Tax Cuts Create Fiscal Straitjacket for Governments
Governments across India find themselves in a tight financial spot. Both central and state administrations face growing constraints on their spending abilities. This situation developed gradually through a series of tax policy changes.
The Three-Pronged Tax Reduction Strategy
First came the corporate tax cuts in 2019. Then followed the restructuring of personal income tax slabs in the 2025-26 Union budget. Most recently, we witnessed the rationalization of GST slabs. Together, these measures have significantly reduced government revenue streams.
Despite substantial expansion of both direct and indirect tax bases over the past decade, these fiscal steps have created constrained finances. Governments now struggle to maintain expenditure levels despite public declarations of generous spending.
Significant Revenue Losses
Estimates of revenue foregone vary considerably but remain substantial. Initial calculations placed corporate tax cut losses at approximately Rs 1.45 lakh crore. Income tax restructuring resulted in about Rs 1 lakh crore in foregone revenue.
For GST rationalization, precise figures prove difficult to determine immediately. However, the impact will gradually manifest in tax collection data over coming periods.
Visible Fiscal Constraints
The financial shackling of government becomes clearly apparent in revenue trends. Over the past decade, the Centre's tax collections showed minimal growth. Net tax revenues stood at 7.2 percent in 2014-15, with only a modest increase to 7.9 percent budgeted for 2025-26. Actual collections might even fall short of these projections.
State governments experienced slight revenue improvements until recently. However, GST rate reductions now threaten their tax collections. Simultaneously, direct tax cuts combined with increased cesses and surcharges affect transfers from the central government.
Budgetary Impacts
The constrained financial position directly influences budget allocations. Consider the PM-Kisan scheme as an example. Actual spending reached Rs 60,989 crore in 2020-21, representing 0.30 percent of GDP. By 2025-26, the budgeted allocation dropped to Rs 63,500 crore, which translates to just 0.18 percent of GDP.
Overall, the Centre's expenditure-to-GDP ratio tells a similar story. Starting at approximately 13.3 percent in 2014-15, it rose during COVID years but settled at 14.2 percent budgeted for 2025-26. Revised estimates might show even lower figures.
Fiscal consolidation during these years resulted primarily from expenditure compression rather than significant revenue enhancement.
State-Level Consequences
The effects extend to state governments as well. Concerns emerged about cash transfer schemes potentially worsening revenue balances and reducing capital spending capacity. However, the reality proved more nuanced.
According to ICRA estimates, several states reduced spending in other areas to accommodate these cash transfers. This reallocation demonstrates their financial limitations.
Changes to the MGNREGA funding structure, now called VB-G RAM G, will further squeeze state fiscal space. Under the new framework, states must contribute 40 percent of incurred costs. If this funding model extends to other schemes, state governments will face even tighter constraints.
Long-Term Implications
These tax cuts will prove difficult to reverse given political economy considerations. Therefore, revenue constraints extend beyond the current period into the long term. This means not only present governments but future administrations will likely face similar financial limitations.
In an environment of competitive populism, this fiscal shackling restricts the political class's ability to adopt expansive welfare schemes. Only significant economic growth could potentially alter this trajectory.
Future Uncertainties
Two major uncertainties loom on the horizon. First, the 16th Finance Commission's recommendations regarding tax pool division between Centre and states will prove crucial. With limited resources available, any division will likely leave one side dissatisfied and financially constrained.
Second, the upcoming Pay Commission award could substantially increase fixed government expenditures. This development would further restrict available funds for other spending priorities.
All indicators suggest we may be moving toward a minimum government model. Whether this translates to maximum governance remains an open question for future assessment.
