GST rate cuts may not immediately boost demand; study by National Institute of Public Finance and Policy shows delayed, nuanced impact on consumption and income
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Illustration: Binay Sinha
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The goods and services tax (GST) regime was introduced with a complicated structure comprising five rate slabs and a general commitment to rationalise rates whenever possible. There have been a number of episodes of such re-calibration of rates, with the latest being operationalised in September 2025.
These adjustments have often been seen as a way to cheer customers and simplify the system. This cheer for the customer is often expected to result in a demand stimulus. A reduction in tax rates for a bundle of commodities, it is expected, would induce an increase in demand for these commodities. The extent of the increase depends on the price elasticity of demand and the degree to which lower taxes are passed on as lower prices to the consumer. Some studies in the Indian context suggest that the extent of passthrough is incomplete. In a working paper by the National Institute of Public Finance and Policy (NIPFP), Sacchidananda Mukherjee and Shivani Badola (working paper 444, 2025) suggest that the transmission varies across different categories of goods, with clear passthrough for consumer durables and limited passthrough for food, and household consumption goods and personal care. This will have implications on the extent of demand stimulus emanating from the tax cut.
An alternative way to look at the impact of tax cuts on the demand for final goods and services can be through marginal and average propensities to consume. Price changes and elasticities tend to focus on the marginal impact of a change in taxes — the impact of price changes on the commodity under consideration and its complements and substitutes. A related question to ask is whether changes in tax rates will translate into a change in the average or marginal propensity to consume. Would a reduction in tax rates result in an increase in aggregate demand such that the average propensity to consume becomes higher? If so, the multiplier for the economy would be higher and the net impact would be higher incomes and consumption. On the other hand, if the propensities to consume remain unchanged, a change in tax rates would lead to a shift in the composition of consumption rather than a change in its overall level. Here the demand stimulus would be limited to expenditure resulting from tax savings.
To explore which of these cases is playing out in India, we look at the monthly total income and consumption data for households available from the consumer pyramids survey by the Centre for Monitoring Indian Economy, the only source of information on monthly data. Two different aggregates of consumption are considered: Total consumption and consumption net of rent, fuel and power and EMIs. The former is referred to as total consumption while the latter is referred to as taxable consumption to derive a base closer to the tax base under GST. The ratio of consumption-to-income represents the average propensity to consume (Figure 1). We consider the average propensity to consume as it is more stable than the marginal propensity to consume.
To disentangle the impact of seasonality in the data, the series for the current year is juxtaposed against a similar ratio for other years. The graphs present some interesting trends. The average propensity to consume (APC) for total consumption in the last two years is moderately lower than during 2022-24. The APC in 2025-26 is not distinctly different until November, when compared to the trends for 2024-25. It should be noted that the reduction in tax rates was introduced effective from September 2025. The annual dip in consumption in December and January, however, seems to have been moderated in 2025-26. The APC in 2025-26 settles higher than in earlier years during the December-February period.
Turning to taxable consumption, the trends noted during December-February are evident. In other words, it appears that tax cuts might be associated with an increase in APC with a lag of a few months.
Taking the argument further, it is possible to argue that an increase in demand in response to a reduction in the tax rate should result in an increase in income for some segments of the population, creating second-round effects of the stimulus. To explore this aspect, Figure 2 shows the monthly growth in income. Here too, there is no evidence of higher growth in income in 2025-26 immediately following the tax cuts. The growth in 2025-26 appears to exceed that in 2024-25 only from January 2026.
From the limited evidence explored here, a change in the tax rate does not seem to induce an immediate increase in the APC. Consumers are not expanding their allocations for consumption expenditure from their incomes. Nor is there any evidence of a non-seasonal increase in income growth until about four months later. This is also a period when the repo rate was consistently being moderated in response to a moderation in inflation in the economy. The last two reductions were undertaken in June 2025 and December 2025, with a 25-basis point cut each time. This is also a period when cash reserve ratio was systematically reduced from 4 per cent to 3 per cent. Clearly, there were other stimuli at work as well. There is a need to disentangle the impact of taxes to the extent possible. The correlations suggested by this discussion imply that the demand stimulus from tax cuts may be more nuanced than widespread.
The authors are with the National Institute of Public Finance and Policy. The views are personal
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