Can tax cuts fuel a consumption boom?

Consumption is the primary lever for the economy given uncertainty over exports and muted corporate investments even as government capex continues to do the heavy lifting. Finance minister Nirmala Sitharaman has creditably pulled off the biggest income-tax giveaway without deviating from fiscal consolidation. The welfare and infrastructure budgets have accommodated higher middle-class disposable income. The anticipated stimulus within a contractionary fiscal stance will be amplified by monetary easing, without significantly raising risks to inflation. Consumption revival is the missing link between public and private investment. It also strengthens immunity against expected trade shocks. The stimulus is well-timed, arriving at the end of a credit-fed consumption recovery cycle since the lifting of coronavirus restrictions.

The effects of the tax breaks, however, are not as clearly defined. The country's narrow taxpayer base raises questions about the extent to which household consumption-or savings-will be impacted. Corporate earnings suggest that the tax giveaways will compensate for slowing consumer credit. This may prevent a stall at the top of the income pyramid, but the bigger constraint on consumption remains real wages, which have yet to recover to pre-pandemic levels. The budget has maintained the previous year's welfare and infrastructure allocations, which have a greater bearing on real incomes and, by extension, on consumption.

Then there is the impact on government finances from a shrinking taxpayer base. Recent fiscal consolidation has been accompanied by healthier books-on the revenue side through the rising share of direct taxes and on the expenditure side through higher capital expenditure allocations. Extra fiscal leeway is being provided by generous public sector dividends, including from RBI's operations to stabilise the rupee. The tax giveaways will require additional efforts to sustain momentum in income and corporate tax revenue while GST collections stabilise after a surge. Breaks for the middle class also affect social infrastructure outlays, which have yet to catch up with physical infrastructure in terms of GDP share.