The Modi government’s main move in the Union Budget 2025 has been to cut personal income tax. As finance minister Nirmala Sitharaman said in her speech, it is meant to boost demand in the economy. However, the government doesn’t expect a higher-than-usual increase in other non-debt receipts and has budgeted a decline in the deficit. The budgeted capital expenditure is the same as the revised estimates for 2024-25.
In other words, the tax cut has come at the cost of lower revenue expenditure as a percentage of GDP. The net impact of this will depend on how the trade-off plays out.
Since 2016, the Indian economy has struggled to sustain rapid growth. From 2016 to 2019, it was in a relentless showdown, with GDP growth falling to 3.9 per cent in 2019-20. The GDP then fell sharply in 2020-21 due to the pandemic.
After this sharp decline, high GDP growth numbers created a false sense of complacency, but the compound annual growth rate between 2019-20 and 2024-25 is only 4.8 per cent. The latest GDP estimates suggest that the economy is slowing down again—with growth clocking at 5.4 per cent in the July-September quarter of 2024. Even if we set aside the critiques of GDP estimation in India, growth remains a topic of concern in policy conversations.
The government’s response to an economic challenge depends on what it considers to be the root cause. The Modi government’s actions over the past decade suggest that it seeks to address India’s economic growth pangs through fiscal policy. Consequently, fiscal policy has done much of the heavy lifting in the government’s growth strategy over the past decade.
In the economic slowdown from 2016-17 to 2019-20, the government sought to maintain its expenditure. To do so without increasing the reported fiscal deficit, from 2017-18 to 2019-20, it transformed a significant part of its on-budget expenditure into off-budget expenditure done by public enterprises. It also sharply raised cesses and surcharges on petroleum products, which are not shared with the states. These unusual tactics allowed the government to spend more, and expenditure continued to outpace GDP growth.
These tactics also allowed the government to introduce new cash transfer schemes such as PM KISAN and increase allocations to existing schemes.
In 2019, in an effort to stimulate investment, the government announced major tax breaks for corporates, especially in manufacturing. At the time, corporate tax collection had been growing rapidly while other taxes were struggling to deliver the budgeted increase. The tax cut led to a sharp reduction in the corporate tax to GDP ratio in the subsequent years.
As the pandemic hit, fiscal policy became even more central. The pandemic allowed the government to suspend its concern for deficits and bring the off-budget expenditure to the Budget in 2020-21. For a few years, revenue expenditure as a percentage of GDP was higher than its pre-pandemic levels. Among other things, this allowed the government to increase subsidies and cash transfers, and introduce production-linked incentives for manufacturing in India. Total subsidies as a percentage of GDP have now gone back to theirpre-pandemic levels.
The most important change in expenditure since the pandemic has been in its composition. Of the Union government’s total expenditure, the share of capital expenditure has increased. Its share rose from 12.5 per cent of total expenditure in 2019-20 to 22.2 per cent in 2023-24.
In 2019-20, capital expenditure was 1.67 per cent of GDP. It rose to 3.21 per cent in 2023-24, before moderating to 3.14 per cent in 2024-25 (revised estimates). It is again budgeted to be 3.14 per cent of GDP in 2025-26.
At the same time, there was a reduction in capital expenditure by public enterprises in these years. If we consider the combined capital expenditure by the Union government and its public enterprises from the pre-pandemic years, there has been a decline.
Between 2017-18 and 2019-20, the combined capital expenditure was 4.94 per cent of GDP, while it has been only 4.32 per cent of GDP between 2022-23 and 2024-25. This probably shows the limitations of implementation capacity that a capital expenditure strategy tends to run into.
So, in the last decade, the government has tried a variety of fiscal tactics—from increasing expenditure by “creatively” easing the Budget constraints, to giving generous corporate tax cuts, to introducing new welfare schemes, to increasing on-budget capital expenditure. The cut in the personal income tax is the latest in this series of measures.
If this does not work, there are other arrows in the fiscal quiver—cut in GST, for instance. The fiscal policy landscape in India is such that there are always some instruments at the government’s disposal, especially because it borrows domestically for the most part, that too, through financial institutions it controls.
All this tells us something about the government’s explanation of how the economy works and what the challenges are. The government probably does not see deeper problems in the political economy. Now that it has made so many fiscal policy interventions, perhaps it should consider whether these can truly address thegrowth pangs of the Indian economy.
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The fundamental challenge for the Indian economy for over a decade has been the lack of revival of private investment and the lackadaisical performance of merchandise exports. While the latter performed well for about six quarters in the post-pandemic period, this was due to temporary opportunities created at that time—the exports are now back to low growth. Similarly, there have been a few quarters of better private investment activity in recent years, but we are not yet in a period of revival.
On the other hand, some high-productivity services sectors continue to be the silver lining. The IT services exports have continued to grow and export services such as business and management consultancy as well as public relations have doubled from the pre-pandemic years.
The FM’s Budget speech and Economic Survey 2024-25 hinted at actions beyond fiscal policy—deregulation and tax code simplification. Depending on what reforms will follow, these can be steps in the right direction. However, two points are worth considering.
First, mere deregulation is not enough—a well-functioning market requires a suitable regulatory role of the state. The growing cottage industry of deregulation enthusiasts focuses too much on removing regulations that it deems unnecessary, without offering a full vision of what regulation is needed in a given sector. In the absence of a proper framework, one step toward deregulation is often followed by another step toward an unnecessary regulation.
Second, there is a need for a broader and deeper introspection on how the government wields power in the economy. Many aspects of the larger institutional environment need careful attention: the centralisation of discretionary power, the top-down mandates issued in areas such as digital transformation, the way tax administration determines the additional demands from individuals and businesses, the checks and balances on various enforcement authorities, the transparency and reasoning of economic policymaking, and the consequences of supporting “national champions” on other investors’ incentives.
It is time to look beyond fiscal policy to address deeper problems in India’s political economy.
Suyash Rai is the Chair of Research, Centre of Excellence, CEPT University. Views are personal.
(Edited by Prasanna Bachchhav)
