Union Finance Minister Nirmala Sitharaman and Revenue Secretary Ajay Bhushan at the 38th GST Council meeting | PTI
Union Finance Minister Nirmala Sitharaman and Revenue Secretary Ajay Bhushan at the 38th GST Council meeting on 18 December | PTI
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Macroeconomic stabilisation policies can sometimes be quite counter-intuitive. When the economy slows down, tax revenues also decline. A civil servant would believe that it is time for her to ramp up efforts to increase tax collection. She may believe that government should spend more and so she must collect more taxes to facilitate greater public spending during the slowdown to push demand up. This thinking may be quite wrong.

Take for example, the current slowdown in growth. It has also been accompanied by tax collections lower than their budget estimates. Indirect taxes have fallen short of the targeted levels, which appear to have been excessively optimistic after the introduction of the GST, particularly when a new tax was clearly taking time to settle.

The growth slowdown has been accompanied by a slowdown in consumption demand. There are three main ways in which consumption demand can increase. Either domestic private consumption of households increases, or the government spends more, or the rest of the world buys more from India.

There may be an argument in favour of rate cuts, from a demand perspective, but not for a rate hike.


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


The consumption conundrum

Consumption demand of households can increase when households have more money. So, if a large number of people are in the lower income tax bracket and paying some income tax, let’s say people earning Rs 8-12 lakh a month and consuming most of their income, then as soon as income tax rates are reduced, this can increase consumption demand. Very often, at low levels of income, the propensity to consume is quite high. Out of the 5.87 crore income tax payers in 2018-19, more than half may fall in the category in which they would consume more if taxes were cut.

But it may be argued that in a country of more than a hundred crore, higher consumption by two or three crore people will not solve the demand problem. In addition, if the problem is a slowdown in rural demand, then considering that income tax is not levied on agricultural income, there would be only a small benefit to this step.

One can argue that since everyone pays GST on the goods and services they buy, consumption can be increased more effectively when GST rates are cut. It leaves people with more money to buy more goods and services. As a consequence, if taxes are below expectations, and the reason is a shortfall in demand, policymakers should not increase taxes. They should cut them to spur demand. Higher spending by consumers will have a multiplier effect and increase consumption demand. Through that, tax collections will also increase.

The difficulty with letting civil servants who focus on tax collections run the economy is that they fail to see that their actions can give the Indian economy a negative multiplier effect. Imagine a situation in which taxes are raised so that the tax-to-GDP ratio increases, without a commensurate increase in government expenditure. This is a likely scenario and tax officials will be happy if this happens. It is likely because government spending is difficult and takes time, and procurement processes are tedious. An increase in taxes in such a situation can lead to a demand contraction by reducing the amount households spend. People pay more taxes and spend less. Those who were earning their livelihoods depending on these people then earn less, and spend less. This multiplier effect gives the system a negative shock and a demand contraction greater than the initial tax increase. Increasing taxes is typically a contractionary move meant to cool down an overheating economy.

The logic of macroeconomic stabilisation policies is that when the economy is overheating, policymakers increase taxes and reduce spending to reduce demand in the economy. On the contrary, when there is low demand, the fiscal stance is expansionary — the government reduces taxes and spends more to push up demand. If the government has been fiscally prudent in good times, and not run up large debt and deficits, then in bad times, it is able to run larger deficits. A commitment such as to fiscal stability is not a commitment to a fixed level of fiscal deficit, but one to what is cyclically required as well as what is prudent. Of course, this requires that during good times, when GDP growth was high, the government was either running fiscal surpluses or low fiscal deficits.

In countries that use fiscal policy as a tool for macroeconomic stabilisation, fiscal policy and tax policy is not made by tax officials. In India, tax policy is made by tax officials. This would be inappropriate for macro-stabilisation of the Indian economy. All decisions about changes in tax rates should be made by policy makers, not by tax officials.

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


Also read: Fall in GDP growth needs to be reversed before it becomes a sustained downward spiral


 

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8 Comments Share Your Views

8 COMMENTS

  1. The indirect tax management system ,all bundled into one tax ,though a good idea needs elaborate study by experts ,as it directly
    impacts prices and influences consumption.The study should encompass all spectrum of products and its variants, Decision needs to be taken product class wise as well any sub classification India can boast of good system of taxes like excise duty ,sales tax and the like
    that paved the way for smooth macroeconomic outputs,be it production or consumption. Some where along the line the thread has been
    lost and has led to complex knots and economic downturn.The tax collection has to be often like honey collection by the bee .
    The process benefits both the flower and the bee.

