The Union Budget 2025-26 takes a bold step in supporting middle-class consumers but does so at the cost of a weakened tax base
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Domestic consumption has long fuelled India’s economic growth, contributing nearly 57 to 60 percent of GDP. Historically, rising incomes, urbanisation, and demographic shifts have driven domestic demand, cementing consumption as a key pillar of India’s growth strategy. However, recent signs of stress have emerged, leading to a divergence between growth in private final consumption expenditure and the real GDP growth rate, primarily due to rising income inequality and a disproportionate tax burden on the middle class, both slowing consumption growth. As the Union Budget 2025-26 attempts to relieve some of these pressures through significant cuts in personal income taxes, concerns over balancing the objectives of growth, inclusivity, and fiscal prudence are likely to emerge.
India’s middle class, expected to reach 800 million people by 2030, plays a critical role in fuelling discretionary spending. Yet, this segment has faced a consistent tax burden, with direct and indirect levies such as GST, fuel duties, and other consumption-based taxes eroding disposable incomes. While successive budgets have attempted to provide relief, stagnating real wages and inflationary pressures continue to limit purchasing power.
The rich and ultra-rich, by contrast, have a low MPC, with a significant portion of additional income directed toward savings, investments, and offshore assets rather than domestic consumption.
In contrast, the ultra-rich in India enjoy significantly lower direct taxation compared to global benchmarks. Unlike many developed economies that implement progressive wealth taxes, capital gains surcharges, or inheritance taxes, India’s tax system places a heavier reliance on indirect taxes, disproportionately impacting lower- and middle-income households. The absence of targeted taxation on the wealthy means that fiscal consolidation efforts largely continue to rely on the middle class with higher Marginal Propensities to Consume (MPC), thereby constraining overall demand growth.
The MPC concept offers a crucial economic linkage between taxation, income distribution, and consumption growth. Low-income households have the highest MPC, meaning that most of their additional income is spent on essentials, creating strong demand-side effects. However, a large share of the Indian population belonging to this segment remains vulnerable to poverty and reliant on social protection to meet their subsistence consumption. The middle class, on the other hand, though having a slightly lower MPC than the poor, still channels much of its income toward consumption, particularly in discretionary sectors such as real estate, automobiles, and white goods. The rich and ultra-rich, by contrast, have a low MPC, with a significant portion of additional income directed toward savings, investments, and offshore assets rather than domestic consumption. While investment incentives for the wealthy can stimulate capital formation, they do little to drive short-term demand. Moreover, with the overall degree of capacity utilisation stagnating at around the 75 percent mark, there is little or no incentive for these households to invest further.
This imbalance creates a paradox. While tax relief for the middle class can boost demand, it also raises the risk of widening the fiscal deficit if not offset by alternative revenue sources. Without progressive taxation mechanisms for high-income groups, India’s consumption-driven growth path remains vulnerable to these structural demand weaknesses.
The Union Budget 2025-26 has delivered substantial tax relief to the middle class, a move designed to uplift disposable incomes and stimulate consumption. The most notable change is the increase in the nil tax slab from INR 7 lakhs to INR12 lakhs under the new tax regime, with salaried taxpayers effectively benefiting up to INR 12.75 lakhs due to the INR 75,000 standard deduction. Additionally, revised slabs ensure that taxpayers earning up to INR 12 lakhs owe no tax, while those earning INR 18 lakhs and INR 25 lakhs see respective reductions of INR 70,000 and INR 1.1 lakhs, annually.
With a shrinking tax base, revenue shortfalls could lead to higher borrowing or expenditure cuts, jeopardising critical long-term investments in the social sector.
While these tax cuts align to boost aggregate household consumption expenditure, a critical issue remains: there has been no compensatory tax increase for high-income earners. Individuals earning above INR 24 lakh continue to be taxed at 30 percent, the same as in previous years, with no additional wealth tax, inheritance tax, or capital gains adjustments. Consequently, the government stands to lose INR 1 lakh crore in direct tax revenue and another INR 2,600 crore from indirect tax reforms, intensifying fiscal pressures.
