The Government of India is considering a cut in personal income tax rates. Comment on whether a tax cut can help.

With various economists, both in and outside the government, advocating for a cut in personal income tax to boost the economy. It’s time we seriously analyse whether a ‘personal income tax’ rate cut would be able to boost the economy or not?

The reason why the Union government, led by Finance Minister Nirmala Sitarama, is actively considering such a cut is because economic growth in India has been sliding continuously for some time now, from 8 per cent to 5 per cent to 4.5 per cent in the September quarter of 2019. 

With most of the factors like foreign exchange, exports, the price of oil etc remaining stable the main reason for this slowdown is the sharp decline in consumer demand in India which is being caused by weak wage growth (especially in the rural areas of the country), high unemployment figures, and uncertainty about future economic prospects of the country. The increased demand for MGNREGA, flagship government employment scheme especially in the rural areas, is a good indicator of the lack of economic opportunities in the country. 

Besides rural distress, demand for consumer goods is sharply down. The country’s thermal power plants are operating at a plant load factor, plant load factor is a measure of the output of a power plant compared to the maximum output it could produce, of below 50%, which means that more than half of India’s thermal capacity is not being utilized due to lack of demand for power.

In such an economic scenario, a rate cut in income tax will provide more disposable income in the hands of the people, which might encourage them to spend extra money on goods and services in order to boost the economy. 

Along with a rate cut, the government should also aim for removal of tax exemptions from the tax system making the system more efficient, and easy to handle for both the taxpayer and the government.

Any cut in income tax rates would lead to a loss of revenue for the government, which will impact the fiscal deficit further. The government needs to evaluate carefully whether it should give preference to fiscal discipline or fiscal stimulus. 

The success of such a cut will also depend on the people themselves, whether they will end up spending more money on goods and services or they will try to hold on to it. This will depend on several other factors, like how secure do the people feel about the future of the economy and the country and how quickly can the current sentiment about the economy improves.

Topics: GS-III: Economic Growth Development