This Income Tax Cut Cuts Many Ways

medium117863159Budget was once a spectacle — and a compendium of quotable quotes, from Thirukkural to Tagore, prefixed by Manmohan Singh’s invocation of Bismil via the evocative “Sarfaroshi ki tamanna” in 1991. It is now a balance sheet of the Union govt. As it should be, as it is in most of the world. Additionally, and understandably for a poor but hyperactive democracy, budget is a platform for political-economy trade-offs. Budgetary tilts in specific domains are to attract political equities in the same.From this functional perspective, Nirmala Sitharaman’s eighth budget speech was unexceptionable. It demonstrated steady management of the fisc, commitment to fiscal consolidation, transparency on and reasonable basis for the fiscal math, and continuing focus on quality of expenditure.But popular consciousness demands grand narratives. Sometimes it even invents them. This time though, the proposed, massive tax break has created a legitimate narrative: boost to flagging consumption, thank-you card for BJP’s middle-class support base, nudge towards the new tax regime. On the other hand, analysts have already opined on its casualties.Rollback on capex growth | Linearly, the math works something like this. Total tax-break is around ₹1L cr. That’s a clean cash transfer from the treasury to private individuals. Beneficiaries will save some of the extra disposable income and spend the rest — buying TV/cars/houses, eating out and so on. The proportion of the latter is called the Marginal Propensity to Consume (MPC). For India, this has been estimated to be around 50% in recent academic literature.Cycle of consumption doesn’t stop at the first level. A beneficiary of the tax-break uses part of the money in (say) going out for a meal — restaurant owners/workers make incremental income as a result, and they in turn spend some of that in consuming more goods and services.This cycle enables a multiplier impact on aggregate national income generated out of the tax-break. Consumption multiplier is calculated like this: 1 divided by 1 minus the value of marginal propensity to consume. If MPC is 0.5 — a reasonable assumption — then the multiplier is 2. So, a ₹1L cr tax break creates ₹2L cr of incremental income. In case MPC is higher, the multiplier will be too, resulting in higher incremental income.But life is rarely linear. This tax-break isn’t ‘free’. It has had to be funded — likely by taking money off the capex budget. Indeed, for FY2026, growth in capex budget, at 10%, is the lowest in last 5 years.Now, it is well-known that income multiplier of capex is higher than income multiplier of consumption. It’s a calculated bet — govt is giving up higher-multiplier capex for lower-multiplier consumption via tax-breaks, in the hope that higher consumption will kickstart private capex that has been anaemic till now.It’s a razor’s edge bet on economic outcomes, though the political trade-offs (middle-class support) are far clearer.Rollback on wider tax net | Contrary to the popular view, India’s tax/GDP ratio isn’t low. It’s actually at par with countries with far higher per-capita incomes, much higher than countries with similar per-capita incomes. The situation is starker for Personal Income Tax (PIT). With incredible buoyancy in recent years, PIT has reached nearly 4% of GDP today, a ratio far higher than richer countries like China (1.1%).However, in line with low incomes, India has very few (income) taxpayers. We have 8cr tax-filers, with roughly 3cr actually paying some tax. With the new tax-break, the number of actual tax-payers will reduce massively.In some ways, this rolls back several years of effort to widen the tax-net, not just for more revenues, but structurally also for a citizenry that has some skin-in-the-game about how govt actually spends its money.A shallower PIT pool also prevents lowering of GST rates — making a regressive indirect tax regime worse. Higher GST not only burdens the poor with its income-agnostic effects, it irritates the top 2-3% of India’s consuming population, which is also the PIT-paying cohort.It feeds alienation of the nation’s elite from how the country is run, as a numerically tiny cohort feels over-taxed and voiceless and hence ‘secedes’ from engaging with the polity, walling itself behind private gated communities.American historian Albert Hart once said, “Taxation is the price which civilised communities pay for the opportunity of remaining civilised.” A smaller cohort of taxpayers weakens this idea of progress.All economics is politics, more so in a democracy. The enduring grand narrative of this budget will be the toss-up between short-term political-economy boost to longer-term social-economy impact.The writer is CIO of a wealth management firm. Views are personal