How to get taxpayers to spend their tax savings
Tax breaks need a nudge to translate into real consumer spending.
The government announced income tax concessions amounting to a total of ₹1 trillion to stimulate demand in the economy. The savings on tax outgo will take time to cumulate into a meaningful chunk of additional purchasing power in the hands of taxpayers. If the amount of tax given away for the entire year could be put into the hands of taxpayers upfront, they might be more inclined to spend it. That, however, would call for an additional government initiative.
“A taxpayer in the new regime with an income of ₹12 lakh will get a benefit of ₹80,000 in tax (which is 100% of tax payable as per existing rates). A person having income of ₹18 lakh will get a benefit of ₹70,000 in tax (30% of tax payable as per existing rates). A person with an income of ₹25 lakh gets a benefit of ₹1,10,000 (25% of his tax payable as per existing rates)", finance minister Nirmala Sitharaman had said after outlining her tax concession proposals.
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Some of the additional disposable income people gain from tax giveaways would go into savings - either to bring down past dissaving, that is, repayment of debt, or to give in to the enticing charm of the pervasive slogan, mutual funds sahi hai.
Since the private sector remains reticent when it comes to investment, such savings are unlikely to stimulate fresh economic activity. For the tax breaks to boost growth, consumption must be maximized out of the additional disposable income people have.
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Take a salaried employee who stands to get a tax relief of ₹1.08 lakh over the year. Her post-tax salary per month will rise by ₹9,000. She might splurge a little on some personal indulgence or even join an instalment scheme to buy some gold. But she is unlikely to buy a consumer durable or two with that additional monthly income.
But if she could get her hands on that entire saving on tax over the year as a lump sum, she might make a down payment on a car, or buy that big television set her children have been campaigning for, with subtle encouragement from her couch potato of a spouse, along with a washing machine upgrade from semi-automatic to fully automatic, and a front-loading model, at that – after all, a front-loading machine takes less water and less detergent. As clothes rotate inside the machine around a horizontal axis, the tub needs to be only half full: the clothes move in and out of the water, instead of being submerged all the time, as in a top-loading machine.
But how to put that tax saving for the year into her hands in the first quarter of the new financial year? The simplest way is for the government to give taxpayers a tax credit upfront, and ask them to keep paying tax at last year’s rates.
But this has two drawbacks. One, it assumes those who paid tax last year would continue to earn at least as much this year, a risky assumption if people are laid off or have fewer hours of gig work. Two, the government would have to advance the amount and recover it as tax payments over the year, incurring interest costs on the money borrowed to make those tax credit payments.
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Another way is to encourage banks to extend personal loans at ultra-cheap rates to taxpayers with incomes below, say, ₹30 lakh a year, each loan being roughly equal to the potential saving on tax at the new, revised rates for the taxpayer in question. The bank could ascertain that by checking with the would-be borrower’s income tax return for the previous year.
The government could offer to refinance these personal loans to the banks at an attractive rate. This would entail some additional outlay on the government’s part, but it would be well worth the effort.
Commentary immediately after the presentation of the Budget had projected giddily optimistic effects of the tax breaks. Some economists had assumed that growth resulting from additional consumption would be five times as much as the additional consumption -- in economic jargon, the growth multiplier for consumption is assumed to be 5. Empirical estimates of the consumption multiplier have come in much lower, some as low as 1.1.
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The government will have to put in effort to ensure that the tax savings are actually spent on fresh consumption, whether by giving tax credits upfront or refinancing bank loans to taxpayers who wish to buy consumer goods with their anticipated tax savings.
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