India's GDP growth dropped to a low of 4.5% in Q2 FY2020, declining for the sixth consecutive quarter. The slowdown can be largely attributed to the decline in consumption demand and slump in manufacturing and agricultural sector. Since these components form a major part of the GDP, improvement in these areas is of utmost importance for the economy to recover.

The government has already slashed corporate tax rates from 35% to 25% and lowered the tax rate for new manufacturing units to 17% from 30% earlier in order to boost private investment.

At present, personal income is taxed at 5% for income between Rs 2.5 and Rs 5 lakh, at 20% for income between Rs 5 lakh and Rs 10 lakh, and 30% for an income of over Rs 10 lakh. These tax slabs have not been revised since many years.

One way of reviving consumption is to put higher disposable income in the hands of the people by cutting personal income tax rates. Recently, during a public address Ms Sitharaman hinted that income tax rate cut was one of the proposals being examined.

It must be noted that even during the previous budget there were hopes for a revision in income tax, though the government did not provide any relief in this regard. This year the buzz is louder as the government is working on replacing the Income Tax Act with the Direct Tax Code. If the government decides to rejig income tax as per the recommendation/s of the Direct Tax taskforce, we may see a revision in tax slab and rates or even flat rates without exemption.

Mr Bibek Debroy, Chairman of the Economic Advisory Council to Prime Minister, believes that it is time to revisit the personal income tax structure to help boost demand, though with certain conditions. According to him, the budget should give the option to either retain the exemption without rate cut for incomes up to certain levels or the option to go for lower rate cuts.

However, Mr Arvind Subramanian, former Chief Economic Adviser, has proposed direct benefit transfer and universal basic income instead of personal income tax rate cut to boost consumption.

Now the question arises whether reduction in income tax rate can actually boost consumption considering that a very low percentage of the population actually falls in the tax bracket?

Even though only around 3-4% of the population are taxpayers, this segment has high purchasing power. Reducing tax rates will put more money in their hands which can potentially increase the demand for goods and services from these individuals and their family members. This increase in spending will benefit other individuals and businesses too, as their income is likely to grow.

Additionally, since the cost of living is on the rise, the government should consider raising deduction limit under Section 80C of the Income Tax Act. This will encourage individuals to save more. And as they channelize these savings into investments, it can reinvigorate economic growth and also help government gather more resources for its projects.

Driving the economy back to growth is the biggest challenge for the government. Revision in income tax rate cut and slab may lead to increased consumption, spurring economic growth.

However, it will cause the fiscal deficit to widen.

But given the state of the economy, focus on boosting demand should be of prime importance rather than achieving fiscal deficit target. As the economy recovers, the government can look at fast-tracking divestment plans, expenditure cuts and increasing GST rates on certain goods to control the deficit.

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