Deficit-financed tax cuts could be a better option to revive the economy hit by global financial crisis as government spending is not effective due to leakages and delay in execution, economists feel.
They say tax cuts have a much better multiplier effect - that is initial spending leading to much greater increase in national income - than government spending. Moreover, impact on government finances is same as both tax cuts and government spending are deficit-financed.
"Tax cuts are a positive booster for the economy. People can decide their spending pattern," said Sumita Kale, chief economist with Indicus Analytics, an economic research firm. However, she added tax cuts could co-exist with government spending also.
Faced with slowdown in growth, the government announced a fiscal package in the first week of December where it outlined plans to spend Rs 20,000 crore (Rs 200 billion) on infrastructure projects in addition to 4 percentage points cut in excise duty. The total cost to the exchequer was estimated at around Rs 31,000 crore (Rs 310 billion).
The government is also planning to announce a second round of stimulus package over the next few days, and enhanced infrastructure spending is likely to remain a top priority along with other sectors that were left out in the first round.
The idea behind government spending is to compensate for projected fall in private investment, which contributed 60 per cent of growth during the last financial year. Investment rate increased to 39.6 per cent of Gross Domestic Product - the sum of goods and services produced - in first half of fiscal 2008-09, compared with 37.4 per cent in 2001-08, according to initial estimates by the Central Statistical Organisation.
"Public investment is not effective as private investment," said D K Joshi, economist with Crisil Ltd, a ratings and advisory firm in an earlier interview.
A recent paper written by two economists after analysing the US economy has found tax cuts are better than government spending. "Our key finding is that the best fiscal policy to stimulate the economy is a deficit-financed tax cut and that the long-term costs of fiscal expansion through government spending are probably greater than the short-term gains," Andrew Mountford and Harald Uhlig wrote in a paper titled 'What are the effects of fiscal policy shocks?' A similar research paper covering the Indian economy could not be found immediately.
Corporate tax cuts preferable: In the current scenario, where individuals are cutting back their spending and hoarding cash, there is a view that deficit-financed tax cuts should be given only to companies.
"Consumer expenditure will not rise fast, as they are in recessionary spending mode," said Manika Prem Singh, an independent economist. "Also, the time-lag is longer," she added, referring to the transmission mechanism where tax cuts to individuals would lead to higher savings, and then banks reduce their lending rates.
Experts also say the government should use the opportunity to create a safety net for workers in the labour-intensive sectors, which are slipping very fast, said Joshi of Crisil, adding this is an "effective form of subsidy".
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