Context: The Union Budget 2025 announced the biggest tax cuts for India’s middle class. While these cuts are expected to provide relief to a small section of taxpayers, they also pose risks related to revenue loss and fiscal consolidation.
Relevance of the Topic:Prelims: Trends in Budget- Taxation
Tax Cuts announced in Budget 2025:
- Expansion of Zero-Tax Bracket: Individuals earning between ₹7-₹12 lakh annually now get a complete tax rebate, which was previously applicable only for those earning below ₹7 lakh.
- Increased Exemption limit: For those earning more than ₹12 lakh, the exemption limit has increased from ₹3 to ₹4 lakh.
- Marginal Tax Rate reduction: All tax slabs have been adjusted in a way that reduces overall tax liabilities for individuals earning above ₹7 lakh.
- Revenue Implications: The Finance Minister estimated that these tax cuts will lead to a revenue loss of ₹1 lakh crore, which is 8% of the direct income tax collection of ₹12.57 lakh crore.
Logic behind Tax rebates
- Despite the fall of 8% in the effective tax rate as a result of tax cuts, the Budget has estimated direct tax collection to go up by 14%.
- This would require a 24% growth in taxpayers' income, which may or may not happen, depending on economic conditions.
- Optimistic scenario: The reductions in personal income-tax rates are set to:
- boost middle-class purchasing power and consumption, which will be credit positive for corporates and financial sectors.
- benefit domestic manufacturers (particularly in automotive two-wheelers, passenger vehicles, and white goods sectors)
- Pessimistic Scenario:
- Projected revenue loss of ₹1 lakh crore due to income-tax cut would slow fiscal consolidation. If it is not offset by increased economic activity or higher GST collections, this would widen the fiscal deficit.
- If income growth remains subdued, tax buoyancy may not improve. The revenue shortfall could lead to cuts in government spending on welfare and development programs.
Impact of Tax Rebates on Fiscal Policy & Economic Growth
- Government Expenditure Constraints: Under Fiscal Responsibility and Budget Management (FRBM) Act, the government cannot spend beyond a set deficit limit. This means:
- Any shortfall in tax revenue could force cuts in government expenditure.
- Fiscal policy could become pro-cyclical instead of counter-cyclical, worsening economic slowdowns.
- Fiscal Deficit Management:
- In 2024, the government lowered its fiscal deficit target from 5% to 4.8%, primarily by cutting expenditures.
- In 2025, the target has been further reduced to 4.4%, signaling fiscal contraction rather than expansion.
- Many flagship government schemes have seen budget cuts to achieve this goal.
- Reliance on Private Sector Investment:
- With government expenditure limited, the corporate sector is expected to drive economic growth.
- However, despite previous tax cuts and capital expenditure boosts, private investment has remained weak.
- Economic Survey 2025 indicates that global demand is uncertain, making exports an unreliable growth driver.
Is the Tax Cut Strategy Sustainable?
- The government is betting on a trickle-down effect, assuming that increased disposable income will boost consumption, leading to higher corporate investment and job creation. However, if private investment does not pick up, the government could face a revenue crisis.
- Cutting expenditures to maintain fiscal discipline could slow down economic growth, making recovery even harder.