Income tax cuts in Budget: A half-hearted recipe to fix India’s consumption woes

If media speculation is to be believed, income taxpayers could be in for some relief when finance minister Nirmala Sitharaman presents the Union Budget for 2024-25 in two weeks. There was none in the interim Budget in February—but the context has changed, courtesy of the ruling party's electoral disappointment and a windfall dividend transfer from the Reserve Bank of India (RBI), along with the growing anxiety over weak consumption.

India ended 2023-24 with an impressive 8.2% GDP growth, but finer details reveal stubborn challenges. Private consumption grew at half that rate (4%), and wages for rural workers are somewhat stagnant when adjusted for inflation. The consumption story looks pale despite the rosy growth, and could do with a fillip from tax cuts.

With a clear dip in popularity for the Narendra Modi-led Bharatiya Janata Party, especially in rural areas, it would be logical to put more money in the hands of the people to overcome inflation and boost spending. Income tax cuts seem like a quick fix, especially since the government has seen an increased tax base and is enjoying strong revenue from both income tax and goods and services tax (GST) collections.

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“When you're talking of tax incentives, it is for the salaried class, people who actually have money to spend on non-food items,” said Madan Sabnavis, chief economist at Bank of Baroda. “So, to my mind, giving a concession out here is definitely something worthwhile.”

However, income tax cuts alone may not solve the problem, especially for the poor.

Lean deal

In the assessment year 2022-23, the latest year with available granular data, India’s income tax base was nearly 92 million (including those who paid income tax or filed a return). 

Of these, 68.5 million were individuals who filed a return, half of whom (34.3 million) reported gross income less than ₹5 lakh in the preceding year, and another 36% (or 24.1 million) fell under the ₹5-10 lakh range. That makes individuals with gross income of less than ₹10 lakh per year the most dominant tax base for the government.

That’s the segment that could be targeted when the government plans any tweaks to tax rates with an eye on providing relief. This could mainly come through raising the tax exemption limit to help boost the consumption of this base, economists said.

Currently, the exemption—the provision of having no income tax liability—applies to a taxable income up to ₹2.5 lakh under the old tax regime and up to ₹3 lakh under the new tax regime. Rebates are also given for taxable incomes up to ₹5 lakh and ₹7 lakh, respectively. (Taxable income is what tax payable is calculated on by adjusting gross income for applicable exemptions.)

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The bigger problem, however, is that India’s income tax base as a share of its population remains tiny, and the benefit of the cuts will only reach a small section as opposed to the far more widespread rejuvenation of consumption that India needs, particularly in rural areas.

“Only around 4% of the Indian population pay direct taxes,” said Lekha Chakraborty, professor at National Institute of Public Finance and Policy (NIPFP). “So tax cuts to increase consumption and aggregate demand would have partial effects only. In case the government is focusing on an income tax cut, they should raise the exemption limit of the lowest tax slabs.”

Indirect route?

Given the low impact that income tax benefits will have, a better approach likely lies outside the realm of the Budget: reduce the burden of GST instead, since the indirect tax is levied on everyone. The GST regime, which recently completed seven years, has multiple tax slabs, with 45% of the 1,455 goods analysed by Mint attracting a hefty tax rate of 18%.

While the government has kept low rates for the most essential goods and food products, which are consumed by all sections of society, some other essential fast-moving consumer goods such as toothpaste, hair oil, shampoo, and packaged drinking water, among others, are still being taxed at either 12% or 18%. That’s possibly being a burden on a large section of Indians who otherwise may not be earning enough in the first place to be looking forward to any income tax sops.

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“In my view, it is indirect taxes that can transmit the impact much faster across the spectrum of the society, compared to income tax. I have been arguing for quite some time that relying heavily on GST to raise revenue may start having a negative impact on the GDP,” said N.R. Bhanumurthy, another professor at NIPFP. “Cutting GST rates will have a broad-based impact, particularly in consumption-led states.”

While GST cuts may be better suited to repair India’s consumption story, the GST Council, not the Budget, will need to address the issue. Last month, the Council exempted hostel stays and some railway services such as platform tickets from the GST levy and reduced rates on milk cans and solar cookers. But a lot more may be required in terms of rate cuts and reductions of tax slabs.

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