Union Budget 2020: Will Cutting Income Tax Spur Demand?

With the announcement of the Union Budget just a week away, there is widespread anticipation of a personal income tax cut. This expectation has gained ground even more ever since the government decided to give a major relief to the corporate India by slashing the corporate tax rate to as low as 15 per cent in certain cases, and 25 per cent for most. So most people believe that it’s only fair that the government, in the upcoming budget, would give a similar relief to the salaried class.

Many experts have advocated that in the light of slowing consumption demand, cutting income tax rates may have a positive impact on spurring demand, thereby boosting the slowing down economy. However, how realistic is it to assume that cutting income tax rates would boost demand?

According to Sunil Kumar Sinha, Principal Economist, India Ratings and Research, cutting the income tax rates may not serve the purpose of boosting consumption.

“How many people in this country, in terms of percentage, are there who pay income tax? Just 3 per cent. So by cutting income tax, you are essentially giving benefit to these 3 per cent. A large number of these people have already bought the consumption items which typically are considered to be aspirational or must-have in nature. So probably an income tax cut would do the same thing which corporate taxes have done. It will not result in investments but savings,” he said.

Sinha added that giving tax benefit would not result in consumption expenditure but may actually result in savings because one doesn’t foresee a very good future income growth, which means that people who get the tax benefit would tend to save the extra money rather than spend it.

“On the contrary, if you give any fiscal giveaway to that section whose propensity to save is less and propensity to consume is higher, then the moment that will get the money, they will spend it. So that can actually spur the demand, not the income tax cut,” he explained.

He said that the focus of expenditure has to be on creating direct employment and putting more money in the pockets of the people at the bottom of the pyramid.

“Therefore, budgetary allocation to heads such as rural infrastructure, road construction, affordable housing and MNREGA must be prioritised,” Sinha said.