Explained: The pros and cons of an income tax cuthttps://indianexpress.com/article/explained/explained-the-pros-and-cons-of-an-income-tax-cut-6080345/

Explained: The pros and cons of an income tax cut

An income tax cut would provide more disposable income in the hands of the taxpayers and the government's hope would be that this extra money would be spent by taxpayers – thus providing a boost to the economy.

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An income tax cut would provide more disposable income in the hands of the taxpayers and the government’s hope would be that this extra money would be spent by taxpayers – thus providing a boost to the economy.

Over the past few weeks, there has been a growing murmur that the government may resort to cutting income tax rates to provide more disposable income with taxpayers.

While some have speculated that possible income tax cuts will be in accordance to the report on the expected Direct Tax Code – the contents of the report are not yet public but it has been submitted to the government – and will rationalise existing income tax structure. Others have quoted senior economic advisors and officials such as Bibek Debroy, who heads the PM’s Economic Advisory Council. Debroy reportedly said: “Now that corporate tax has come down, it is certain that government will sooner or later reduce the income tax rate also”.

Is an income tax cut justified?

Regardless of the speculation, there is a valid reason why the government may think in terms of reducing the income tax. The Indian economic growth has been continuously decelerating for the past 6 quarters. The next quarterly GDP data – for July to September quarter – is also expected to show a further slowdown. The key reason for the slowdown is the sharp decline in consumer demand, which, in turn, is a result of weaker wage growth, high unemployment and uncertainty about economic prospects, at least in the near term.

An income tax cut would provide more disposable income in the hands of the taxpayers and the government’s hope would be that this extra money would be spent by taxpayers – thus providing a boost to the economy.

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What about exemptions?

As things stand, while calculating one’s tax liability, that is the total “taxable” income, an individual can claim exemptions if he or she has saved money in certain saving instrument, such as the Public Provident Fund (PPF). It is expected that an income tax rate cut if undertaken, would also be accompanied with a doing away with existing exemptions. Much like what happened in the corporate tax cut – where a lower tax rate applies provided all exemptions are given up – a lower income tax rate will possibly rule out exemptions.

As a basic rule, a tax system with no or fewer exemptions is considered more efficient as it is easier to both comply with and administer.

How far would an income tax rate cut help in boosting the economy?

Any answer to this question will depend on the exact cuts. Most of the income tax collection comes from the super-rich. A lot of people file tax returns but they may not be paying taxes or paying very little.

However, Kotak Economic Research team has analysed this based on two different sets of assumed tax structures (see Exhibit 1).

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Exhibit 1 (Source: Union Budget, Kotak Institutional Equities estimates)

What is the likely impact?

Analysts Suvodeep Rakshit and Anindya Bhowmik call a possible income tax cut-led stimulus a “double-edged sword”. They state such an exercise may have the following effect:

-The government will likely face a revenue loss ranging from Rs6,200 cr to 1,25,000 cr for the current financial year
-As a result, the government fiscal deficit is likely to slip by 2 to 37 basis points
-But for individuals, gains will range from 1-49% higher income across income ranges mentioned above; most of the gains are likely to be on the lower-income bands