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With all the hype around the tax rate reduction now having died down, it is worthwhile to explore if there is any tangible benefit from the announcements. 1/n
An FM and government that have repeatedly refused to acknowledge any negatives and commit to a fiscal deficit, suddenly openly talking about a 1.4 lakh cr revenue foregone can only mean one thing - they have finally woken up from their dreams on meeting fiscal deficit targets 2/n
Having set unrealistic expectations of GDP (high denominator) and high tax growth (low numerator) to justify projected fiscal deficit targets. 3/n
Problem may be tax buoyancy est, which is seen as a multiplier of GDP, though it is likely to be a kick in function kicking in only at elevated levels of GDP; since most correlations have been run during period when India has never had negative growth, correlation may be suspect
With fiscal deficits estimates having become too tough to spin by even the consultants in the Niti Aayog, they are now forced to find excuses for the slippage in targets and have sought to take refuge in the notional loss of 1.4 lakh cr based on a ‘structural tax reform’. 4/n
It is very unlikely that the tax revenue foregone because of the tax cuts will be more than a 25-40k crores (based on back of envelope calculations) and the remaining shortfall is likely because of their mismanagement of the economy, which now conveniently gets fudged. 5/n
Also, having now set expectations of higher fiscal deficit on account of ‘structural tax reforms’, the government can spend freely to the extent of the actual loss being lesser than 1.4 lakh cr, if by any chance that happens. 6/n
The government has already tried every trick outside the book - 1) Amending the terms of reference of the 15th finance commission for allocation for defence and internal security before devolution to states, 2) Increased Surcharges and cess which accrue solely to the centre, 7/n
and 3) Convert J&K to an Union Territory and thereby, absorb their share of revenues into the central pool - and therefore is now left with fudging outcomes and measurements. 8/n
I distinctly remember the FM mentioning in the budget that with the 25% tax rate being extended to companies upto 400 cr, almost 98% of companies by number have been covered under the peak tax rate of 25% 9/n
Which means that very few companies actually are currently under higher marginal tax rates (though it is also true that these companies contribute a disproportionate portion of the profits and therefore, taxes) 10/n
Given that effective tax rates for India Inc have averaged around 26-28% historically, the marginal benefit for these firms is about 1-3% tax rate or in terms of profits, the tax cuts result in an increase profit by 1.5%-4%, which is of very little benefit in the short term 11/n
In terms of Free Cashflow or Net cash Accruals, the relative increase in cash available as a result of the tax cuts could actually be much lower. 12/n
The industry most likely to benefit from this will be financial services, which has traditionally paid high marginal tax rates. 13/n
The banks are likely to use the additional tax savings to either bolster capital (eliminating further need for government infusion), or pay dividends (boosting government coffers) or buy Gsecs and monetise government debt, so little is expected to make its way as credit. 14/n
There is also the devil in the details on the incentives - the incentives take various forms and shapes including tax holidays, industry specific incentives and sometimes even unit specific incentives - it is not yet clear if this includes state or regional level incentives 15/n
Arbitrage between current tax (net of incentives) and proposed tax (excluding incentives) is a very involved exercise, particularly for the target audience of large, complex companies, which is also going to raise more uncertainty in the minds of companies on tax extortion. 16/n
Hence, companies are unlikely to start spending or passing on the bonus and the only people expected to make a windfall are the Big4, consultants & law firms. 17/n
If the government really wanted to spur the economy in the short term, it should have rather focused on simplifying personal taxes and reducing effective rates. If the intent was to incentivise foreign investors, they would have been better served by eliminating DDT and WHT. 18/n
Of course, the decision is not without long term positives - having publicly committed to a lowering of marginal tax rates through an ordinance rather than as intent in Jaitely’s first budget, the government is unlikely to backtrack 19/n
Further, proposal for incentive free tax rate may finally make the Direct Tax Code a reality in the form in was originally envisaged, which was diluted by Pranab Mukherjee. Of course, given this government’s track record on surcharges and cess..... 19/n
