Finance minister (FM) Nirmala Sitharaman will present her eighth consecutive Union Budget on 1 February 2025. This will be the first full Budget of the National Democratic Alliance (NDA)-3 government for the financial year (FY)25-26.
Broadly, there are two categories of taxes: direct and indirect. Direct taxes are progressive levies, including income tax, wealth tax, and capital gains tax, wherein individuals with greater income or wealth incur higher tax obligations. Indirect taxes are regressive as they impose the same tax burden on all individuals, from affluent industrialists to the impoverished, exemplified by taxes such as goods and services tax (GST), gas tax, or levies on cinema tickets.
In this context, all Indians contribute to indirect taxes, whereas just 22.4mn (million) individuals currently pay income-tax (I-T). In FY23–24, personal income-tax constituted 19% of the overall Budget and exceeded 30% of total tax revenues. Recent policies have redistributed the tax burden from companies to individuals. This is detrimental for a middle-income nation such as India, where the per capita income is approximately US$2,500.
The Great Indian Middle Class
The Indian middle class is a significant demographic contributing diligently to the nation's revenue via I-T and GST. As per the People Research on India's Consumer Economy (PRICE), India's middle class currently comprises approximately 32% of the total population (around 500mn) and plays a substantial role in the nation's economy, significantly contributing to infrastructure development and welfare policies.
Currently, middle-class salaried individuals in India are contending with the burden of direct and indirect taxes. The OECD (Organisation for Economic Co-operation and Development) reports that India's I-T rate is the sixth highest among 91 countries. The elevated tax rate and indirect taxes such as GST, grocery, tolls, and restaurant bills are exacerbating the financial strain on the middle class.
Today, the middle class in India has no social security, except for those in government employment, which is steadily diminishing. Government hospitals and schools frequently have poor quality and the majority of health and education services are not free.
The middle class is currently rushing to make their equated monthly instalment (EMI) payments on consumer goods, housing, school loans, and medical expenditures. These families now have less disposable income as a result of rising income taxes and GST which is a major factor in the decline in market demand.
In 2023–2024, personal final consumption expenditure (PFCE) accounted for 55.8% of gross domestic product (GDP), down from 58.1% in 2021–2022. The middle class wonders what they are receiving in exchange for paying high taxes. These worries have been exacerbated by the politics of freebies.
Indian vs Other Countries' Tax System
The US, European nations, and China generate 60% of revenue from direct taxes and 40% from indirect taxes. In India, the ratio is 65% regressive taxes to 35% direct taxes. Approximately 55% of the nation's income taxes are currently remitted by individuals, whereas corporations contribute merely 45%.
Until a few years ago, this ratio was inverted. Individuals facing financial hardship endure the strain of double taxation, incurring income tax and, subsequently, taxation on their expenditures, while companies are taxed solely on profits after deducting expenses. Salaried individuals do not receive refunds for GST paid, whereas corporations are eligible for input tax credits.
Decreasing Portion of Corporate Tax
The government's 2019 tax reduction in response to COVID-19 intended to stimulate private sector investment in infrastructure (capex) and generate additional employment, however, this outcome did not materialise.
The World Bank estimates India's infrastructure deficit to be about US$1.5trn (trillion). The Economic Survey indicates that data from a sample of over 33,000 companies reveal that the Indian corporate sector's profit before tax (PBT) has nearly quadrupled in the three years from FY19-20 to FY22-23.
Despite the profitability of Nifty 500 companies reaching a 15-year high in FY24, there was no new job creation or corresponding rise in employee wages. In the last 12 years, the stock market has increased fourfold, with the BSE Sensex escalating from approximately 19,000 in 2012 to 80,000 in 2024, while corporate tax revenues as a proportion of total receipts have diminished.
In September 2019, FM Sitharaman announced a 22% reduction in the corporate tax rate. The corporate tax rate for Indian companies is 25.17%, inclusive of all cesses and surcharges. Manufacturing companies founded after 1 October 2019 are subject to a tax rate of 15%. These reductions will result in a loss of Rs1.45 lakh crore in tax revenue for the government.
