Why an income tax cut may not work like a magic bullet during a slump

Why an income tax cut may not work like a magic bullet during a slump

As the economy is in the throes of a downturn, many have suggested that an income tax cut would have been a better move to revive demand in the short-term.

The government had cut the corporate tax in September to boost investments. It was welcomed as a bold move both by industry and the global investor community.


However, there are questions around the effectiveness of the corporate tax cut, in the short term, to address the immediate need to stop the economy from slipping further.

Madan Sabnavis, Chief Economist at CARE Ratings, sees little chances of the corporate tax cut flowing into investments in the short term, given the excess capacity with the industry.

“One and a half lakh crores of revenue lost (on account of corporate tax cut), what are companies really going to do with it? We have surplus capacity. There’s no reason why any company should go for investment… so it’s (the tax cut) not really going to flow into investments,” Sabnavis said.

Economists have pegged the second quarter economic growth lower than the first quarter in the wake of various high-frequency indicators nosediving — especially the industrial production in the month of September.
The first quarter GDP growth slowed to 5 per cent and various agencies have predicted an even lower second quarter figures.

The government responded swiftly, taking measures to avert any further damage. This included tax cuts for industry, measures for NBFCs and a stress fund for realty sector.

However, experts feel that expectations of a quick recovery are misplaced as the effects of the steps taken by the government to boost economic growth will only start showing impact from the next fiscal.

On whether an intervention on the income tax front would have acted like a magic bullet, economists are skeptical. While theoretically it is effective to spur demand in the short-term, there is no certainty of an income tax cut translating into more spending on part of the consumers, as during tough times the tendency is to save more.

“If I get a cut in my income tax rate, do I have to spend this money or do I have to save it? It all depends upon what my expectations of the economy are,” Sabnavis added.

So, while a personal income tax cut makes theoretical sense, the government chose to give preference to corporate tax cuts for stimulating growth in the medium term, in the hope that it could lead to higher investments, he said.

The government has dismissed reports of an income tax cut happening anytime soon. The corporate tax cut has meant that the government will have a tough task managing the fiscal deficit target.

“Overall direct and indirect taxes have shown subdued performance so far in FY20, and there is a considerable likelihood that the shortfall relative to government’s budget estimates will be quite large so far as overall taxes are concerned,” Aditi Nayar, principal economist at ICRANSE -1.20 %, said.

First it needs to be assessed what kind of impact the corporate tax cut will have on revenue, and how much fiscal space there will be for another tax rejig, she added.


Source:- economictimes