The biggest headline from the Union Budget for FY 2025-26 was the reduction in income tax for individuals. The government adjusted tax slabs and rebates, ensuring that individuals earning up to Rs. 12.75 lakh a year would pay no income tax. That translated to a maximum benefit of Rs. 83,200 for such taxpayers, with the relief increasing to over Rs. 1.25 lakh for higher income levels.
The government touted these tax breaks as a boost for the ‘middle class’ to drive consumption, estimating a total benefit of Rs. 1 lakh crore. However, while initial reactions, even from several misguided economists, were euphoric, stock markets soon turned pessimistic.
Was this tax relief overhyped? Could the same revenue sacrifice have been more effective in jumpstarting the economy? This article explores these questions and suggests what would have been a better approach.
Who Really Benefits from These Tax Cuts?
The claim that these tax cuts help the ‘middle class’ needs closer examination.
Less than 2% of Indians pay income tax. The remaining 98% either earn below the exemption limit or have tax-free agricultural income. Calling this small taxpayer base the ‘middle class’ is misleading.
According to the Pew Research Center, the middle class consists of individuals earning between two-thirds and twice the median income. In India, where the median annual income is about Rs. 3.3 lakh, the middle class falls within the Rs. 2.2 lakh to Rs. 6.6 lakh bracket. Many within this range do not significantly benefit from these tax cuts, while the wealthier gain disproportionately.
Will Tax Cuts Boost Consumption?
The effectiveness of tax cuts in driving consumption depends on the marginal propensity to consume (MPC)—the fraction of additional income that people spend rather than save. Lower-income groups have a high MPC, often spending every additional rupee they earn. In contrast, higher-income earners tend to save rather than spend additional disposable income.
Since these tax cuts primarily benefit the wealthier segment, the additional disposable income is unlikely to translate into substantial consumer spending. The Rs. 1 lakh crore in tax relief may not generate the intended economic boost.
A Smarter Alternative: Reduce GST on Essential Goods
Rather than offering tax cuts to a small, wealthier segment of the population, the government could have spurred consumption more effectively by reducing Goods and Services Tax (GST) on essential consumer goods.
GST affects every consumer, rich or poor, making it a fairer tool to stimulate demand. Currently, many essential items, such as those listed below, are taxed at high rates:
· Food & Kitchen: Sugar, tea, spices, edible oils (5% GST), and kitchen appliances (18% GST).
· Personal Care: Hair oil, soap, and toothpaste (18% GST).
· Home Essentials: Umbrellas (12% GST), Electric lamps, furniture, mobile phones (18% GST).
· Clothing: Footwear (5% – 18% GST), apparel, and fabric (5% – 12% GST).
High GST rates on widely used goods hurt affordability, especially for lower-income groups. Cutting GST on these items would have lowered prices, boosted demand, and benefited a far broader segment of the population than income tax relief ever could.
The Politics of GST
A key challenge is that GST changes require consultation with state governments. While direct income tax changes can be announced in the Union Budget, GST adjustments involve a lengthier process. However, the government could have allocated funds for GST reductions in the budget and initiated the necessary discussions with states.
Moreover, broader tax reforms are needed to address the inequity in revenue sharing between the Centre and states. A more balanced tax structure would ensure that economic benefits reach all sections of society, rather than favoring a small group of taxpayers.
Conclusion: A Missed Opportunity?
The government had Rs. 1 lakh crore in tax relief at its disposal—but it used it in a way that primarily benefited a wealthy minority rather than the true middle class or lower-income groups. A better approach would have been targeted GST reductions that directly impact consumption and drive real economic growth.
If the goal was to boost demand and help the average Indian, the government squandered a golden opportunity to make a real difference.
It is still not late. The government should seriously consider Rs. 1-2 lakh crore GST relief on items of daily use even if that implies a slight increase in the budget deficit.
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