Corporate tax cut fulfils BJP’s promise but won’t fix slowdown

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Published: September 30, 2019 12:59:55 AM

In the short run, the government must re-examine whether its revenue projections for GST make sense given the many effective cuts in the rates paid either due to consolidation of categories, which is an effective tax rate cut as well as direct cuts in tax rates.

Inflation needs to be controlled, but the issue is whether inflation is a monetary phenomenon or a supply-side problem, mainly in food items. Prudently used, deficits may be growth-enhancing.

I am not a friend of tax cuts. If you must be a Keynesian in your fiscal policy, it would be better to increase public spending to put purchasing power in the hands of a large part of the population, than to give a tax cut to businesses, which may or may not increase investment.

The deep cut in corporation tax does deliver on what Jaitley had promised. But, the record of corporation tax cuts as a stimulating device is mixed. Yes, there is a surge in equity prices for a short time. But, a stock market boom does not create wealth in a permanent way. Nor is wealth destroyed when stock prices fall. It
is just a redistribution among the stock-owners.

Corporation tax cuts do not boost investment in a sustained fashion. Businessmen advocate them because it makes them richer. Stock markets exchange existing stock of equity. A very small percentage of new investment is financed by IPOs, or new equity floatation by existing corporations. This is true, universally, of all stock markets.

There are reasons why we are experiencing the slowdown in growth rate. The credit markets have become dysfunctional. The nationalisation of the banking system, fifty years ago, worsened the cost of borrowing for all but a few favoured cronies. Attempts by Modi 1.0 to reform PSU banks were overdue, but they seem to have stalled. At the same time, the non-banking credit market had a breakdown with the collapse of IL&FS.

There needs to be a serious policy intervention in this respect. The IB code was welcome, but once again, debtors have found ways of delaying repayments. The principal reason is the fractured nature of the Judiciary. At the apex level, the Judiciary is efficient, though somewhat overstretched. But, nationally, it is understaffed. Its procedures encourage delays. There seem to be no incentives to speed up proceedings in courts. Someone needs to ask whether the reward system for lawyers can be reformed. There is a shamefully large backlog of undecided cases. The cost of credit is high, largely due to the cost of recovery of debts with a dysfunctional judicial system. We need to examine the economic costs of the judicial system. Its ills will not be cured by asking active or retired judges to examine the issue. We need economists to look at this economic problem as a matter of urgency. It is in such matters that the answer to the issue of growth slowdown is to be sought.

Fears have been expressed that the FM’s tax cuts will bust the deficit target. This deserves a short-run, and a long-run answer. In the short run, the government must re-examine whether its revenue projections for GST make sense given the many effective cuts in the rates paid either due to consolidation of categories, which is an effective tax rate cut as well as direct cuts in tax rates. Informal observations reveal that sellers invite the buyers to collude with them in evading tax by not insisting on a receipt. The jugaad economy is back in town.

But, the more important issue is to question the overwhelming importance given to deficit reduction. There is a global debate on fiscal constraint. During the years of Monetarism’s dominance, and prevalence of high inflation rates, the issue of fiscal discipline became urgent. But, across the world, though government debts are rising, bond yields are collapsing. There is a new fashion called Modern Monetary Theory, which takes the same view as early Keynesians. This view says that as the debts are denominated in the national currency, the government has the power to print as much currency as it wishes. The aim of the government should be full employment, and not balancing budgets.

The high inflation of the 1970’s and 1980’s brought the debt-income ratio in fashion as a target, and the idea that governments are driven by short-term political gains rather than prudence. Hence, central banks had to be independent guardians of the currency, and a medium-run macroeconomic strategy was essential, which bore down on deficits. That world has, happily, gone. Though fiscal orthodoxy is still prevalent in financial circles, the inflation threat having gone, governments may be free to spend as they please. The USA is an interesting example of this dual attitude. Politicians swear by fiscal probity, and warn against saddling future generations with debt. But, year after year, the US government debt rises, budgets have been balanced in a maximum of ten years in the last seventy-four since 1945, and most of those came before 1960. The USA has prospered in the meantime.

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India needs a debate on this question. Inflation needs to be controlled, but the issue is whether inflation is a monetary phenomenon or a supply-side problem, mainly in food items. Prudently used, deficits may be growth-enhancing. It would be a major change in economic policy, worth examining.

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