India's Budget Squeeze May Put Corporate Tax Cuts On Hold

In his last full budget before 2019 elections, Modi is facing a revenue squeeze that may make it difficult to deliver on a promise to lower the basic corporate tax rate over time to 25 per cent from 30 per cent. It’s a catch-22 situation for the premier, who is also trying to lure foreign investors at a time when the US, UK and other countries are lowering business taxes.

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Here’s a look at Modi’s challenge ahead of the government’s budget on Thursday.

Why Cut?

Modi pledged in 2015 to bring down corporate taxes over four years, but businesses are still waiting for a roadmap on how that will happen. It’s part of his mission to improve India’s investment climate: he is also reducing red-tape, spurring the liquidation of assets to speed-up the recovery of bad loans, and introduced GST last year to cut down business costs. India is ranked 119 out of 190 countries when it comes to ease of paying taxes, according to the World Bank’s Doing Business index.

While those reforms have helped India win a credit rating upgrade and record foreign direct inflows last year, Modi needs to keep investment going to help support an economy that’s set to expand at its slowest pace in four years.

Tax competition around the world is heating up. The US lowered corporate taxes by 14 percentage points to 21 per cent, with companies like Apple, Walmart Stores and JPMorgan Chase announcing plans to raise investment, hiring or wages.

“The US has made corporate tax rates competitive and India needs to respond,” said Jayesh Sanghvi, a tax partner at EY in Hyderabad. If it doesn’t, companies will examine arbitrage opportunities given the 10-15 percentage point difference, he said.

After reducing the rate last year to 25 per cent for small companies with a turnover of up to Rs 50 crore, businesses are expecting Finance Minister Arun Jaitley to move again this week. Half of the 120 professionals surveyed by Deloitte expect the rate to be cut to 25 per cent for all companies. Rakesh Nangia, head of tax advisory firm Nangia & Co., warned of a “flight of capital” if tax rates aren’t reduced.

Can India afford it?

Modi is in a fiscal bind. Revenue collection remains under pressure following the disruptive roll-out of GST, and with an eye on next year’s election, his spending priorities may turn to the distressed rural sector, putting pressure on the budget deficit.

The government signaled on Monday it may slow the pace of fiscal consolidation after pledging to narrow the budget gap to 3 per cent of gross domestic product in the year beginning April 1 from an estimated 3.2 per cent this year. Chief Economic Adviser Arvind Subramanian told lawmakers that setting “overly ambitious targets” may undermine the credibility of fiscal policy.

Abhishek Gupta, a Mumbai-based analyst with Bloomberg Economics, expects the budget deficit to come in at 3.4 per cent of GDP this year. The median estimate in a Bloomberg survey of 18 economists is for 3.5 per cent this year and 3.2 per cent next year.

Political considerations may also prevent Modi from reducing corporate taxes now, said Shailesh Kumar, a senior analyst at Eurasia Group in Washington.

“In addition to concerns that a reduction will further widen the deficit, a move by Modi to cut corporate rates ahead of next year’s election would expose him to opposition criticism that he is a crony capitalist who only wants to help friends in the business sector,” he said.

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