Corporate Tax Cuts: Assessing The Multiplier Impact On Economic Growth

A 10 percent reduction in corporate tax rate can result in 0.20-0.50 bps increase in GDP growth, says HDFC Bank’s Abheek Barua.

Finance Minister Nirmala Sitharaman. (Photographer: T. Narayan/Bloomberg)
Finance Minister Nirmala Sitharaman. (Photographer: T. Narayan/Bloomberg)

India’s decision to cut the corporate tax rate for domestic companies will have a positive impact on growth, said economists even though estimates of the extent of impact differ.

The tax cuts take the effective tax rate down from 34.93 percent to 25.17 percent, should corporations be willing to give up on prevailing exemptions. The finance ministry pegged the revenue loss as a result of the tax cuts at Rs 1.45 lakh crore.

One way to assess the growth impact of the corporate tax cuts is to look at the tax multiplier of growth. The measure is used to capture the impact of an increase or a reduction in tax on nominal output.

According to a research paper titled, Fiscal Multipliers For India, by Sukanya Bose and N R Bhanumurthy at the National Institute of Public Finance and Policy, published in September 2013, the corporate tax multiplier has been estimated at approximately -1.

The value of about -1 implies that a fall of about Rs 1 crore in corporate tax collections by the government could raise the GDP by about Rs 1 crore by the end of the year, where both are measured in nominal terms.

Though the size of the multiplier keeps changing every financial year, it is likely to be close to -1, said NR Bhanumurthy, one of the authors of the paper. The tax multiplier is always negative because of an inverse relationship between tax rates and economic growth, he explained.

The negative shock to corporate tax revenue would boost corporate income and facilitate private investments⁠—both domestic and foreign.
NR Bhanumurthy, Co-Author, Fiscal Multipliers For India (2013)

To be sure, the impact of the corporate tax multiplier also depends on the prevailing macroeconomic scenario, including constraints placed on the fiscal deficit by the Fiscal Responsibility And Budget Management Act. For instance, if the government were to cut expenditure to balance out the revenue loss from the corporate tax cuts, the impact would be not be as pronounced.

Some have argued that if the government wanted to give a fiscal boost to the economy, increased spending may have had wider impact.

Bhanumurthy’s research had shown that the multipliers of capital expenditure are the highest at about 2.5 times. As such, for every Rs 1 crore of capital expenditure, about Rs 2.45 crore would be added to nominal GDP. He, however, cautions that this may not hold true in the current environment.

The FRBM is basically an expenditure switching mechanism, explained Bhanumurthy. It focused on bringing down the fiscal deficit to 3 percent while bringing the revenue deficit to zero. In the current circumstances, the focus has shifted to compressing the fiscal deficit, he said. Revenue deficit targeting has been dropped and revenue expenditure has risen.

In these circumstances, capital expenditure may not have an expansionary impact and hence the rationale to instead reduce corporate tax rates.
NR Bhanumurthy, Co-Author, Fiscal Multipliers For India (2013)

Abheek Barua, chief economist at HDFC Bank Ltd., also expects the tax multipliers to play out favourably for the economy.

“We are revising our GDP growth forecast to 6.5 percent from 6.3 percent for 2019-20”, Barua said in a research note dated September 20, 2019. The corporate tax cut is likely to not only attract greater foreign investments but could also support some revival in the domestic capex cycle driven by greater corporate savings.

Our analysis show that a 10 percent reduction in corporate tax rate can result in 0.20-0.50 basis points increase in GDP growth.
Abheek Barua, Chief Economist, HDFC Bank

An uptick in consumption in the second half of fiscal 2019-20, greater transmission of interest rate cuts, accommodative monetary policy, and a normal monsoon are likely to support demand, he added.

Pranjul Bhandari, chief India economist at HSBC, also expects a 20 basis point boost to GDP growth in the current year. HSBC has raised its growth estimate from 5.7 percent to 5.9 percent in FY20 and from 6.4 percent to 6.5 percent in FY21.

The positive impact of lower corporate taxes may take some time to play out, though.

“Though we do not expect any near term impact on GDP growth from the current set of measures, the impact is likely to play out over the medium term as the tax multiplier kicks in," said Shubada Rao and Vivek Kumar, economists at Yes Bank Ltd., in a research note dated Sept. 23, 2019.

The boost to bottom-line for companies is likely to manifest in the form of (i) higher capex, (ii) higher payment to shareholders, and/or (iii) payment of past debt. This is likely to boost investments and consumption in the economy over the medium term.
Shubhada Rao, Chief Economist, Yes Bank