Budget: Tax cuts may not boost GDP growth that much

The bounce in consumption is likely to be mild while slower fiscal spending might counter the tax stimulus

- NIKHIL GUPTA

Ahead of the Union budget, there was a demand from various economic participants to stimulate consumption. The government delivered this in a balanced way by boosting the disposable income of individuals through tax cuts while keeping a tight leash on its fiscal deficit. No individual needs to pay any tax on their salary income up to ₹12 lakh per annum in 2025-26, up from ₹7 lakh in 2024-25. The tax outgo for richer individuals has also been cut. This will cost the exchequer ₹1 trillion, according to government estimates.

Two obvious questions arise. Will these tax changes be sufficient to create a virtuous cycle of private final consumption expenditure (PFCE)? What would be the likely boost to real GDP growth? With more money in the hands of individuals, their spending will surely increase. But there are several caveats to consider when we look at the impact of these changes on GDP growth.

The positive impact of higher individual spending on GDP growth can be measured through the marginal propensity to consume (MPC). It measures incremental consumption out of additional disposable income. The higher the MPC, the greater the positive impact of a rise in disposable income on consumption. India's household savings are about 25% of disposable income, implying that consumption takes up three-quarters of it. The MPC would logically be higher than 75% for low-income individuals and much lower for the country's richest.