Do tax cuts boost growth? What history tells us about fiscal stimulus—in charts
Tax cuts, like interest rate cuts, are a tool to stimulate economic growth, but their effectiveness is mixed and depends on various factors. Mint looks back at major tax cuts and fiscal stimulus, and whether they were able to achieve their intended goals.
Tax cuts are to fiscal policy what rate cuts are to monetary policy—both are tools to stimulate economic growth. This has been a bumper year for tax cuts: in February the Union Budget raised the exemption limit for income tax, and in August GST rates were cut across a swathe of goods and services. The former was pitched as a reward for the hardworking middle class and the latter as a structural reform, but both measures were aimed at stimulating growth through increased consumption.
Tax cuts contribute to growth through two channels. The income effect boosts consumption and investment by unlocking income. A cut in income tax payable directly increases disposable income; a drop in GST does the same by reducing the cost of goods and services purchased. The price effect boosts demand by increasing purchasing power: that’s because a GST cut is expected to reduce MRPs of affected items. Additionally, an across-the-board GST cut encourages consumers to upgrade to premium items.
That’s the theory— but past episodes show that the impact of tax cuts on growth is mixed and depends on other factors, both internal and external.
1997: Dream budget
Consider the 1997-98 ‘Dream Budget’, which ushered sweeping cuts in personal and corporate income taxes, abolished double taxation of dividends, reduced peak customs duty, and simplified excise duties. Fortunately, wage hikes awarded by the Fifth Pay Commission were also implemented during 1997-99.
The result was a reversal of the cyclical downturn that had bogged the economy since the end of 1996-97. More importantly, tax collections remained buoyant for a few years following this budget, thus allowing the government to fund its fiscal expansion without excessive borrowing.
2009: Fiscal stimulus
If the 1997-98 budget improved investor sentiment and laid the policy groundwork for the 2003-07 boom, tax cuts in 2009 had the opposite effect. The government introduced three fiscal stimulus packages between December 2008 and February 2009 in response to the global financial crisis. The package included across-the-board excise duty cuts, a 2% cut in service tax and customs duty exemptions for inputs to specific exports. The cuts were temporary and meant to support the economy.
Sure enough, by 2010-11, both consumption and investment had rebounded, and economic growth shot up to 8.5%. But the effect was short-lived. Farm loan waivers and food and fuel subsidies had already caused a fiscal slippage in 2008-09; the additional stimulus only worsened the centre’s fiscal deficit.
The 2009 strategy backfired for two reasons. One, instead of offsetting tax cuts with lower spending, the government increased welfare expenditure, thereby worsening its fiscal deficit. Since the adoption of FRBM rules in 2004 and until the global financial crisis, the centre was on a path of fiscal consolidation, largely driven by buoyant tax revenues. But the growth slowdown in 2008, and the 4-6% cut in excise duties led to a sharp drop in tax revenue (excise was the government’s second largest revenue earner).
Two, by 2012, rising crude prices pushed up imports, and slowing growth hurt exports. As the current account deficit worsened, the rupee depreciated, and foreign investors pulled out of India. Inflation shot up to 10.2% in 2012-13. In sum, all macros were flashing red. The result was that India flipped from emerging market star to a “fragile five" nation.
2019: Corporate tax cut
In September 2019, the corporate tax rate for domestic companies, including surcharge and cess, was cut from 34.94% to 25.17% for existing firms, and to 17.16% for firms incorporated on or after 1 October 2019. The aim was to stimulate corporate investment and create a multiplier effect on growth through job creation and income generation.
Unfortunately, demand conditions worsened soon after, beginning with the pandemic in 2020, which was followed by the Ukraine-Russia war in 2022. The resulting uncertainty caused corporates to save rather than invest. In fact, while corporate profits were up by 22.3% in 2023-24, employment grew by only 1.5% (Economic Survey 2024-25). In other words, the private sector was not only refraining from investing, but also cutting back on hiring and expansion.
The 2019 tax reduction may not have started a private capex cycle, but it has made corporate balance sheets healthier because many firms used the funds released by the tax cut to pay down debt and build up cash balances. Presumably, these companies will be in a strong position to invest once demand picks up.
2025: GST cut
A successful transmission of GST cuts to growth will depend on a few factors. One, prices have to fall significantly for demand to pick up, but the extent to which rate cuts will be passed on to consumers is yet to be seen. Two, given the recent rise in household indebtedness, it is likely that debt reduction will take priority over consumption spending, thus reducing the effectiveness of a GST cut. Three, a demand boost, if any, may just offset the expected decline in exports, so it may end up stabilizing growth rather than boosting it.
This creates a chicken-and-egg situation: households will spend if confident about future incomes and jobs, while businesses will hire and invest when they see demand from households. How this plays out will depend primarily on the global economic situation. A quick resolution of tariffs could spur exports and give the economy a solid growth impetus.
The author is an independent writer in economics and finance.
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