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The Union Budget shot down all talk of a boring, business-as-usual budget by delivering on several fronts. The Finance Bill, which made substantial changes to the income tax rates, contained the most noteworthy reform. The government has offered significant tax breaks to all income levels, answering the middle class’s demands. Under the new rates, a person making INR 21 lakh (US$100,000 at PPP) will pay INR 95,000 less in taxes. Even while this could be classified as populist policymaking, it nevertheless benefits development in two different ways. First, increased consumption will lead to growth by increasing aggregate demand. Second, distributive fairness and inequality reduction will result from the tax cuts.
India's growth trajectory has not followed the export-led, manufacturing-dominant model of the East Asian tigers or the growth marvels of the previous century.
Shifting the focus to consumption-led growth
India's growth trajectory has not followed the export-led, manufacturing-dominant model of the East Asian tigers or the growth marvels of the previous century. Although services have been essential to the supply side, it is frequently forgotten that India has grown mostly due to demand, following a path of consumption-led growth. Both the co-movement of their development paths (barring shock outliers) and the dominant share of consumption in GDP (C/Y) make this clear. Over the past 10 years, this phenomenon has become even more pronounced, with a higher correlation between GDP growth and a rise in consumption. Increased disposable incomes that directly stimulate discretionary spending are therefore likely to have a significant multiplier effect on growth.
Source: RBI
The Finance Minister, Sitharaman, anticipates a loss of INR 1 lakh crore in direct tax income under the new proposed rates. The author has estimated the costs and benefits of the proposed adjustment using the income tax return statistics for 2023–2024 for consistency. 7.6 crore of the 9.1 crore taxpayers submitted taxes in 2023–2024. This indicates that barely 15 percent of India's 64 crore workers pay taxes. Nonetheless, the number of taxpayers has increased substantially, rising by 82 percent during the past 10 years. Nearly 90 percent of tax filers will not be required to pay any income tax, which will relieve an additional 50 lakh people of their tax duties, according to data on income distribution.
Economic benefits of the tax cut
Using averages for each income group and analysing the change in tax requirements, it was predicted that the net difference in tax collection would be around INR 80,000 crore. Stated differently, Indian consumers will have access to an extra INR 80,000 crore in revenue. The multiplier mechanism—the repeated rounds of injection into the economy because of its circular nature—would have a far greater overall impact on this transfer. To keep things simple, let us look at India's gross savings rate, which is about 30 percent. As a result, the average propensity to consume accounts for 70 percent of income. The marginal propensity to consume (mpc) is approximated to this. Note that this is a strained assumption since mpc being equated to apc, is usually applicable at high-income levels.
Lower public borrowing in the upcoming years will reduce inflation, given the government's prudent approach by the Fiscal Rules and Budget Management Act (FRBMA).
The multiplier impact has the potential to raise consumption expenditure by INR 2.5 lakh crore, or 1.25 percent in nominal terms. GDP growth will directly mirror this, yielding nominal growth of about 11 percent in 2025–2026. Furthermore, the steady rise in tax revenue will make fiscal consolidation easier, presuming that India is operating in the Laffer Curve's prohibitive range. Lower public borrowing in the upcoming years will reduce inflation, given the government's prudent approach by the Fiscal Rules and Budget Management Act (FRBMA). Real economic growth of at least 8 percent can be achieved with the resulting lower deflator.
Distributive justice through a tax cut?
India's income disparity has been a recurring topic of discussion, raising concerns about the country's development potential and fiscal policies. Even among taxpayers, where only 40 percent of income goes to the poorest 90 percent of the population, income inequality is present. The degree of income inequality among taxpayers is indicated by the area between the Lorenz Curve and the line of equality (Figure 2). Tax cuts exacerbate income disparity, according to conventional economic literature. The premise that social transfers will be reduced while the wealthy benefit is the result of these studies' primary focus on tax breaks for the wealthy. On the other hand, total tax rate rationalisation with reduced burdens at the lower end of the income distribution may produce different outcomes.
Figure 2: Lorenz Curve of Income Tax Payers in India
Source: Computed by author from IT statistics
The tax burden will shift to high-income earners as a result of the decision to decrease taxes across all segments until INR 30 lakhs. 81 percent of the tax burden would now fall on those making more than INR 1 crore per year, up from 77 percent under the previous rates. Even if it's a modest step in the right direction, it can inspire bigger ones down the road. The growth process is also linked to greater equality. Because of the behavioural characteristics of mpc, a lower proportion of tax burden at lower income levels results in a bigger consumption multiplier. As a result, by strengthening the mechanism for consumption, the tax change may both reduce inequality and promote growth.
The nation's desired self-sufficient, industry-heavy growth trajectory can be started with a gradual increase in the savings rate.
Implications for Viksit Bharat
For India to achieve its aim of becoming a high-income country by 2047, there must be a structural change in its rate of growth. In addition to boosting demand, the implicit increase in disposable income will allow for more capital accumulation through the savings channel. The nation's desired self-sufficient, industry-heavy growth trajectory can be started with a gradual increase in the savings rate. It should be highlighted, nevertheless, that consumption will remain the crucial element for at least the medium term. The multiplier results presented here are cautious underestimates that do not take into account the relationships between supply and demand. If there are no restrictions on growth, more consumption will result in a greater need for services, which will increase output and exports. Therefore, Viksit Bharat's chances depend on how consistently, creatively, and quickly policies are implemented.
Arya Roy Bardhan is a Research Assistant with the Centre for New Economic Diplomacy at the Observer Research Foundation
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