The Three Important Tax Cuts: Prof Prasanna Tantri On Why Less Government Means More Growth

In our latest conversation on Swarajya's "What This Means" podcast, Professor Prasanna Tantri, Associate Professor of Finance and Executive Director at the Centre for Analytical Finance at the Indian School of Business, shared his takeaways on Q1 GDP numbers, GST reforms, the next-gen reforms and the road ahead. Here's a comprehensive breakdown of the key takeaways from this discussion.

Q1 GDP Numbers: Understanding The Business Cycle Reality

The Q1 GDP growth of 7.8% caught markets and analysts off guard, significantly outperforming expectations of 6.5-7%. However, Professor Tantri warns against reading too much into a single quarter's performance. "This is a business cycle," he explains. "There will be times when you get six, times when you get seven."

The key insight is that India appears to be moving from an average growth trajectory of 6.5% to 7%, with quarterly oscillations between 6% and 8%. This represents genuine improvement, but not a fundamental shift to a higher growth trajectory. As Tantri emphasises, "Moving averages are better numbers – the last four-quarter average or six-quarter average" provide clearer insights than single-quarter data.

RBI's Policy Corrections: From Monetary Tightness To Growth Support

The Reserve Bank of India's role in the recent growth acceleration cannot be understated. Tantri had previously criticised the RBI for maintaining artificially tight monetary policy, arguing that "at least a per cent was artificial" in the earlier 5.7% growth figure (Q2 GDP FY25). The central bank was "unnecessarily keeping things very tight" due to food inflation concerns.

The RBI's logic was flawed, according to Tantri's analysis. Using a practical example, he notes, "Last year the onion price went up. Did employers increase salaries dramatically? I don't think so." The fear that food inflation would lead to wage-price spirals was unfounded, as demonstrated when good monsoons brought food prices down naturally.

The RBI has since cut rates by 100 basis points, contributing to the growth recovery. However, Tantri cautions against excessive rate cuts, suggesting another 25-50 basis points would be appropriate while avoiding the trap of cutting rates to 3%, which "will create too much money in the system."

GST Revolution: From Complex Web To Simple Structure

The GST rate rationalisation represents perhaps the most significant tax reform done recently. The reduction to essentially two main slabs (5% and 18%) marks a dramatic simplification from the previous complex structure that generated numerous classification disputes.

"Even in my wildest dreams, I did not expect such a nice clean reform," Tantri admits. The previous system created endless disputes – businesses arguing their products belonged in lower tax brackets while the government insisted on higher rates. The new structure eliminates most of these conflicts.

Beyond rate cuts, procedural reforms may prove even more impactful. The promise of GST registration within three days and operationalising GST appellate tribunals represents a fundamental shift in the government's approach to taxpayer relations.

The Economics of Tax Cuts: Why Short-term Pain Leads To Long-term Gain

A critical misconception surrounds the impact of recent tax cuts. Many expect immediate consumption boosts, but Tantri explains why this logic is flawed. When someone receives a tax cut of ₹1 lakh, they indeed have more money to spend. However, "this ₹1 lakh government used to spend this ₹1 lakh earlier. That used to be income for someone. That guy used to spend."

The government's approach of cutting taxes while simultaneously reducing expenditure means there's no net consumption boost in the short term. "Somebody who would have earned that money is not going to earn that money and will not spend – that will offset this," Tantri explains.

However, there will be some consumption boost post 22 September, but the real benefits lie beyond the consumption boost. The benefits operate through more sophisticated economic channels:

Eliminating Deadweight Losses: Taxes create inefficiencies where production gets lost because taxes increase producers' costs without providing equivalent consumer utility. Reducing taxes restores this lost production.

Labour Supply Response: Higher after-tax returns make work more attractive relative to leisure. As Tantri illustrates: "By working one hour, if I can buy one chocolate... if by increasing taxes by working for one hour I get only half chocolate, then I would say maybe this chocolate is not worth this one hour work - I will not do it."

Investment Incentives: Lower taxes mean higher returns to capital, encouraging increased investment across the economy.

These mechanisms will add an estimated 0.5% to GDP growth in the long run, though it will not be immediately visible in quarterly numbers.

Government Expenditure: The Path To Minimum Government

The three tax cuts have been very clean. The corporate tax cut, along with the individual tax cut and GST reforms, has been substantial enough to make a real difference, according to Prof Tantri.

One of the most underappreciated achievements of the central government has been the reduction in government size as a proportion of GDP.

When the corporate tax cut happened in 2019, it did not lead to investments at the time. This was because the government simultaneously increased tax collections and expanded its size. Government expenditure went up to about 15% of GDP, and tax collection rose. But in the last two years, that number has been brought down. According to the data, the government’s share of GDP has fallen from 15.5% to less than 14%.