Companies sometimes book a disproportionate amount of profits in areas with low or no taxation, known as 'tax havens'. Companies also reduce their tax liability by using tax havens in India.
Since FY22-23, personal I-T collections have surpassed corporate collections, constituting approximately 54%. Personal I-T revenues rose 21.6% to Rs8.74 lakh crore in FY24-25, up from Rs7.2 lakh crore. During this period, corporate tax collections have risen by only 8.12%, reaching Rs 7.7 lakh crore, up from Rs7.10 lakh crore.
In the new tax regime, personal income of Rs15 lakh and above Rs10 lakh in the old tax system incurs a 30% tax rate. Corporate income amounting to crores of rupees is taxed at a rate of merely 22%, applicable only after the deduction of expenses. Moreover, corporations are taxed on profits (after deducting expenses from revenue), whereas individuals are taxed on income (salaries and professional fees).
Under the new tax regime, no deductions are permitted for expenses incurred to generate income. In FY10–11, corporate tax collections were twice that of personal income tax. The proportion of corporate tax revenues within direct tax collections is projected to decrease from 67% to 46% from 2010-11 to 2024-25.
Despite government data indicating a reduction in the average tax liability, how is market demand declining?
Inflation and Old Tax Slabs
An attempt has been made to provide some relief to middle-class taxpayers by introducing a new tax regime with no tax on income up to Rs7 lakh, but the new tax regime does not contain any significant deductions and exemptions available under the old tax regime.
If tax slabs are not increased over time, it would mean that people are paying income tax on lower real income. Since the 2005-06 Budget, gold prices have increased more than 10 times in the last 20 years, but the tax slabs have not changed much.
A new tax regime has been introduced to alleviate the burden on middle-class taxpayers by exempting income up to Rs7 lakh. However, it lacks the substantial deductions and exemptions present in the previous tax regime. Assuming an average inflation rate of 6%, the current real value of Rs5 lakh and Rs10 lakh from 2014 will be Rs2.8 lakh and Rs5.6 lakh, respectively.
If tax slabs are not adjusted over time, individuals will be liable for income tax on diminished real income. Since the 2005-06 Budget, the price of gold has risen over tenfold in the past two decades, yet the tax slabs have remained largely unchanged.
In the fiscal year 2005-06, the basic I-T exemption threshold of Rs1 lakh corresponded to 145gm (grammes) of gold at that period. Tax slabs should be established considering the detrimental effects of inflation, commencing from Rs7-Rs15-Rs20 lakh in accordance with current inflation rates.
The Way Forward
The government advocates for increased insurance coverage; however, an 18% GST is imposed on insurance, as well as on education. These policies are largely to blame for the growing brain drain trend in India. Between 2015 and 2022, 1.3mn Indians, many of whom were professionals with advanced degrees, departed the nation. In 2022 alone, 2,25,000 Indians left their citizenship. The top destinations for these skilled workers continue to be the US, Canada, Australia and Europe.
This concerns not just the loss of talent but also the associated economic potential. Therefore, it is necessary to rationalise GST in certain categories. In the US, about 43% of the population pays taxes, whereas in India, only 2% do so; thus, significantly increasing the taxpayer base should be a priority. This will alleviate the tax burden and enhance the tax-to-GDP ratio.
This is possible only when free schemes are stopped in the country and investment is made in making the labour force skilled. Remember, until India's middle class gains more purchasing power, demand will remain low. Clearly, there is still much to be done to fix our tax systems.
The primary concern of the middle class is that their tax contributions are being used to appease non-tax-paying communities for the vote bank. In fact, an ideal tax system should be just like a bee sucking juice from a flower without causing any harm and giving honey to the people in return.
(Views expressed are personal)
(Dr Brajesh K Tiwari is an Associate Professor at Atal Bihari Vajpayee School of Management & Entrepreneurship (ABVSME) of Jawaharlal Nehru University (JNU). He regularly writes for several publications.)
Unfortunately, the current GoI is secure in the knowledge that they will continue to get re-elected as long as they continue their vitriolic rhetoric against minorities, mainly Muslims.
Only a shock , like the general election gave to the ruling party , will bring about any change.
I won't hold my breath for that to happen.