Budget 2025 | Why cutting income tax could be a win-win for the government

Income tax collections have not only grown rapidly in recent years but have also consistently exceeded the Centre’s expectations. (Image: Pixabay)
Income tax collections have not only grown rapidly in recent years but have also consistently exceeded the Centre’s expectations. (Image: Pixabay)

Summary

  • India’s income taxpayer base has grown rapidly but so has resentment over “high taxes”, which often get amplified on social media, putting enormous pressure on the government to announce tax sops. Mint explores why income tax cuts may be necessary.

Finance minister Nirmala Sitharaman’s eighth union budget, set to be presented on 1 February, provides a critical opportunity to boost Indian economy's slowing consumption momentum through income tax cuts. There is a compelling case for this move: tax relief announced in the budget in July last year offered minimal benefits to low-income groups and, when adjusted for inflation, worsened the situation for high-income groups, a Mint analysis showed.

Five years ago, the tax exemption limit for income was 2.5 lakh. Adjusted for inflation, this would need to be 3.1 lakh in 2024-25 to maintain the same purchasing power. However, under the current tax regime, the exemption limit is 3 lakh for those earning above 7 lakh, which does not fully account for inflation and effectively increases the tax burden. For individuals earning between 7 and 15 lakh, the situation has only slightly improved when adjusted for inflation.

Read this | Budget 2025 | Tax breaks to spur spending, boost economy?

Meanwhile, high earners above 15 lakh continue to pay the top tax rate of 30%, unchanged from 2020-21 even though it would take an income of 18.6 lakh to maintain the same purchasing power.

The July budget’s limited relief, combined with slowing wage growth, has further constrained urban Indians’ purchasing power. A recent analysis by Emkay Global of listed companies’ real wage growth reveals a slowdown in recent quarters, with growth now substantially below pre-pandemic levels.

Income vs consumption

The underlying stress in the economy became more apparent in 2024 as consumption momentum slowed. Private final consumption expenditure grew by 5.96% at constant prices in Q2 FY25, compared to 7.45% in the previous quarter. This deceleration was reflected in the government’s goods and services tax (GST) collections, a key indicator of domestic consumption. GST collections as a share of GDP are estimated to rise modestly to 3.28% in 2024-25 from 3.15% in 2022-23. However, the income tax collection as a share of GDP is projected to rise more significantly, from 3% two years ago to 3.55% in 2024-25.

Read this | Budget 2025's top priorities: Farmers, small businesses, consumption, and jobs

Cutting income tax rates to address slowing consumption, however, presents a dilemma. In recent years, income tax has become a robust source of government revenue, while other streams like corporate tax and excise duty have shown limited growth. While income tax cuts could impact this strong revenue stream, they might also stimulate higher GST collections through increased consumption and stronger economic growth, creating a potential trade-off for policymakers.

Mega mop-up

Income tax collections have not only grown rapidly in recent years but have also consistently exceeded the Centre’s expectations. This trend is likely to continue in the current financial year, with estimated collections as a percentage of GDP potentially exceeding the projected 3.55%. In fact, actual income tax collections surpassed budget estimates by 24%, 19%, and 16% in FY22, FY23, and FY24, respectively.

In the first seven months of FY25 alone, income tax collections have reached 61% of the budgeted target. If this momentum continues, total collections could surpass 12 trillion by the end of the fiscal year.

“Now that the government has moved up the curve as far as collections are concerned, it makes sense to rationalize taxes," said Yuvika Singhal, an economist at QuantEco Research.

 

Growing taxpayer base

India’s income tax collections have risen significantly, driven by a rapidly expanding taxpayer base. In 2023-24, a total of 86 million income tax returns were filed, an 11% increase over the previous fiscal year, according to data from the income tax department. This number has more than doubled since FY14, when only 40 million returns were filed, reflecting the country’s economic growth, increased formalization, and improved compliance.

However, the growing taxpayer base has also led to increased dissatisfaction with “high taxes," a sentiment often amplified on social media. This has intensified pressure on the government to introduce tax relief measures. Beyond meeting taxpayer demands, the pressing need to boost consumption in the economy further strengthens the case for income tax cuts.

Also read | India should take cues from Piketty on enlarging its tax mop-up

“People with higher incomes have more spending power. Therefore, to revive consumption, we need to give higher disposable income to all, including those with higher incomes," said Madan Sabnavis, chief economist at Bank of Baroda.

Pragya Srivastava contributed to this story.

 

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