 15% and 12% respectively. In fact, as the graphic below indicates, these businesses at the vanguard of the knowledge based business sector, used to annual revenue and profit growth rates of 25-35%, are unable to come to grips with the reality that such growth is unsustainable and lower rates are the inevitable long-term consequence of any maturing sector. Further, they must realize their overwhelming dependence on the world economy and the resultant vulnerability to a global business cycle and then need to adjust such volatility. Their cry for government stimulus echoes the similar calls of politicians to control the prices of global commodities like petrol and diesel.

The intense lobbying for extending the ten year tax-holiday for IT companies under the Software Technology Parks of India (STPI) scheme, which originally ended in March 2009 and was extended for a year till March 2010 in last years budget, can only be explained as a reflection of the dependency syndrome that afflicts all industry, including these knowledge based ones, in India. The jubiliation at its extension for one more year till March 2011 and abolition of fringe benefit tax and the dismay at the hike in Minimum Alternate Tax only indicates an industry unsure of itself.

In any case, given the need to indulge in fiscal expansion and the limited fiscal space available, exacerbated by the weak growth in corporate tax collections, the government has few options on the tax front. Tax give aways and other revenue lowering policies are certainly not advisable or appropriate at such times.

Update 1
It now emerges that India Inc's 51.4% increase in net profits in the second quarter of 2009-10 may have been boosted by the reduction in excise duties as part of the stimulus plans. Companies have preferred to keep the savings rather than pass it on to customers.