Budget 2020: Income tax cuts aren’t the solution to India’s economic woes

Overworked and underpaid.
Overworked and underpaid.
Image: REUTERS/Anindito Mukherjee
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As Nirmala Sitharaman prepares to present Budget 2020, India’s taxpayers are high on hope that the finance minister will announce personal income tax sops.

Taxpayers are expecting some financial relief, especially since Sitharaman was generous in extending tax breaks to the corporate sector in September last year. At the time, the reasoning was that corporates would channel the taxes saved—the government had forgone Rs1.45 lakh crore ($20 billion) in revenues—into creating more jobs.

However, companies have been reluctant to invest amid weak consumer demand, and the slowdown has only worsened since then.

Advance estimates peg nominal GDP growth, ie without adjusting for inflation, at 7.5% in the financial year 2020, a 42-year low.

Now, it is anticipated that the finance minister will shift the focus directly to consumers by lowering income tax rates, according to reports.

This has surprised experts, who say the government needs more tax revenues to increase expenditure. “At a time when growth is slowing sharply, we need an expansionary fiscal policy. The question is what should we spend on?”, Radhicka Kapoor, a fellow at the Indian Council for Research on International Economic Relations (ICRIER), said.

Moreover, a further dent in tax revenues can widen the fiscal deficit, which could be as high as 4.5% this financial year, against the government’s 3.3% target.

A quick look signals why income tax cuts may not boost consumption.

Not a solution

Only about 7.4% of working-age adults fall within the tax net in India. This is a small tax base, compared with other emerging economies such as Vietnam, where the share of taxpayers is 58%.

Moreover, three-fifths of India’s total tax collection is contributed by just the top 5% of taxpayers, which is 0.1% of the country’s population.

“[This small] group has a little propensity to consume, and is more likely to save, unlike the rest of the population. Consumption has to be increased for those in the lower-income deciles, particularly in rural areas,” said Kapoor.

Average income Indian households, most of them in rural areas, have cut spending on essentials such as food, as real rural wages contracted 3.8% in September, show labour bureau data.

With contraction in industrial output, the labour force participation rate (LFPR), too, registered a fall in the first half of November to about 41.8%, according to data from Centre for Monitoring Indian Economy. Most of the decline was concentrated in rural areas.

“Corporate or personal income tax cuts cannot boost consumption. The crisis is elsewhere,” said Devinder Sharma, a trade and food policy analyst in New Delhi. “The quantum of demand that this country needs at the moment to revive growth has to come from rural areas, especially agriculture.”

The finance minister should not worry too much about fiscal deficit and should spend on cash transfer and job guarantee schemes, added Sharma. He also recommends an economic stimulus to the agricultural sector.

Support universal basic income

By giving more support to quasi-universal basic income (UBI) schemes, such as the Pradhan Mantri Kisan Samman Nidhi (PMKISAN), consumption can be boosted, say experts. So far, PMKISAN has covered just 45% of India’s 126 million small and marginal farmers.

The government should increase the budgetary allocation for this scheme to about Rs2.25 lakh crore, which is about 1.1% of GDP, from the current Rs75,000 crore, according to Sharma. This would amount to Rs18,000 annual cash transfer per farmer household, compared with the existing Rs6,000.

This would also help check rising poverty and hunger as slowdown permeates the rural economy, as has been reported by NITI Aayog in a report

The government should also include tenant farmers under the PMKISAN scheme in addition to landholding farmers, says Sharma. 

“Any monetary stimulus given to the rural sector would come back in the market and help revive demand, which is the primary objective,” Sharma said.

Time is ripe

Arvind Subramanian, the former chief economic advisor to prime minister Narendra Modi, last year said that the time was ripe for a quasi-UBI scheme for rural India to boost its faltering economy. Subramanian suggested a cash transfer scheme targeting 60-80% of rural poor, to kickstart demand.

Thus, experts are increasingly suggesting alternatives to income tax cuts to boost consumer demand. “The problem of demand is a symptom of the fact that incomes are not rising and people do not have enough purchasing power,” Kapoor said.

“The key is to increase the incomes of these people.”

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