Govt Considers Income Tax Rate Cut to Boost Demand and Private Investment

In an effort to address the problem of declining consumption, Indian government policymakers are leaning towards rationalizing the current income tax structure, particularly for lower income levels.

Two government officials, speaking with The Indian Express, suggested that tax rate reductions for lower earners may take priority over freebies or extensive welfare spending, given the focus on fiscal consolidation.

Officials believe that tax cuts could more effectively enhance disposable income, leading to increased consumption and stimulating economic activities.

Boosting consumption is viewed as essential for reviving demand, which is critical for restarting the investment cycle, especially in consumer-focused sectors. This could also lead to higher GST collections, an official noted.

“Tax rationalization can unlock consumption. Increased disposable income means greater consumption, more economic activity, and higher GST collections. This could result in more direct and indirect revenue collection and higher corporate tax revenue as businesses report increased income,” another official explained.

Discussions have highlighted that the current rise in marginal income tax rates is “too steep.” “In the new tax system, the first 5 percent tax slab starts at Rs 3 lakh. By the time income reaches Rs 15 lakh, the marginal tax rate jumps to 30 percent — a sixfold increase while income only increases five times,” the official said.

Revenue loss from tax cuts requires a dynamic analysis, officials noted. “A general equilibrium analysis is needed to assess the net effect since the tax cuts are expected to spur demand. Increased money in people’s hands would lead to better consumption and higher tax revenues. Even with some revenue loss, the net effect will likely be positive,” the official stated.

Tax simplification is also considered a better approach than extensive welfare spending, which may be prone to leakages. “Our deficit is not low. Benefits to the poor should not come at the cost of fiscal instability. Consumption should arise from economic activities generated through appropriate government schemes, not welfare spending. This can be achieved through tax cuts, especially for lower income levels,” another official said.

The Bharatiya Janata Party-led National Democratic Alliance (NDA) is expected to present the full Budget for the financial year 2024-25 by the third week of July.

Despite India posting an average GDP growth rate of over 7 percent in the past three years, challenges remain due to weak agricultural growth, low exports, and lackluster private investment amid declining consumption demand. Private investment has not picked up broadly, and subdued demand continues to concern the Indian industry.

Recent GDP data for the January-March quarter showed that Private Final Consumption Expenditure (PFCE), an indicator of consumption demand, dropped to 52.9 percent of GDP, the lowest level in the 2011-12 base year series. For the full financial year 2023-24, consumption expenditure grew by just 4 percent, the slowest rate in two decades excluding the pandemic year.

The government has been focusing on fiscal consolidation, aiming to reduce the fiscal deficit to 5.1 percent of GDP in 2024-25 and further below 4.5 percent by 2025-26. Finance Minister Nirmala Sitharaman had outlined this goal in her 2021-22 Budget speech, targeting improved tax compliance and increased receipts from asset monetization, including Public Sector Enterprises and land.

For the last financial year 2023-24, the fiscal deficit was curtailed to 5.6 percent of GDP, lower than the revised estimate of 5.8 percent, due to better-than-expected tax revenues and reduced subsidy payouts.