Can Government Increase Demand By Cutting Income Tax?

Can Government Increase Demand By Cutting Income Tax?

Updated on 22 October, 2019

GS3 Economy
can-government-increase-demand-by-cutting-income-tax

Over the past few weeks, there has been a growing murmur that the government may resort to cutting income tax rates to provide more disposable income with taxpayers. Background:

  • While some have speculated that possible income tax cuts will be in accordance with the report on the expected Direct Tax Code
  • The contents of the report are not yet public but it has been submitted to the government and will rationalize existing income tax structure
  • Bibek Debroy, heads of PM’s Economic Advisory Council has said: “Now that corporate tax has come down, it is certain that government will sooner or later reduce the income tax rate also”.

Is an income tax cut justified?

  • The Indian economic growth has been continuously decelerating for the past 6 quarters. 
  • The next quarterly GDP data for July to September quarter is also expected to show a further slowdown. 
  • An income tax cut would provide more disposable income in the hands of taxpayers and the government’s hope would be that this extra money would be spent by taxpayers thus will boost to the economy.

What is the reason for the slowdown?

  • The key reason for the slowdown is the sharp decline in consumer demand
  • The sharp decline in consumer demand is a result of weaker wage growth, high unemployment, and uncertainty about economic prospects, at least in the near term.

What about exemptions?

  • It is expected that an income tax rate cut if undertaken, would also be accompanied by a doing away with existing exemptions
  • Much like what happened in the corporate tax cut where a lower tax rate applies provided all exemptions are given up a lower income tax rate will possibly rule out exemptions.

What are tax exemptions?

  • As a basic rule, a tax system with no or fewer exemptions is considered more efficient as it is easier to both comply with and administer.
  • As things stand, while calculating one’s tax liability, that is the total “taxable” income, an individual can claim exemptions if he or she has saved money in certain saving instruments, such as the Public Provident Fund (PPF).

What section of people will be affected by the income tax cut?

  • Most of the income tax collection comes from the super-rich
  • A lot of people file tax returns but they may not be paying taxes or paying very little.

What is the likely impact of the tax cuts?

  • A possible income tax cut-led stimulus a “double-edged sword”. They state such an exercise may have the following effects:
  • The government will likely face a revenue loss ranging from Rs 6,200 cr to 1,25,000 cr for the current financial year.
  • As a result, the government fiscal deficit is likely to slip by 2 to 37 basis points.
  • But for individuals, gains will range from 1-49% higher income across income ranges mentioned above
  • Most of the gains are likely to be on the lower-income bands.

Also read: Corporate Tax Rate Cuts: Was It Required? Corporate Tax Rate Cut


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