Will the Budget boost consumption?

This year’s budget has further lowered the tax rates in the new tax regime. The only economic logic of such a policy will be that the government hopes that the amount not paid in taxes will now be spent by the taxpayers

The budget has pinned its hopes on boosting personal disposable incomes rather than personal incomes by offering relief to the lowest and highest income earners in the income tax bracket. This policy, as is the case for most economic policy objectives of the current government, has been in the making for the past few years.

The positive impact on consumption spending could increase further if the government eventually drops the old-tax regime completely. (Bloomberg File)

Let us cut through the economic jargon of personal income versus personal disposable income. A lot of saving decisions in India, especially by income tax payees, have been the result of a nudge from the income tax regime, which has traditionally allowed deduction of such payments from the taxable income thereby bringing down tax liability. Such payments include premium for life insurance policies, most of which in reality are small savings plans and many other heads such as house rent deduction or interest payments on housing loans. Tax saving is, in fact, a major driver behind low-ticket house purchases in India.

When the government introduced the new tax regime in 2020, it offered significantly lower tax rates to income tax payers, provided they were willing to let go of the exemptions offered. This year’s budget has further lowered the tax rates in the new tax regime and announced that it will be the default regime for income tax payments. The only economic logic of such a policy will be that the government hopes that the amount not paid in taxes will now be spent by the taxpayers, thereby, giving a boost to private consumption.

By bringing down the marginal tax rate on the super-rich, the government is perhaps hoping to achieve two objectives. One, slow down the (not insignificant) exodus of the high net worth individuals to tax havens or low tax countries. And two, deploy the prime minister’s political capital to nudge the rich to spend more in the domestic economy. The Prime Minister’s appeals asking domestic tourists to spend on local artisanal products and the budget’s reiteration of this appeal as well as announcing tied capital grants to promote state-level artisanal malls are moves in this direction.

Will this plan work? The long-term impact of dropping the nudge towards forced savings to save taxes will not be insignificant. The positive impact on consumption spending could increase further if the government eventually drops the old-tax regime completely.

Is there a problem with this kind of a strategy to boost consumption? At one level, there is. Almost 40% of India’s Consumer Price Index (CPI) basket comprises of food items. This is basically a reflection of the fact that the average Indian household is still struggling to make ends meet and anyway spends most of its income. Only income growth can increase the consumption of this segment.

And at another level, there isn’t. As consumer products marketers will vouch, much of consumption is driven by the middle- and upper-classes.

And to be sure, the government’s answer to the criticism of the first part is that its formalisation push will increase incomes as well.