India’s tax cuts: Structural inefficiencies temper expected benefits

Need for holistic policy reforms beyond tax cuts

In India, recent fiscal policies have aimed to stimulate economic growth through tax cuts, with the government reducing corporate tax rates in 2019 and personal income tax rates in 2025. While the former bought little change, experts argue that tax reforms alone may not be enough to generate sustainable growth, calling for a more comprehensive approach to address underlying issues.

In the Union Budget of 2019, the Government of India announced a substantial cut in corporate tax rates, aiming to stimulate private investment and boost economic growth. The government reduced the tax rate for existing companies from 30 pc to 22 pc, and for new manufacturing companies, the rate was slashed from 25 pc to 15 pc.

This move was part of a broader set of fiscal measures intended to revive the Indian economy, which was facing a slowdown at the time. The intention was to create a more attractive business environment, encouraging both domestic and foreign investments, thereby spurring job creation and economic growth.

However, despite the government’s expectations, the tax rate cuts did not lead to the desired surge in private investment. In fact, the reduction in corporate tax rates resulted in a significant tax revenue loss, amounting to approximately INR 1 trillion in the fiscal year 2020-21. This loss raised concerns about the long-term fiscal health of the country, as it reduced the government’s ability to fund public welfare schemes and infrastructure projects.

A key reason for the limited impact of the tax cuts on private investment is the broader structural issues in the Indian economy. According to the Economic Survey 2020-21, corporate investments in India have remained sluggish due to several factors, including low consumer demand, a fragile banking system, and high levels of non-performing assets (NPAs) in public sector banks. Despite the tax incentives, the demand-side challenges, including a slowdown in consumption and the global economic uncertainty, meant that businesses were reluctant to increase their capital expenditure.

Another factor to consider is the profound impact of the pandemic, the aftershocks of which continue to be felt both within the Indian economy and across the global landscape.

“While evaluating corporate tax reforms of 2019, we have to consider the impact of Covid-19 on the global economic conditions. While theoretically, the corporate tax cuts are known to stimulate private sector investments, however, this policy did not yield the desired results primarily due to Covid-19. Post the pandemic, the corporates re-strategized their investment patterns, expenditures and overall market strategy. While tax cuts should improve corporate profitability and free up capital for reinvestment, businesses require policy clarity before committing to long-term projects. Ambiguity on economic rebound post lockdowns discouraged firms from making fresh capital expenditures,” says Afaq Hussain, Director at the Bureau of Research on Industry and Economic Fundamentals (BRIEF), a public policy research and consulting organisation, tells Media India Group.

Data from the Ministry of Finance showed that despite the corporate tax rate reduction, the country’s Gross Fixed Capital Formation (GFCF) remained low, indicating that the anticipated boost in private investments was not materialising. According to the National Accounts Statistics, India’s GFCF as a percentage of GDP stood at a mere 28.6 pc in 2019-20, down from 31 pc in 2017-18, pointing to a lack of substantial private sector investment in capital-intensive projects.

One of the more significant criticisms of the government’s tax cut move was the missed opportunity to pair the tax reduction with complementary structural reforms, such as labour market flexibility, infrastructure development, and improvements in the ease of doing business. A lack of a comprehensive strategy to address the root causes of poor investment, including regulatory hurdles and poor infrastructure, meant that the tax cuts alone did not lead to a significant increase in private sector activity.

“Despite potential benefits from lower tax burdens, companies limited reinvestments of profits at the expected scale. Instead, they have prioritised cash reserves, debt reduction, and shareholder pay-outs over fresh capital expenditure. This also reinforces the idea that tax cuts alone are not sufficient to drive investment, broader economic stability, demand revival, and cost rationalisation play equally critical roles,” adds Hussain.

The union budget 2025

This year, the government has put an additional INR 1 trillion into the hands of India’s urban middle class by cutting personal income tax (PIT). The new tax regime includes full exemption for individuals earning up to INR 1.2 million per year and extends tax slabs, with a new 25 pc slab for incomes between INR 2 million and INR 2.4 million.

The introduction of this new tax regime in Budget 2020-21 aimed to simplify tax compliance and provide relief to middle-class taxpayers, with the intention of stimulating consumption. But the responses of the beneficiaries of the tax rebate seem to be skewed towards investing or saving the additional disposable income that they may end up, rather than follow the government’s expectations of spending the windfall.

“I will mostly invest it, makes sense to put the extra money to work while it is still tax-free. Might set some aside for experiences too, but the priority is growing it for the long run,” Deepti Sachdeva, a teacher based in Delhi tells Media India Group.

However, one may question whether this scheme will be truly effective if the government does not focus on addressing other critical issues, such as inflation and necessary structural reforms.  The Monetary Policy Committee of the Reserve Bank of India, at its meeting last week, has retained its inflation projection for FY25 at 4.8 pc.

While tax cuts might provide immediate relief, without tackling the broader economic challenges, such as rising prices and structural inefficiencies, the scheme’s long-term impact could be limited. The old debate resurfaces: will the tax relief be enough to drive sustainable growth, or will it only temporarily hide the deeper, unresolved structural problems in the economy?

“Favouring one policy reform over the other can be detrimental to the economy. For instance, the 2019 corporate tax cuts aimed to stimulate private investment, yet their impact was constrained by high personal income taxes, which limited disposable income and consumer demand. The 2025 income tax reduction seeks to correct this imbalance by boosting household spending, which would drive economic activity. A synergistic approach, rather than favouring one policy over the other, is essential for fostering holistic economic momentum that reverberates at all socio-economic levels and class groups. With the revised lower tax slabs, earners now have more scope for higher disposable income and increased consumer spending,” says Hussain.

“While the need of the hour is tax cuts and the government has successfully delivered, . Long-term sustainable growth cannot be achieved through tax cuts alone. While the income tax reduction fuels demand, the government must complement this with policy measures that lower business costs, ease credit access, and support MSMEs, owing to their economic importance, as they contribute 30 pc to India’s GDP and approximately 46 pc to India’s exports. This goes in line with India’s vision of establishing itself as a global manufacturing hub, making MSMEs crucial for growth. An additional boost is also expected for the logistics and shipping due to an extension of tax exemptions for another 10 years for raw materials. Combined, these sectors will determine the true effectiveness of these fiscal policies,” he adds.