'Income tax cut can boost consumption by 10%': Ex-CEA KV Subramanian

International Monetary Fund (IMF) Executive Director and former chief economic advisor Krishnamurthy V Subramanian has said that the effects of the measures announced by Finance Minister Nirmala Sitharaman today on personal income tax are going to be "huge". He says that even if estimated conservatively, this could lead to an increase in consumption by over 10% and GDP will increase by more than 8%.

Subramanian, in a tweet, wrote: "The "EFFECT OF PERSONAL INCOME TAX (PIT) CUT IS HUGE!!! I estimate consumption in FY26 will ↑↑ (increase) by >10% and GDP will ↑↑ (rise) by >8%."

In a significant relief to the middle class and taxpayers, Sitharaman, in her eighth consecutive budget speech today, said there will be no income tax payable on income up to ₹12 lakh under the new tax regime. The FM, apart from rejigging the income tax slabs, also increased the tax rebate available under Section 87A.

Giving a step-by-step rationale behind his estimate, Subramanian says that the tax forego of about Rs 1 lakh crore in the income tax due to the measures announced today will lead to an increase in the disposable income of the middle class. "Step 1: I heard Madam FM @nsitharaman estimate in her budget speech that the tax forego due to PIT (personal income tax) is about ₹1 Lakh cr. This is a direct ↑ in disposable income of middle class."

The former CEA is of the opinion that a majority of the disposable income chunk comes back into the economy as the consumption will increase. "Data shows that middle class saves about 20%. So, 80% of this ↑ (increase) in disposable income will go into consumption."

Giving an example while showing consumption multiplier formula, Subramanian says if the government injects ₹1 crore into the economy via tax relief or public spending, total consumption could rise by ₹5 crore because of this multiplier effect. "Consumption multiplier = 1/(1-MPC), where MPC is marginal propensity to consume. MPC = 1 - Savings rate = 0.8. So, consumption multiplier= 1/(1-0.8) = 5."

The economist says the income tax measures could, as per estimates, lead to a 5x increase in consumption, a huge boom to India's economy. "Combine with #1 above, ↑↑ in consumption will be = (consumption multiplier) * (↑ in disposable income) = 5* ₹1 Lakh cr = ₹5 Lakh cr."

He says this year, increase in consumption is 7.3% on a GDP increase of 6.4%. "So, for FY26, with expected GDP ↑ (increase) of 6.3%, ↑ (increase) in consumption can be estimated proportionally to be 7.2%. Remember, this is without the impact of the ↓ (increase) in PIT in #Budget2025."

He estimated that in FY26, the increase in consumption will be around 12%. "Now, we can estimate what will be the total increase in consumption due to ↓ (fall) in PIT. From GDP estimates (https://tinyurl.com/2s47xfxz), consumption (real) in FY25 is ₹104 Lakh cr. As 5/104=4.8%, ↓ (fall) in PIT (personal income tax) will deliver additional ↑ in consumption of 4.8%. So, I estimate ↑ in consumption in FY26 to be 4.8% + 7.2% (as estimated in step #5) = 12%."

He also claims the overall impact of this on India's economy will be GDP increase of 9%. "Finally, what will be the impact on GDP? GDP (real) in FY25 is ₹185 Lakh cr. As 5/185=2.7%, ↓ (fall) in PIT will deliver additional ↑ (rise) in GDP of 2.7%. So, I estimate ↑ (rise) in GDP in FY26 to be 6.3% (w/o ↓ (fall) in PIT) + 2.7% (impact of ↓ (fall) in PIT) = 9%."