Tax cuts can escalate disposable income, reduce revenue deficit

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: Expectations and speculations, about the measures the newly formed government is likely to introduce to battle the current economic downturn, are towering high as the countdown for the release of full Budget has begun.

The ongoing global financial crisis has affected the growth of Indian economy in a significant manner. According to the recent World Economic Outlook released by International Monetary Fund, India is projected to grow at 4.5% during 2009 and at 5.6% during 2010 as against the previous estimates of 9-10%.

The economic slowdown has also resulted in increase of revenue and fiscal deficit of the country. Significant market borrowing by the government to finance the fiscal deficit renders the monetary policy ineffective, thus an alternative source of financing the fiscal deficit is required. It is imperative for the government to ensure that there is more purchasing power in the hands of the people and more liquidity in the hands of companies.

Tax reforms, are increasingly being viewed as an important fiscal stimulus tool.

Timely tax cuts by the government can achieve the dual purposes of escalating the personal disposable income of the masses and thereby reducing the revenue deficit of the country.

Historical evidence provides sufficient evidence about the ability of tax cuts (to an optimal level) to generate higher revenues for the government as well as greater tax compliance. In fact, a report on direct taxes, submitted by the task force headed by Dr Kelkar in December 2002, noted that there was a direct relation between increase in exemption limit and rise in tax compliance in India.

The maximum rate of individual income tax in the country is 33.99% (including surcharge and education cess), which is high when compared to the other developing nations. The Centre may thus, consider reducing the peak personal income-tax rate by 5% that may be made applicable on an income slab of over Rs 10 lakh. Another measure that may induce a productive upshot will be the increment of the basic exemption limit to Rs 2.5 lakh. This will increase the personal disposable income in the hands of individual and provide a much needed impetus to the economy.