The budget bets that increased disposable incomes among the middle class will translate into higher spending, supporting industries such as housing, consumer goods, and automobiles. However, this assumes that a significant share of the additional income will be spent rather than saved, a premise that remains uncertain given current economic conditions. Moreover, the fiscal deficit is targeted at 4.4 percent of GDP for FY 2025-26 (40 basis points lower than the revised estimates for FY 2024-25), necessitating stringent fiscal discipline. With a shrinking tax base, revenue shortfalls could lead to higher borrowing or expenditure cuts, jeopardising critical long-term investments in the social sector.
While the budget promises increased spending on social protection and development, the lack of revenue offsets raises concerns about long-term funding sustainability. Several key welfare and infrastructure programs could face constraints. The government has expanded funding for livelihood programmes targeted at the informal sector, including a revamped PM SVANidhi scheme to provide increased credit limits for street vendors. Additionally, a social security scheme for gig workers will offer e-Shram registration and healthcare benefits to nearly 1 crore platform-based workers. However, sustaining these programmes amidst declining tax revenues may prove challenging, forcing potential reductions in scope.
A major budget commitment includes setting up 200 Day Care Cancer Centres in district hospitals and adding 10,000 medical college seats as part of a broader plan to create 75,000 seats over five years. While these initiatives are crucial for human capital development, their execution depends on stable fiscal resources. If revenue constraints emerge, healthcare and education spending could face delays or cuts.
The budget earmarks INR 1.5 lakh crore for interest-free loans to states for capital expenditure and an INR 1 lakh crore Urban Challenge Fund to drive city renewal projects, including improved water and sanitation. These programs are vital for long-term economic competitiveness but require predictable revenue streams to avoid disruptions. With the government foregoing over INR 1.026 lakh crore in tax revenues, financing these initiatives might become increasingly difficult in the absence of a widening tax base and a conservative estimate of tax buoyancy at 1.1. In the absence of new revenue sources, India may face a policy trade-off between fiscal consolidation and social investment.
While tax reliefs for the middle class are well-intended, the sustainability of this strategy remains questionable without targeted taxation for the ultra-rich. A few policy options could be explored to balance fiscal needs while maintaining economic equity.
Surcharges on ultra-high-income earners: Many advanced economies implement additional levies on annual incomes exceeding a certain threshold. A similar structure in India could offset revenue losses without harming middle-class consumption.
Capital gains and inheritance taxes: A progressive tax system should include mechanisms to tax inherited wealth and speculative capital gains, ensuring fair contributions from high-net-worth individuals.
Closing tax loopholes and strengthening compliance: Enhancing tax enforcement, reducing evasion, and rationalising corporate tax exemptions could improve revenue collection without broadening the fiscal deficit.
By implementing a balanced approach that includes targeted taxation on ultra-high-income earners, India can ensure that economic growth remains inclusive, sustainable, and fiscally responsible.
The Union Budget 2025-26 takes a bold step in supporting middle-class consumers but does so at the cost of a weakened tax base. The absence of compensatory taxation on high-income groups exacerbates fiscal pressures, raising concerns about the sustainability of critical social and infrastructure investments. While immediate consumption gains may provide short-term economic momentum, long-term growth and fiscal resilience require a more equitable tax framework. By implementing a balanced approach that includes targeted taxation on ultra-high-income earners, India can ensure that economic growth remains inclusive, sustainable, and fiscally responsible.
Debosmita Sarkar is an Associate Fellow at the Centre for New Economic Diplomacy at the Observer Research Foundation.
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Debosmita Sarkar is an Associate Fellow with the SDGs and Inclusive Growth programme at the Centre for New Economic Diplomacy at Observer Research Foundation, India. Her ...
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