Union Finance Minister Nirmala Sitharaman has got it all wrong

It is not every day that the Union Finance Minister decides to forgo ₹1.45 lakh crore in revenue but for Nirmala Sitharaman, desperate times call for desperate measures. There is only one minor problem. Sitharaman has bandaged the other foot.

It is the wrong medicine at the wrong time and it is going to have serious consequences in the short term. In the long term, all of us would be dead anyways. This is another missed opportunity for the government and it could have used the money to cut GST on automobiles, biscuits, etc. and other indirect taxes and given consumer demand a sold boost.

The government has decided to cut corporate taxes but not provide any relief to the average consumer by cutting GST on the aforementioned sectors and indirect taxes. A ₹1.45 crore tax cut in indirect taxes would meant an uptick in consumption. It would have allowed a little bit of breathing space to the consumer to go out and spend a little more during the festive season which could have helped in reviving consumption. The government, however, decided to provide relief to corporates on income which they are not likely to earn.

To be fair to the Union Finance Minister, the move to bring new manufacturing companies at 15 percent tax rate is one of the best things that could have been done under the circumstances, but the question is if the move has come too late. Would it help India attract manufacturing investments that are moving out of China to Vietnam and other countries?

First, let’s look at the move to cut corporate taxes. The government’s move has taken a long time to come and this was one of the first few announcements made by former Union Finance Minister Arun Jaitley. The tax collections were looking good and the government had momentum on its side. Five years later, the government does not have the fiscal space, consumption is declining and there is little hope of an immediate revival. To put it straight, this is no time for trickle down economics.

Like all right leaning economists (and policy makers), you grow up believing that the large corporates run the world, a tax break for them would lead to greater investments which would create new jobs that would kick-start the virtuous cycle of growth. There is a strong flip side to it. None of this happens if consumer demand is low, like it is now.

So how will the tax cut play out in the next few months?

The government’s move to cut taxes at the top means ₹1.45 lakh crore off the table. If you decide to abandon one source of income for your family, it either means you would have to cut down expenses, borrow money to continue with your expenditure or sell family holdings to raise money. Borrowing money is a good idea if you want to set up a new business but only adds to your financial mess if you are using borrowed money to meet household expenses.

In simple terms, the government would either have to cut down expenses, borrow or disinvest to maintain current levels of spending. The government would probably have to do all three to stay afloat this year and perhaps revisit the numbers next year when she (hopefully) presents the Budget.

A section of economists believe, not without reason, that the government had made a virtue of a bad situation because a shortfall was expected in corporate tax collections and the present rate of taxation is more realistic, considering the overall state of the economy. This is reflected in CMIE data for companies which states that corporate incomes were rising at less than 5 percent and the net profits of non-financial companies were declining by almost 10 percent in the June quarter.

This makes it clear that the private sector is in poor state and it would not have been in a position to meet the hefty revenue collection targets. With direct tax collections growing at 4-5 percent in the first quarter, the government would have needed a 25 percent plus growth in revenue collections to meet its direct tax collection targets. That was unlikely to happen, considering the current state of the economy.

The government looks to have abandoned its pursuit of a 3.3 percent fiscal deficit target and estimates suggests that fiscal deficit would be in the range of 3.7 percent to 4 percent of the GDP. In addition to this, there would be massive off-the-books borrowing, pushing the real deficit to almost 5-6 percent range. This would mean that the government borrowings are going to be a cause of concern for those watching the economy.

The markets reacted positively to the rate cut but that was only along expected lines to an early Diwali present. As we go deeper into the fiscal year, the enormity of the mess would become clearer to everyone. The future would depend on GST collections and what kind of spending cuts we can expect in welfare schemes, including the PM Kisan scheme which is struggling to meet its disbursement targets.

Only time will tell if the move to cut corporate taxes was a wise one or another misadventure which pushed the economy into deeper distress. We hope it turns out well but something tells us that the Union Finance Minister turned right when a slight left turn would have been more appropriate. She could have blamed her predecessors for the economy she had inherited but, now, she would only have herself to blame.