Why Arvind Subramanian Is Warning Against A Corporate Tax Rate Cut

Arvind Subramanian feels govt should focus on completing tasks like resolving the twin balancesheet problem

Chief Economic Adviser Arvind Subramanian with Finance Minister Arun Jaitley, (Photograph: Anindito Mukherjee/Bloomberg)
Chief Economic Adviser Arvind Subramanian with Finance Minister Arun Jaitley, (Photograph: Anindito Mukherjee/Bloomberg)

Chief Economic Adviser Arvind Subramanian said he would not advise the government to keep announcing new measures, for instance a cut in the corporate tax rate, to speed up revival in investment and in the broader economy. Instead, policymakers should focus on finishing what they have already started.

Speaking to BloombergQuint a day after presenting the Economic Survey for 2017-18, Subramanian said that a number of measures have already been taken and taking them to their logical conclusion should be the prime agenda for the coming financial year. Among these is a step-up in public investment and resolution of the twin balance sheet problem plaguing some large corporations and banks.

When asked whether the government needs to announce a corporate tax cut to revive animal spirits in the economy, Subramanian said he would warn against the temptation of ‘doing more and more’. Finishing policy tasks already initiated could go a long way in reviving investment along with a supportive global economy.

I would caution against this [view] that you have done something and now you need to do something more. I think the policy agenda for this year would be ambitious and ample if government just completed all the things that it has started – support agriculture, stabilise GST, privatise Air India and complete the [stressed asset] resolution and [bank] recapitalisation effort.
Arvind Subramanian, Chief Economic Adviser, Government of India

The government had promised a reduction in corporate taxes early in its term but has so far only brought down the headline tax rate for small and medium enterprises from 30 percent to 25 percent. In its Economic Survey, the government had warned that a reversal in the investment slowdown may be gradual and may need urgent policy attention.

View On Fiscal Consolidation

Sharing his views on fiscal consolidation, Subramanian said that as an economist he does not believe that there is ‘sanctity’ to any specific number being set as a target for the fiscal deficit. He was referring to the bond market’s concerns that the government will not be able to meet it’s medium-term commitment towards bringing down the fiscal deficit to 3 percent of GDP even in the next fiscal year.

For 2017-18, the government is widely expected to miss its fiscal deficit target of 3.2 percent of GDP. This has lead to a sell-off in bonds, pushing up the benchmark 10-year bond yield to near 7.45 percent. Higher oil prices have only added to the bond market’s concerns. Comments in the Economic Survey, which suggested there may be a pause in fiscal consolidation in the current year, added to those concerns.

Subramanian said that the government remains committed to fiscal consolidation but this does not necessarily mean being fixated on a specific number.

Investing numbers with a an economist I can’t really justify that. This government has pursued fiscal consolidation steadily over the years because it believes in macro prudence, it believes in stability. That will continue. I don’t think one should be obsessed with any one number for debt or deficits. You can be prudent and undertake the path of consolidation without being wedded to any one number.
Arvind Subramanian, Chief Economic Adviser, Government of India

Watch full interview here:

Here are edited excerpts from the conversation.

Since you presented the Economic Survey, the 10-year bond yield has moved up another 15-basis point. The market is sending a very clear signal. a) It does not believe that the 3 percent fiscal target should be pushed out to another year. b) And there is not going to be enough demand and liquidity to support the supply of paper that could come in. Is that message being heard in Delhi?

You will find that out day after tomorrow, whether the message is being heard or not. The government is committed to fiscal consolidation and is well aware of the situation in the market. The secretary has clarified what the situation is for this year, and the government will be very responsible next year.

Your survey talked about modest consolidation. If that is the track we have to follow then perhaps we have to move away from committing to 3 percent and never meeting it, would you not say?

My view is, investing numbers with an economist I can’t justify these things. Governments consolidate, as this government has been doing steadily for the last 3-4 years because it believes in consolidation, micro prudence, and macro stability. That will continue. I don’t think one should obsess with only one number of debt or deficit. So, it is completely consistent to be absolutely prudent and responsible and undertake a path of steady consolidation without being necessarily wedded to any one number.

Going by the tax data put out by you, does it give the government courage to put forth more ambitious tax targets and therefore feel more comfortable with spending not just in this budget but the next few budgets?

In the medium term, beginning the next year one should expect greater revenue buoyancy both from direct and indirect taxes. And that will no doubt be factored in as the government thinks about its fiscal and macroeconomic stance. So, it is very encouraging, the strengths which we documented in the survey.

Is there any further data that suggests to us that how much more aggression in terms of tax targets would be justified by these additions to the tax base?

