Monday, 8 August, 2022
HomeIlanomicsCutting income tax and raising GST makes no sense. Both need to...

Cutting income tax and raising GST makes no sense. Both need to fall together

Before govt decides to do either, it needs to take a view about the macroeconomic picture. Is this a time for fiscal expansion, or for fiscal consolidation?

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Media reports suggest that the GST Council is expected to increase rates to counter the shortfall in GST collections. At the same time, there is discussion that personal income taxes could be cut to counter the demand decline.

A GST rate increase will be contractionary for the economy, if it results in higher tax collections. A cut in income tax will be expansionary, and give a boost to consumption demand, which has been sluggish.

Since the two moves have different effects, and since they are based on a different diagnosis of the economic situation, they may counter each other and produce little or no result for the overall economy, while causing disruption in specific sectors. So, before the government decides to do either, it needs to take a view about the macroeconomic picture, about whether there needs to be a tax cut or a tax increase. Is this a time for fiscal expansion, or for fiscal consolidation?

Also read: The disruptive reform that’s responsible for India’s consumption slowdown

Time to cut both together

In an economy, like in a human body, there are many factors at work, and it is difficult to quantify the overall effect of any intervention, such as a particular medicine or a tax cut. The problem will only get more complex if two medicines with opposite effects are given together.

Under the present business cycle conditions of the Indian economy, surely the government cannot believe that it is time for increasing taxes to reduce demand further. Indeed, it should be a time to talk about cutting tax rates to increase demand quickly, and faster than government spending can.

Cutting taxes puts money saved on taxes directly into the hands of consumers, which they can spend on other goods and services. From a macroeconomic stabilisation point of view, this is a time to cut both personal income taxes and indirect taxes. That would be the quickest way to push demand and try to correct the cyclical downturn in demand.

Will GST go the excise way?

It is not clear that increasing GST rates for some items is going to increase tax collections. We started with high rates, but because of the complications, we reduced them. Higher rates can also produce higher tax evasion.

When the present GST regime, with multiple and high rates was introduced, it was feared that the lack of simplicity in the system would create difficulties with compliance. What was not fully anticipated was the infinite appetite of the Indian bureaucrat for tinkering. Year after year, in response to various lobbies and short-falls in tax collections, officials exercised their power to change excise duty rates.

If anyone tries to make a list of the excise duty rates applicable on each item in each year for the last 30 years, it is nearly impossible. The rates change, the definitions change, what is exempted from taxation changes.

Is GST going to go the same way as excise went, with constant changes and no predictability? The whole purpose of the GST was to give the nation a simple, single tax rate that would improve compliance and bring the economy. What is the vision of policy makers for the GST? When is it expected to stabilise? Or, will it always be like a bunch of instruments, to be continuously tweaked, and never a set of stable rates?

Is the GST council meant to be like a monetary policy committee that is expected to look at GDP growth or tax collections, and to increase or reduce GST rates on various items?

Also read: Tackling onion price rise leads to policy distortions, but it seems nothing will change

Need clear policy direction

Even while one asks the question about what is the vision of the government’s economic policy team about the fiscal stance and role of the GST council, it is not clear that there is a consensus among policy makers with clarity on these issues. Tax officials always prefer more arbitrary power to less power.

If there is no clear position taken by the government to bind the hands of tax officials, if there is no clear-cut policy direction, they will always choose to tweak rates the way they used to do with excise.

This creates policy uncertainty and is bad for investment and growth. The government should begin with a white paper that clearly states its view on the present fiscal stance. Further, it should decide what should be the role of the GST Council and how the GST is expected to evolve over time.

If it is going to be forever changing, and that is the vision, we may never yield the benefits of the GST, and it may be time to go back to the drawing board.

Also read: Fiscal stress offers Modi govt great opportunity to push disinvestment

The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.

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  1. I disagree with Mr Vijay. As Economist Ila Patnaik says that any increase in GST will be contractionary and any cut in the direct tax will be expansionary. Economy should expand to nullify the demonic effects of demonetization and devilish effect of GST. Unless economy expands, there is no chance of revival – we will only go down the line to abysmal degradation. Put lot of money in the hands of people. Either they will save or spend. If they spend, consumption goes up. When consumption goes up, demand goes up. When demand goes up, production goes up. When production goes up, employment opportunities go up, When all these go up, tax collection will go up. In case people save the extra money, the household savings go up. When household savings go up, the government can tap this bonanza for developmental expenditure – capital is thus formed and comfort level of the people goes up. I just do not understand the “bania type” attitude of the government. They want squeeze people and take every drop of blood from the common man. Saint Thiruvalluvar gave the following advice to the king in the matter of tax collection. King should collect tax in the same manner a Bee takes honey from the flower – which it does without letting the flower know that its honey is being extracted. Please take lessons from Saint Thiruvalluvar or from Prof Illa Patnaik.
    a k pattabirman chennai

    • How does giving money to people hand different if Income tax rates are slashed? Point of matter is income tax payers pay Income as well as Indirect tax. And in an ideal scenario, indirect taxes should be low and direct taxes based on ones income. But when large percentage of population does not pa Income Tax, and the government’s efforts to that effect do not show result, the government at a point in time has to resort to raising indirect taxes so that it meets it’s fiscal obligation.
      Mr Pattabiraman Enjoy your Senior Citizens tax cuts & senior citizen FD rates since you sign internet comments with signature and location.
      I guess you needs common sense lessons from anyone who can give it (since they would have more than it) and cure you of racism since you abuse a community that has backbone of trading business.

  2. I believe the author is missing a key factor while linking GST and Income Tax and that is low number of direct tax payers. If one excludes salaried class then as the PM pointed out there are more luxury car buyers than tax payers. I believe the Modi government has tried to include more and more people in direct tax with Demonatization, GST, PAN-Aadhar linking, PAN card mandatory for high value purchase etc. But alas, I feel the efforts are not as successful as one might have expected. Therefore, there is no option but to raise indirect taxes.
    But the salaried class which can be grouped as middle class is hit by direct taxes & indirect taxes and a consolation gets a PDF certificate from Income Tax. Therefore, a lower direct tax will provide some relief to this class.

  3. The government is acting like a headless chicken when it’s not behaving like an ostrich. Am I the only one or there are others who rue the day we voted for BJP earlier this year?

  4. Does anything this government does makes sense? They’re improvising as they go along.

    Maybe next budget will be in Sanskrit ;).

  5. Yes, nothing will work. Hand over Power to Congress & everything will be alright. GDP will go above 10%,Unemployment will vanish & Gharibi will be eradicated completely from India. India will have 10 trillion economy. NPA from Banks & NBCC will vanish in 6 months. Every Indian will live without scare or Fear. India will become more secular. Freedom of Press will increase.

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