Tax Cut Boosts Spending and Economic Growth

Source: The post Tax Cut Boosts Spending and Economic Growth has been created, based on the article “Budget 2025’s tax cuts for middle class will boost consumption many times over” published in “Indian Express” on 7th February 2025.

UPSC Syllabus Topic: GS Paper3- Economy- Growth and Development

Context: The article explains how the Budget 2025 tax cut of ₹1 lakh crore for the urban middle class will boost spending. This extra money will create more demand, increasing consumption and GDP growth. It is a short-term stimulus, not a replacement for long-term infrastructure investment.

For detailed information on How to Boost Investment and Economic Growth read this article here

What are the Multiplier effects of tax cut of ₹1 lakh crore?

The multiplier effects of the ₹1 lakh crore tax cut are substantial and can be understood through the following points:

1. Increased Disposable Income: The tax cut directly increases the disposable income of urban middle-class households by ₹1 lakh crore, empowering them to spend more.
2. High Consumption Multiplier: The estimated consumption multiplier for the urban middle class is 5. This suggests that every ₹1 of tax cut could generate ₹5 in new consumption. This multiplier is derived from a marginal propensity to save (MPS) of 20%, indicating these households typically save 20% of any additional income.
3. Total Economic Impact: Applying the consumption multiplier, the ₹1 lakh crore tax cut could lead to an additional ₹5 lakh crore in consumption. This would significantly boost the economy by increasing demand for goods and services.
4. Boost to GDP: The additional consumption could enhance GDP growth. A ₹5 lakh crore increase in consumption translates to about a 2.7% increase in GDP, based on India’s current GDP of ₹185 lakh crore.
5. Supports Private Investment: By increasing demand, the tax cut encourages businesses to invest and expand, potentially leading to more job creation and higher incomes, further stimulating economic growth.

What can be done to support this growth?

1. Implement Easy Monetary Policies: The RBI should adopt easier monetary policies to lower interest rates and encourage private investment, supporting businesses in expanding and creating jobs.
2. Encourage Local Consumption: Promote purchasing domestically produced goods to ensure that the increased spending benefits the local economy.
3. Maintain Fiscal Discipline: Continue managing the fiscal deficit effectively, which is projected to be below 4.4% of GDP, to maintain economic stability and investor confidence.
4. Support Private Investment: The tax cut can stimulate demand, encouraging firms to launch new projects and hire more, thus increasing consumer spending and further boosting growth.

Question for practice:

Discuss the multiplier effects of the ₹1 lakh crore tax cut for the urban middle class and how it can impact economic growth.