Relying on rate cuts

The government recently announced a 2% cut in excise duty and service tax rate to put some money into individual wallets and to boost consumer demand.

Rakesh Rai        Print Edition: March 19, 2009

It is not possible for me to indulge in financial profligacy without adequate resources,” said the acting Finance Minister Pranab Mukherjee, brushing aside criticism that the government was not doing enough to overcome the slowdown. However, the government recently announced a 2% cut in excise duty and service tax rate to put some money into individual wallets and to boost consumer demand.

The general excise duty has been reduced from 10% to 8%, and the rate of service tax cut from 12% to 10%. Also, the 4% excise duty cut announced in December 2008 will now continue beyond 31 March 2009. “The amount of money in the system is the same, but with this measure, the government has shifted some amount from its own reserves to the taxpayer’s wallet. This should spur demand,” says financial planner Rohit Sarin.

While the excise cut, if passed on to consumers, will mean that the prices of consumer durables, steel products and cars will come down marginally, it is the reduction in the service tax rate that will bring direct relief. Processing charges on loans and credit card transaction costs could witness some reduction as they include a service tax component. Consumers can also hope to save on outgoings on mobile recharge vouchers, direct-tohome packages and operating systems software..

For investors, risk premium charges for insurance policies, brokerage charges on securities and transaction costs on mutual fund investments will see a marginal reduction because all of them include a service tax element as well. “The cut in service tax will have a much wider impact,” says Sarin.

Will these tax cuts impact overall expenses? The indirect taxes contribute 6-15% of average monthly spending. Considering a typical taxpayer (between 28 and 35 years, living in a metro, with a family of three), we asked experts to work out a spending pattern and average applicable indirect taxes. The result: the minimum gain for someone earning Rs 5 lakh annually will be to the tune of 10%. These gains are more pronounced as income, and therefore spending, goes up (see table).

 

What you save after tax cuts
How much money does an average person save (on an annual basis)?
                                                                         Average* indirect tax (%)
Expense heads (Routine)
Expense (Rs)
Previous
Now 
Savings
Food   
72,000-1,20,000
12.5
10
1,800-3,000
Housing1,80,000-4,80,000
7
7
0
Health 
1,500-25,000
8
6
30-500 
Transport   
25,000-60,000
12.5
10
625-1,500 
Education 
8,000-35,0003
3
0
Clothing    
5,000-20,000
12.5
10
125-500
Durables    
3,500-25,000
12.5
10
87.5-625
Entertainment    
10,500-60,000
15
12.5
262.5-1500
Others 
12,000-75,000
7
7
0
Non-routine
Ceremonies 10,000-55,000
10
10
0
Medical 
3,000-15,000
6
6
0
Education 
2,500-8,000
3
3
0
Travel
20,000-75,000
87
200-750
Total 
3,53,000-10,53,000
  3,130-8,375 
Average saving from rate cuts: 10%
Figures are indicative. Actual tax may vary depending on income components. Actual indirect tax rates may vary considerably subject to actual component of expenditure, state and facts of case.


Will these measures induce people to spend more of what they’ve saved? “This will put additional income in the hands of the consumer. However, their impact on consumer demand will be limited,” says Hitesh Agrawal, head, research, Angel Broking. Experts believe that given the uncertainty over retaining jobs, consumption will remain tardy and the increased money will be saved. “These measures will mean that prices won’t go up,” says financial planner Brijesh Dalmia. That’s something, but a spending boost it isn’t.

- Rakesh Rai

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