Budget 2020 Ideas For Growth: Tax Cut Or Spending Increase?

India’s weak economy, which has seen growth sliding to multi-year lows, has prompted calls for greater government intervention. After a period of substantial monetary policy easing, investors and analysts are now calling for fiscal support.

BloombergQuint’s conversations with senior economists threw up considerable support for fiscal easing, even if it meant a temporary widening of India’s fiscal deficit. Should the government accept that argument, what is the best route to take in order to support the economy?

Should the government cut taxes? And what taxes? Or should it spend? And where?

Here’s what senior economists recommend.

N. R. Bhanumurthy: Infrastructure, Need Of The Hour

Fiscal policy choices in the budget should primarily depend on the nature of the economic slowdown and the fiscal space available, said N. R. Bhanumurthy, professor at NIPFP. The broad consensus is that the current slowdown is a mix of cyclical and structural factors. As such, the budget should focus on fiscal stimulus through tax cuts and higher expenditure.

Any stimulus through tax cuts is easily reversible and, hence, could be used as a short term measure.

Additional spending, however, needs to be thought through carefully. Spending on the rural employment guarantee scheme MGNREGA could act as a strong automatic stabiliser and enhanced allocations could address rural demand issues. But to have strong multiplier impact on both short term and long term growth, there is a need to prioritise spending on infrastructure.

Radhika Rao: A Spending Mix

Radhika Rao, economist at DBS Bank expects that the budget will include some measures to boost demand and provide relief to individual sectors. An infrastructure push may accompany these measures as an over-arching theme.

This will ensure that a cyclical recovery is sustained by a structural turnaround, Rao said.

Should the government decide to rely on tax cuts, lowering indirect taxes via lower GST rates would be preferable, Rao said. Indirect taxes have a much wider reach and impact consumers across economic strata. In contrast, a personal income tax cut will impact a relatively limited pool of income tax payers.

Tax cuts, however, would provide only a short term fillip to consumption spending. For a sustained improvement, a push towards raising job creation would be required, said Rao.

Anubhuti Sahay: The Multiplier Effect

In deciding the mix of fiscal support, the government should focus on the multiplier effect, said Anubhuti Sahay, head of South Asia economic research at Standard Chartered bank.

Any personal income tax cut should be limited to low income earners as that can maximise gains with limited fiscal strain. While GST rates are outside Union Budget’s ambit, Sahay said the government may actually have to consider higher rates on so-called ‘sin goods’.

The spending focus should be on capital expenditure, she said.

Sahay also advises greater focus on implementation of planned expenditure. For instance, the allocation for the farmer income support scheme is unlikely to be fully exhausted in FY20.

Rahul Bajoria: Time Bound Tax Cuts

If the government decides that a short term push to demand is needed, GST rate cuts are likely more powerful, said Rahul Bajoria, chief India economist at Barclays. “Targeted and time-bound GST cuts are likely to be more powerful than blanket income tax cuts,” Bajoria said.

Still, personal tax cuts may be preferred even though they may not guarantee additional spending.

In contrast, a decision to provide government spending support to the economy should focus on social sector schemes.

Between infrastructure spending and spending on social sector schemes, the latter can have a quicker impact, Bajoria said. He, however, does not expect a significant pick up in either in the upcoming Union Budget.

Abheek Barua: No Big Bang

A major fiscal stimulus to push up growth is unlikely, said Abheek Barua, chief economist at HDFC Bank. Still, if the government were to step in to provide support, the choice should be between personal tax cuts and social sector schemes such as PM Kisan and MGNREGA, he added.

A cut in personal income tax would benefit a small section of people as only about 5.7 percent of India’s population paid income tax in FY19. As such, a personal income tax cut is unlikely to have a significant impact on growth.

Instead, a higher allocations to direct benefit transfer schemes could boost consumption.

Govinda Rao: Tax Rationalisation Key

One focus for the government should be income tax rationalisation, said Govinda Rao, member of the Fourteenth Finance Commission. This needs to be done not so much from the point of view of stimulating the economy but to remove anomalies.

Rao explained that the individual income tax rate schedule is applicable to individuals, Hindu undivided families, association of persons and small businesses. Thus, while the corporate tax rates have been reduced to 22 percent, small businesses continue to pay 33 percent, which needs to be corrected.

Of course, this would also have a favourable impact in reviving consumption demand but it will not be a major factor, Rao said.

Should the government choose to step up spending, the focus should be on infrastructure.