A cut in income tax will naturally mean a loss of revenue for the government, which will impact the fiscal deficit.
Finance Minister Nirmala Sitharaman has said that the government is considering cutting tax rates to revive growth. "Tax rate cut is one among the many things we are thinking to boost growth," Sitharaman said at The Hindustan Times Leadership Summit on Saturday (December 7), according to a report in the Hindustan Times.
"Fiscal discipline is a law. I have to obey the act. I have to go by the glide path given to me from 2014 if not 2004. The learned economists are telling us that we have to pause the fiscal discipline and move towards more fiscal stimulus," Sitharaman said.
How can a tax cut help?
There is, indeed, a reason why the government might be considering cutting personal income tax rates. Economic growth has been sliding continuously—official figures show the GDP numbers of the past six quarters to be 8 per cent, 7 per cent, 6.6 per cent, 5.8 per cent, 5 per cent and 4.5 per cent.
The main reason for this slowdown is the sharp decline in consumer demand—which is the result of weak wage growth (especially in the rural areas), high unemployment, and uncertainty about future economic prospects. In many places, daily wagers have no work on average for perhaps half the month. MGNREGA data show demand for the UPA government's flagship rural employment scheme, is up.
Consumer goods sales are sharply down. Thermal plants are operating at a plant load factor of less than 50%, which means that more than half the thermal capacity is inoperative due to lack of demand for power.
In this situation, a cut in income tax will provide more disposable income in the hands of the people, and they might—or so the government would hope —spend this extra money to give a boost to the economy.
The Finance Minister also said that “from now on, the taxation regime will be simplified, exemption free", the Hindustan Times reported.
It has always been expected that an income tax rate cut —if it happens —will be accompanied by the removal of existing exemptions.
In general, a taxation system that has no or only a few exemptions is considered to be more efficient, and easier to handle for both the taxpayer and the government.
The question, though, is whether a tax cut will actually help in boosting the economy.
A cut in income tax will naturally mean a loss of revenue for the government, which will impact the fiscal deficit. The quantum of the revenue loss will depend on how deep the tax cut is.
And to what extent people actually end up spending the extra money in hand (as opposed to holding on to it), will probably depend on several other factors, including how secure they feel about the future, and how quickly the current sentiment about the economy improves.