  2. Doing business as a small trader has newer been so tough as of now with GST as a dragon on head. My business remains a white collar and since last 2 decades till the end of VAT my tax liability newer crossed 4 lakhs annually. But since GST was forcely applied it has gone upto 8-9 lakhs now. With shrinking profits are volume in sales today my savings are being taken away by the Govt. leaving behind empty hands. Today even paying School fees for the only daughter i have has become a challenge, not to think about a holiday , picnic or Purchases at a shopping Mall. The money I used to earn after all tax liabilities allowed me to purchase medicines, cloths , electronic gadgets and other consumer goods for home on regular basis. Now I rarely visit for a purchase as the wallet is dry and empty only to be filled for the Govt. Tijori. Many countries have experienced rise of Capitalism but the civilian livelihoods were not threatened but Indian Citizens face a daunting task to survive. Instead of making changes in the Income Tax , The GST ratio should be revised immediately to occupy the traders to energize their setups with a new lifeline. 18% GST should be revised to 10-12 % which may bring down the collection down temporarily but in long term once the volume of sales increases with a stable market , this will be covered and perhaps may cross the existing collection targets. The Finance Minister has tried many options but in vain, this may get back the traders on their feet’s and collectively the challenges we face from the international market may be balanced with ease. Let’s hope the Govt. takes a serious note of this.

  3. It’s no brainer that indirect tax (such as GST) is regressive because even the poor need to pay as much as the rich would, for the same product or service. On the other hand direct tax (such as income tax) is progressive since it hits the richer class harder as they earn more. So, there is indeed a case for streamlining the GST rates, which, as I understand, go up and down in India like the stock market indices..

    It makes no sense to tax an individual whose annual income is barely Rupees 600,000, which appears to be the living wage in a city. The tax collected from this band of taxpayers is likely to be less than the cost of resources employed to collect it. Or at best it may be even- stevens. Corporation tax collection, another direct tax, which was quite healthy up until now, is likely to go down. In order to encourage enterprise it would make enormous sense to reduce the corporation tax rates further. Income tax rates at the highest level could go up though, taxing those fat cats at the highest income band more.

    Expanding the tax base is a good talk, but so, long as the state elections are not aligned with the national one, taxing agricultural income would be a non-starter.

  4. “Tax policies should be decided by the Government, not by the economists.” This is not so in other countries. Taxmen in India, especially GST officers have too much power. The government is clueless on what tax policy to adopt. It is guided by CBIC whose job is to collect more revenue, does not matter if the economy is wrecked in the process. Both in direct taxes and indirect taxes, the tail is wagging the Dog! Change the FM. There is urgent need for this step!

  5. This may not be as simple as it is argued, If argument is that just about 5 crores out of 130 crore Indians are in the income range of upto 12 lacs a year and pay taxes, it does not make sense to reduce Personal Income but instead it makes more sense to reduce GST. It should be noted that GST on items of mass consumption is mostly zero or 5%. So reduction in GST per se will only benefit upper middle classes, if GST is collected and finally paid to the government. Hence, any such alternative will have problem in solving the issue of increasing consumption in short run. Instead, what government should do is to clean and simplify the system- no IT upto 12 lacs of income and remove all exemptions along with moderating IT rates on income beyond this level, have a single or two tier GST for every product or service bought and sold but have a DBT for the poor giving them reimbursement for higher levels of GST paid on items of mass consumption, remove all subsidies and make a DBT transfer in lieu of it etc. Of course, there will be a huge impact on fiscal deficit (dump FRBM for a while!) but we have many many Harvard and other Ivy League universities trained brilliant economists to offer solicited or unsolicited solutions for such an issue! If they can’t give a good advice, then ask RBI to create OD and credit government of India account with the required funds! But give yourself next 3 years and manage this transition. Every economic policy solution has a subsidiary problem but finally, all it needs is a political will to solve even an economic problem!.

  6. If tax collection is to go up, economic activity must expand. If economy is to expand, there should be a great spurt in demand. To create that spurt,
    people must have money. Demonetization destroyed that. Botched up GST has really botched up the small and medium business leading to job loss
    which in turn impoverished the people. This trend must be reversed. Government must few things: Abolish income tax upto 48 lakhs per annum, Increase the tax upto 80% beyond Rs 48 lakhs to establish an egalitarian society. Have a single GST, say 10 % ad valorem. Raise the interest for senior citizens to 9.5% and enhance the cap for SCSS to One crore with guaranteed interest of 10 % ( tax free). People will have a lot of money in the hand – and their spending will kick start the economy. Prime Minister Modi speaks of US $ 5 Trillion – he can realize that dream only if economy expands. Policy planners therefore must concentrate their efforts to expand the economy. Happiness index of common man will correspondingly go up. Modi can claim that he has ushered in “Aache Din” – which is still a far cry as the matter stands now.
    a. k.pattabiraman, chennai

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