Tax Cuts or Government Spending: What Really Drives Growth in India’s Economy?

Few ideas in economics have travelled as far — or as controversially — as the Laffer Curve. Whether or not economist Arthur Laffer actually sketched it on a café napkin, the idea that lower taxes can spur growth and eventually raise tax revenues shaped decades of supply-side policy, most famously under Ronald Reagan. In India today, echoes of that thinking can be seen in recent income tax relief and GST rate rationalisation. But a closer look at how households and firms behave suggests that tax cuts alone may not deliver the growth dividend policymakers hope for — especially in an economy grappling with uneven demand and job creation.

The logic behind tax cuts and demand revival

In its broadest interpretation, the Laffer argument is not just about incentives to work, but about spending power. Lower taxes increase disposable income, which can boost consumption, lift growth, and indirectly raise tax collections.

This logic underpins two recent policy moves. Income tax relief is expected to release around ₹1 lakh crore into household hands, while GST rate rationalisation has resulted in a revenue foregone of about ₹48,000 crore. The intent is clear: raise disposable income, stimulate demand — especially during the festive season — and support growth.

Do income-side measures really translate into spending?

The effectiveness of tax cuts depends critically on who receives the benefit. Higher-income households are less likely to spend incremental income; a larger share tends to be saved or invested in financial assets. For them, consumption is rarely constrained by prices or taxes.

By contrast, middle- and lower-income households are far more sensitive to price changes. GST reductions on consumer goods can meaningfully alter purchasing decisions in these segments. Even so, many of these purchases — automobiles or durables — are infrequent. The result is often a temporary bunching of demand over a quarter or two, followed by a return to trend.

Sustained consumption growth requires a steady inflow of new consumers, which ultimately depends on job creation — not just tax relief.

Why expenditure policies show stronger results

India’s recent experience suggests that direct government expenditure has had a clearer and more durable impact on consumption. The free foodgrain programme covering nearly 800 million people has fundamentally altered spending patterns at the bottom of the income pyramid. When basic food needs are met, households redirect money toward discretionary consumption.

This shift is visible in household consumption surveys showing lower food expenditure shares and higher spending on non-food items. Crucially, this is not because people are worse off, but because income previously tied up in survival has been freed.

Cash transfers and targeted schemes as demand engines

Several government schemes function as direct demand boosters. PM-Kisan transfers of ₹6,000 annually to farmers, women-centric state schemes providing ₹1,000–1,500 per month, and programmes like MGNREGA all channel money toward households with high propensities to consume.

In-kind transfers — sewing machines, bicycles, laptops — also stimulate production directly, supporting manufacturing and adding to GDP. Unlike tax cuts, these measures are tightly targeted and their impact on spending is more predictable.

Infrastructure spending and the multiplier effect

Among all expenditure tools, public capital expenditure stands out as the most powerful. Large infrastructure outlays create strong backward linkages with industries such as steel, cement and construction, while also laying the foundation for long-term productivity gains.

This blend of immediate demand stimulus and future growth potential makes capex a cornerstone of development-oriented fiscal policy — something tax cuts alone cannot replicate.

Lessons from past tax experiments

India’s 2019 corporate tax cut offers a cautionary example. The expectation was that lower tax rates would trigger a surge in private investment. That did not happen. Firms invest when capacity utilisation is high and demand is strong — not simply because taxes are lower. In the absence of demand, tax savings were largely retained rather than reinvested.

What the balance of evidence suggests

From a policy perspective, working on both fronts — taxation and expenditure — is sensible. But the evidence tilts in favour of expenditure as the more reliable growth lever. Spending programmes are direct, targeted, and their beneficiaries are more likely to consume. Tax cuts, by contrast, rely on assumptions about spending behaviour that vary sharply across income groups and may not hold consistently over time.

Why targeting matters more than optics

Ultimately, the choice is not ideological but practical. Expenditure policies allow the government to identify beneficiaries, predict outcomes, and align spending with development goals. Tax cuts offer visibility and short-term relief, but their growth impact is uncertain unless accompanied by job creation and sustained demand.

In an economy where consumption revival remains fragile, the lesson is clear: growth is driven less by what the government forgoes in taxes, and more by where — and on whom — it chooses to spend.