"This is a BIG achievement." After this year’s budget, if spending stays around ₹52 lakh crore and GDP is roughly ₹400 lakh crore, the government’s share will be about 12.5%.

For context, in the 1920s, before the Great Depression, the US had its best decade when government spending was nearly 10% of GDP. "You really cannot get more “minimum government” than that," says Prof Tantri.

People often don’t realise that India is among the least taxed countries in the world. Yes, the burden is concentrated on certain groups, which is why complaints are common, but at an economy-wide level, the tax take is very low.

These 3 tax cuts represent a fundamental philosophical shift. The previous approach of "tax people to the hilt and then put it on infrastructure" has been abandoned in favour of leaving more resources with the private sector. The government promised "minimum government, maximum governance" and is delivering on this vision.

"The last two years of tax cuts, combined with expenditure cuts, send a clear signal: the government wants to leave more money with private players and make things simpler. I believe this will spur growth, and that’s why I remain very optimistic," he adds.

However, questions remain about infrastructure spending priorities. Tantri questions whether taxpayer money should fund projects like Vande Bharat trains or airports in commercial locations: "If Vande Bharat is a good investment, then the railway should be able to borrow. If an airport in some random place is a good investment, then the airport authority should be able to borrow."

Public spending should focus on genuine market failures – health insurance (due to information asymmetries), education, and infrastructure in strategic border areas where private markets won't operate.

Manufacturing vs Services: Challenging Conventional Wisdom

Despite celebrating manufacturing through PLI schemes, Tantri notes that "share of manufacturing as GDP has gone down, hasn't increased. All the growth that we're celebrating is driven by services."

The common belief that manufacturing creates jobs for the poor while services only benefit the educated is "so wrong." Two-thirds of workers are in services, including drivers, hairstylists, entertainers, and tourism workers. "The Kumbh Mela is service/tourism."

India's tourism performance illustrates missed opportunities. Paris receives more tourist income than all of India, which earns just $27 billion annually. India's world share of tourism revenue has declined from 2.2% to 1.8% post-COVID.

The PLI scheme analysis is sobering: ₹15,000 crore spent allegedly generating 5 lakh jobs works out to ₹5-6 lakh per job - assuming all jobs were incremental, which is questionable.

More than manufacturing, Prof Tantri believes better alternatives might include improving tourist destinations like Hampi or attracting innovative talent back to India.

He says: "One thing the government should focus on more than "Build in India" is to "Innovate in India". And bring back innovators living abroad who are frustrated with what’s happening in the US and Australia and want to return. Create campuses where they can stay and work. They will be the job creators, and that will be a game changer."

Next-Generation Reforms: Focus On Innovation

Looking ahead, India's reform agenda should focus on structural changes rather than protective measures. Tantri warns against excessive protectionism in the name of Atmanirbhar Bharat: "If in the name of helping businesses, if we just block ourselves to international trade... that is my worry."

The textile sector provides a cautionary example, where quality control requirements have made imports so difficult that small players are struggling. This risks returning to pre-1990 inefficiencies where lack of competition produced inferior products – "Bajaj Chetak, as we remember, you had to tilt and start."

Three critical areas need attention:

Contract Enforcement: Without reliable contract enforcement, large-scale investment remains constrained. The government can lead by reducing its own litigation and reforming commercial courts.

Competition Policy: Many sectors have become oligopolistic - airlines effectively have two major players, telecom is dominated by two-three companies. "Oligopolists and monopolists have no interest in expanding production. They want to reduce production and keep prices high."

Talent Attraction: Rather than low-value production, India should focus on attracting innovative talent. European countries like France offer tax waivers to returning innovators. India should create similar programmes and improve urban infrastructure to support high-skilled professionals.

The Road Ahead: Building On Strong Foundations

The confluence of factors - fiscal consolidation, monetary policy normalisation, tax simplification, and regulatory improvements – creates an unusually favourable environment for growth. Unlike previous reform cycles, this time multiple policy levers are aligned correctly.

The government has demonstrated its willingness to take revenue losses from tax cuts while maintaining expenditure discipline. This approach, while not providing immediate consumption boosts, creates the foundation for sustainable long-term growth through improved incentives for work, saving, and investment.

Critics expecting immediate dramatic changes will be disappointed. But for those understanding economic fundamentals, these reforms represent the most comprehensive pro-growth policy package in recent memory.

The foundations are now strong, if executed consistently, these reforms could establish India on a higher sustainable growth trajectory – not through government spending or short-term stimulus, but through the more powerful mechanism of removing impediments to private sector dynamism.

The true test will be whether this momentum continues with deeper structural reforms in contract enforcement, competition policy, and talent attraction.