For GST this year, we have put out some numbers which show that GST has drawn 12 percent this year which reflects the buoyancy which is greater than historical standards. Going forward, this will improve over time. But, we need to wait a little bit more for the system to stabilise before we can be super confident about any precise estimate that we want to make. The finance minister said that we are in the process of stabilising it, but it will take a 1-2 quarters before we can be confident about where we stabilise it.

You made two points on growth, savings, and investment slowdown. That it should not be assumed that we will automatically move back to the levels of 2007. And other was the balance sheet nature of the investment slowdown means that the rebound could be slow. Do both indicate that India’s potential growth rate and rebound in growth that has been anticipated will stop at 7-7.5 percent rather than move up above 8 percent?

For the coming year, we are seeing 7-7.5 percent. The early signs are showing that private investments have turned the corner. If that can continue on the back of some important policy reforms like the resolutions and recapitalisation, also the world economy is doing well, so a combination of the actions on the twin balance sheets, a pick-up in world demand means that investment would come back, and we could start edging our way back to 8 or 8+ percent. Of course we also have to factor in what happens to the oil prices and possible challenges on the downside from oil prices. All of these factors will determine how quickly we can get to 8 percent.

Whatis your own assessment of potential growth number?

Calculations of potential are very tricky. These are very sensitive calculations. You will have to make assumptions about what you think the total factor productivity will be, what participation rates will be. My sense is, India’s potential, under reasonable assumptions, is somewhere around 8 percent plus. The more we get investment up, the higher the potential can be. Remember, we still have a lot of excess capacity. So, if growth reaches 7.5-8 percent, then I am not sure that will start leading to high inflation necessarily. So, potential output calculations are important but there is too much uncertainty around those estimates for us to be confident about saying that at some level inflation will start picking up.

Do you think a tax rate cut for corporations is what it will take to revive animal spirits if it is going to take a too long period of time otherwise for a natural process of things to restore order?

One of the most important determinants of weak investments in the past has been the twin balance sheet challenges. With resolution and recapitalisation, those are major policy initiatives aimed at reversing that investment decline. I think I would caution against the need to do more. The policy agenda for this year would be ambitious and ample if the government just completed all the things which it started like support agriculture or stabilise the GST, privatise Air India and complete the resolution efforts.  I am warning against the kind of temptation that says you need to do more and more. There is a lot which is being done, finishing them will bring back the animal spirits along with the cooperative world economy.

You talked about the privatisation of banking as opposed to privatisation of individual banks. Which means greater private participation in the banking sector, is that what you are hinting at?

In my view, reforms need to encompass both kind of shrinking banks that are fundamentally unviable over time, gradually. Maybe different marketing niches for different banks. But fundamentally unviable ones need to be shunned.

What I mean by greater private sector participation is also for good banks. One of the things which we have realised, from the experience of last 5-10 years of infrastructure boom which is an era of stigmatised capitalism, I think the public to private lending has proven very toxic. Going forward, if we don’t want this experience to repeat itself, then maybe there could be less public ownership because you will get less public to private lending.

I do think that some roadmap for greater private sector participation would help and it has to be done at an appropriate time. But that should not to be ruled out going forward.

Can you explain the less public to private lending aspect?

During the period of infrastructure surge in the mid-2000s, we had a lot of public-sector banks lending to private sector companies. Now when those loans turned sour, and we found ourselves with this twin balance sheet challenges, we found that it was very difficult to exit from that because of this zeitgeist of stigmatised capitalism. Any attempt to get out of this is open to the charge that you are letting the promoter off the hook. If we don’t want that experience to repeat itself, then we need to have less public to private lending. Going forward, the funding needs should be met by a variety of other sources but also more participation of the private sector in the banking system itself.

Is there a message in terms of the role that equity markets are playing in the larger economy and whether something needs to change that role?

We know from the history of financial markets and asset prices that the higher they go and more they are with the historical trends, the more likely that you will get corrections and mean reversion. So, it is a call for greater vigilance because if some disruptive corrections where to happen then that could have cause for the economy and we have to guard against it. It’s a call for vigilance.

Is it a precursor or a warning that LTCG tax might be something that you are in favor of when it comes to equities?

I have no views on LTCG. It is just the analysis of asset valuations and how they are different from what they are elsewhere and what itis that we should be watchful about. We believe that government should never second guess market or market valuations because nobody knows what the true valuation is. But we know from the lessons of history that the higher they go the more likely mean reversion happens and we have to make sure that we guard against any kind of disruptive corrections.

You didn’t venture into the controversy of job creation. But you put a higher number on formal non-farm payrolls. What is the message?

It’s a stock calculation. Because we have access to GST and EPFO data, it is just very novel, surprising and interesting about the Indian economy that the level of formal employment is much greater than we believed. It is a stock calculation and not a calculation on how many jobs very created in 2017-18 or 2016-17.