The government’s political economy approach is clear
The tax cut reveals it is pro-capital; is focused on the formal sector; and is willing to deviate from the fiscal path
Last week, finance minister Nirmala Sitharaman announced the government’s biggest move to deal with the economic slowdown — a huge cut in corporate tax. The effective tax rate, including all surcharges, is now 25%, compared to 30% earlier. The reduction is even bigger for manufacturing firms that will be set up from next month, provided they start production by 2023. They will have to pay 15%. This, the government expects, will boost investment and economic activity. This is explained by the 2023 deadline for commencing production by new companies, which will pay only 15% in corporate tax. The year 2024 is when the government wants India’s GDP to reach $5trillion.
What does this reveal about the government’s political economy approach? One, it recognises that economic sentiment is the key to economic revival, and it needs more than political stability. Two, it is an indication that fiscal concerns have been given a go-by to promote growth. Three, this is in keeping with the government’s emphasis on the formal sector.
The “Gujarat Model of Development” was Prime Minister Narendra Modi’s biggest pitch in his bid for the 2014 elections. Vibrant Gujarat summits, where Modi invited industry leaders from both within and outside India to attract investments in the state, showcased this model. However, there is a crucial difference between courting capital as a chief minister and prime minister. Larger macro-environment is a given for the former; the latter can shape it, whichever way he wants. By slashing tax rates for businesses, Modi has demonstrated that he is willing to offer better deals to corporations. This is also a complete about-turn from the tax proposals given in the July budget, such as capital gains tax (already rolled back), and higher income taxes on the super-rich.themovehascomeafterconsultations with various segments, including industry. This shows that the government is sensitive to criticism from the big business.
Rough calculations suggest that the fiscal deficit is likely to increase by 70 basis points due to the tax cuts. Whether or not it is offset by a disproportionate increase in output, as has been claimed, remains to be seen. Fiscal profligacy spooks bond markets. This raises the cost of State borrowing even more. It can have a cascading effect on the fiscal deficit.
In theory, the economy has two autonomous drivers for fiscal and monetary policy interventions. The government controls the former, while the Reserve Bank of India (RBI) aided by an independent Monetary Policy Committee (MPC), has control of the latter. If the MPC were to feel that a tax cut and rise in fiscal deficit can lead to inflation, it could end, or worse, roll back the rate-cut cycle. This can neutralise the gainful effects of tax cuts. It remains to be seen whether this happens. The RBI governor, Shaktikanta Das, recently said there was little fiscal space to tackle the slowdown. Interestingly Arvind Panagariya, former deputy chairman of NITI Aayog, had recently argued that the MPC should consider revising the inflation target from 4% (plus minus two percentage points) to 5 to 6%. If the government were to push for such a decision, it would mean that it plans to dilute the recently bestowed autonomy on India’s monetary policy framework. Then, this is an