India's response to US tax rate cut
US has passed the bill to cut its corporate tax rate and IMF loves the move. The tax rate has been slashed from 35% to around 20%. That's a BIG cut which would make every organisation in the USA rethink its tax planning. The rethink has already begun at organisations like Apple, which reamined innovative in its tax planning all these years, and had stashed profits abroad to avoid taxes, and is now thinking of moving it back. Even domestic firms are looking at increased cashflows, e.g. Comcast as shown in figure below.
|Tax cut leads to higher cash flow to Comcast: Source Economist|
Before going further, let me sum up the changes envisaged in the corporate tax reform
a) The corporate tax rates in US is being brought down from 35% to around 20%
b) US is moving into territorial taxation system where the earnings abroad would be facing a one-time repatriation tax of around 15% on cash and and lesser on other assets. After this one time measure, US would continue with base erosion and avoidance tax (BEAT - similar to other base erosion and profit shifting rules prevalent elsewhere) and would ensure that a minimum of 10% tax is collected in case the multinational organisation based in US is not being taxed anywhere or is moving profits abroad. Exporting firms would get taxed at a lower rate, an aspect that might be challenged at WTO. The aspect of taxing 10% might hurt Indian IT companies operating in USA and trying to repatriate the profits back to India.
c) The investment in capital by any firm can be deducted upfront in full as expenses. This is indeed significant as only depreciation part was deducted as expenses all these years. An upfront full deduction should lead to a huge shot in investments, at least in the short run while the 35% tax lasts, and relatively slowly yet significantly later on.
The plan once implemented would leave a hole of around 1.5 trillion USD over years and moving the fiscal deficit from current approx. 3% to a future of 4% and it might not be very comfortable unless other tax collections pick up in future.
With this reform, the administration claims, there would be multiple benefits:
a) There would be less transfer pricing abuses through moving profits/offices abroad to save taxes.
b) US would get an investment boost as now full amount of investments would be expensed immediately in the balance sheet thus helping investing firms avoid taxes.
c) The tax cuts will trickle down to shareholders, workers (wages might go up), and consumers (cheaper products) in the medium run.
d) It would create more jobs in US due to higher investments domestically.
e) Multinationals would find US an attractive destination to invest.
f) Exports would pick up.
g) And if you believe President Trump, this would make America Great again - well almost.
It would just look like a wish list, had it not been sanitised by IMF's latest economic outlook which bumps up the GDP growth of US due to this reform. To quote IMF:
Overall, the policy changes are projected to add to growth through 2020, so that U.S. real GDP is 1.2 percent higher by 2020 than in a projection without the tax policy changes.
That makes me wonder if a Republican wrote the economic outlook this time.
Nevertheless, there is news about challenging some aspects of this reform at WTO.
There are also fears that if corporate tax rate is significantly lower than personal income tax rate, which would happen in this case, there would be perverse incentives to rich employees and high wage earners to become pseudo corporate entities in order to save taxes.
The decrease in US corporate tax rate would have international ramifications, and it won't be limited to financial world of lending and profit shifting. Significant investment decisions would be now reconsidered. There might also be a race to reduce corporate tax rates elsewhere. This brings us to India.
We have a corporate tax rate of 30%, which after inclusion of cesses/surcharges (our way of doing things) goes almost upto 35%. Corporate tax contributes between 60-65% of total direct taxes (rest being income tax) and direct taxes contribute almost 60% of total taxes collected. So the corporate tax is almost 36-39% of total taxes collected. This is a significant sum for a country where the tax to GDP ratio is less than 18% (for US it is around 26% and other developed countries hover between 30 to 45%). Therefore, any significant cutting of corporate tax is going to hurt us, especially during the times when we have tweaked the indirect tax collections under GST and are struggling to stabilise the indirect tax regime.
So what should India do.
First, do nothing but watch.
India has not been a tax haven anyway, and given the capital controls, we don't have any stake in firms moving in here for any kind of tax/profit saving measures. We are not Ireland in that sense and therefore the moving apple won't bite us. However, we need to watch out for funds investing into India through FII route.
Second, make India a good destination to invest, through inherent reasons than for taxation reasons. This in a way is already happening through tax reforms and other ease of doing business measures.
Three, take a cue from US on not worrying about fiscal deficits, and spend to build infrastructure in a massive way. This would hurt fiscal deficit numbers, but then, while the inflation is subdued and employment is down, this might just be the doctor's prescription to take away demonetisation and GST birthing woes.
Fourth, and most important, detax merchandise exports and incentivise the goods exporting firms in order to spur make in India and increase jobs in this sector, and I am not talking about indirect taxes here (we already have zero rating there). Corporates who export manufactured items, should be taxed at lower rate on their profits earned through exports. Yes, it would be challenged at multilateral forums, but then, if the US doesn't care, why should we?