Whether apocryphal or true, it is said economist Arthur Laffer, while dining with some government dignitaries in a café, used a paper napkin to draw a curve which mapped lower taxes to higher growth. This became the famous Laffer Curve in supply side economics; it was believed that lower taxes make people work more which generates higher income and hence growth. Simultaneously, the tax revenue also grows. This approach was part of what became Reaganomics.
While this theory is neat, the willingness to work does not translate into more work being generated as companies do not operate this way. But if one were to look at this theory in a broader sense, lower taxes should help in augmenting spending and hence increase growth as well as taxes. This is the spirit in which the two rather important measures taken by the government on income tax and GST 2.0 can be viewed.
The income tax benefit was to release ₹1 lakh crore of income that is expected to be spent on goods and services. The ₹48,000 crore of revenue foregone by the government on GST on account of rate rationalisation is also expected to create demand as well as raise disposable income during the festival season. Thus, both these measures are growth-enhancing.
A point of debate is whether income measures work better or expenditure? It has been seen that the government’s free food policy to 800 million people has helped them to move up the ladder of consumption as basic necessities have been provided free of cost.
Discretionary spend
Hence when data on household consumption surveys show that people are spending less on food and more on discretionary items it is due to release of money that would otherwise have been spent on food. The view on balance is that while both the approaches are useful from the point of view of optics, expenditure is a more effective way of bringing about development as it is direct.
On the other hand, an income tax cut helps only those who pay taxes. While the exemption limits have been enhanced for those lower down the income stream, the revenue that would have been generated would have been lower than what is mopped up at higher levels.
If income tax cuts are to benefit those earning higher income, the outcome on spending may be limited as this group may not really have been constrained by the existing tax rates.
A similar picture can be seen when it comes to GST reduction. Demand for products like automobiles or durable goods would not have been constrained on the price front for those in the higher income groups. But for the middle-class and lower income groups, this will make a difference, leading to an increase in demand. This view is also echoed by companies in the consumer goods space.
However, these are products which people normally purchase occasionally. Hence, a bunching of demand and consumption will be seen for one or two quarters. But it would be back to normal subsequently. This is because the spending cycle can be maintained only if there are new consumers entering the market which is linked with job creation.
Overall, fiscal policy has provided both the props for consumption. First the prices of goods have come down and second, disposable income has gone up. But for this to work, households need to spend. There would be a normal tendency for 30 per cent to be saved, which is the savings rate. This would be much higher for the higher income groups which invest in stocks; hence expenditure on consumption may take a back seat.
Expenditure impact
This can be contrasted with the expenditure programmes of the government at both the Central and State levels. As mentioned earlier, the free food scheme is a continuous booster for spending as it targets only those lower down the income ladder.
Second, the same holds for the PM Kisan Scheme where individual farmers receive ₹6,000 per month.
Third, the various States’ schemes for women, which range from ₹1,000-1,500 per month, is a direct booster for spending.
Fourth, physical goods given in the form of sewing machines, bicycles and laptops provide a direct boost to the industries which adds to the GDP.
Fifth, the MGNREGA programme is another cash transfer scheme which adds directly to spending of poorer households. Last, the large outlays of the government on infrastructure are probably the most effective way of forging strong backward linkages with industries while bringing about growth with development.
Therefore, on balance it does appear that expenditure plans, whether capex on revenue expenditure tend to be more effective in terms of having a direct impact on the economy. Any benefit on the taxation front assumes that the beneficiaries will all spend the gains on both the taxation and price fronts in a certain manner irrespective of their income level.
Also, the same may not necessarily be replicated in future. It can be pointed out here that in 2019 when the government reduced the corporate tax rate the expectation was that companies would use this prop to invest more. But that did not happen as all investment decisions are based on capacity utilisation, which in turn is dependent on demand.
From the government’s point of view it makes sense to work on both fronts. Expenditure is certainly more direct, the benefits are known as they are targeted to specific sections of society to deliver superior outcomes.
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