Daily Editorial Update – American economic policy’s impact on Indian business

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India and the United States have a positive economic relation that can be strengthened in the context of the policies of the new US administration. The Trump administration has made increasing economic growth its primary economic goal. Since the United States is the largest market for India’s exports, the increasing strength of the US economy will have a direct positive impact on India’s exports.

After a long and slow recovery from the economic downturn that began a decade ago, the American economy is now at full employment. The unemployment rate is just 4.7% and real wages are rising at an increasing rate. Household wealth has increased because of the rise in the real value of homes and the even faster rise of the stock market. Consumers are therefore in a good position to increase their spending on imports as well as on domestic products.

The Trump administration has a two-part strategy for stimulating stronger growth in the future. A key part is to reduce government regulations that discourage business activity, including regulations of labour markets and of financial institutions.

The primary pro-growth strategy is to reform the tax system to encourage business investment.

It is too soon to be confident about the success of the Trump administration in achieving its tax reform goals. Although the Republican party now controls not only the White House but also both houses of Congress, there are factions within the Republican party that make it difficult to agree on the details of legislation.

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But the basic outlines of the pro-growth tax legislation were developed in the House of Representatives and are largely favoured by the Trump administration.

The core of the corporate tax reform is to lower the tax rate on corporate profits from 35% – the highest rate among industrial countries – to approximately half that level.

The lower corporate tax rate will attract capital from noncorporate uses in housing and other activities that contribute less to overall GDP growth.

A second major part of the corporate tax reform is to shift the taxation of the profits of America’s foreign subsidiaries to what is known as the territorial system – the form of taxation used by all other industrial countries. Under current US law, the subsidiary of an American corporation that earns profits in a low tax foreign jurisdiction like Ireland pays the Irish corporate tax and is then free to invest the after tax profits anywhere in the world except the United States.

If the company brings those funds back to the United States, it must pay the full 35% US tax on the profits with a credit for the tax already paid. The result is to discourage a repatriation of profits to the United States.

Under the proposed territorial system, the company could bring those profits back to the United States with no additional tax. The territorial tax system will encourage American subsidiaries to return after tax profits to the United States, further increasing capital formation and growth. But a US territorial system also makes it more attractive for firms to invest abroad since they can repatriate the profits earned abroad. India should take advantage of these new rules to induce American firms to invest in Indian manufacturing.

The new Goods and Services Tax in India should also encourage American firms to invest in India since they now face a single tax throughout India.

Rising wages in China provides a further reason for American companies to shift production from China to India. To take full advantage of this, India needs to improve infrastructure and primary education, changes that take substantial time. But there are other policy changes that can be implemented more quickly to make India a more attractive destination for foreign investment. The most important of these is to reduce tariffs and other impediments to imports of machinery and of components that could be used in India by foreign firms.

India should therefore see the new Trump administration policies as providing a base for stronger growth in India.

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