The recent announcement of tax relief in the Union Budget has sparked widespread discussion. While the Finance Minister has highlighted that approximately one crore people earning up to 12 lakh rupees annually will benefit, the broader question remains: will this truly help the economy? Understanding the nuances of taxation and its economic implications is crucial to answering this.
The Reason Behind Tax Cuts
A major reason for this tax cut is to boost demand in the economy. Over the past few years, inflation has surged while wages have remained stagnant, leaving people with less disposable income. This has resulted in reduced spending, which in turn slows down economic growth. When demand declines, businesses cut production, leading to job losses and increasing poverty. The government’s aim behind this tax relief is to put more money in the hands of taxpayers so they can spend more, thereby stimulating demand.
However, the effectiveness of this approach depends on who benefits from the tax cut. While the middle class, estimated at about 2-3 crore people, may experience some relief, the unorganized sector—comprising nearly 94% of India’s workforce—remains largely unaffected. This segment includes daily wage labourers, small farmers, and micro-business owners, whose incomes have either stagnated or declined. If their purchasing power does not increase, overall demand will not see a substantial boost.
Who Really Benefits from the Tax Cuts?
Currently, about 9.5 crore people file income tax returns or pay tax through TDS. Previously, the exemption limit was set at ₹5 lakh, meaning that individuals earning below this amount paid no tax. This limit has now been raised to ₹7 lakh, meaning around six crore people who were already paying little to no tax remain unaffected by the new tax relief.
The actual beneficiaries of this tax cut are estimated to be around three crore people. However, within this group, nearly 50 lakh individuals earn over ₹30 lakh annually, meaning their spending habits will likely remain unchanged. This leaves about 2.5 crore people with extra disposable income, a relatively small segment compared to India’s total population of 140 crore. As a result, the impact of increased spending due to this tax cut is expected to be limited.
The Trade-Off: Reduced Government Expenditure
The government has forgone approximately ₹1 lakh crore in tax revenue due to this relief. While this may appear beneficial to taxpayers, it has led to budget cuts in critical sectors such as education, agriculture, and rural development. For example:
- Expenditure on education has declined in real terms.
- Allocations for agriculture and allied activities have been reduced.
- Rural development schemes, including MGNREGA, have seen stagnant budgets, effectively decreasing due to inflation.
These reductions negatively impact employment generation and economic stability in rural areas, which are home to the majority of India’s population. The government’s strategy appears to be focused on promoting capital-intensive projects rather than labour-intensive sectors.
The Shift Towards Capital-Intensive Growth
The government has prioritized infrastructure development, such as freight corridors, highways, and large construction projects. While these initiatives may seem beneficial for economic growth, they generate far fewer jobs compared to labour-intensive sectors. Modern construction techniques involve automation and heavy machinery, reducing the need for manual labour.
For example, where hundreds of workers were once required for infrastructure projects, now a handful of machine operators can accomplish the same work. This means that even though infrastructure is improving, it is not addressing the pressing issue of unemployment.
The Misconception About Organizing the Unorganized Sector
A common argument is that India should focus on transitioning its massive unorganized sector into an organized one. However, this is a misconception. The unorganized sector includes agriculture, where nearly 46% of India’s workforce is employed. Most farms are small, with 85% being less than five acres. Formalizing such farms is impractical; they cannot be turned into large-scale industrial agricultural units.
Similarly, the non-agricultural unorganized sector comprises about six crore micro-enterprises, six lakh small and medium enterprises, and only about 6,000 large industries. The micro-enterprises, on average, employ only 1.7 people each. These businesses cannot be turned into large, formal organizations without eliminating jobs in the process.
In contrast, the organized sector is heavily mechanized. For example, Tata Steel employed 88,000 people in 1990 to produce 2 million tons of steel. Today, it produces 15 million tons but employs only 30,000 people. Similarly, banking has shifted most of its services online, drastically reducing the need for employees. The notion that formalization will create jobs is flawed; instead, it may result in widespread job losses.
The Role of Demand in Economic Growth
The real issue in India’s economy is weak demand, not insufficient supply. According to RBI data, capacity utilization in the organized sector is only 70-75%, meaning industries are not operating at full potential. If companies cannot sell what they already produce, they have little incentive to invest in expanding production.
Private sector investment remains sluggish because businesses see no demand growth. Industry bodies like CII and FICCI have repeatedly stated that without an increase in consumer spending, businesses will not expand. The government’s decision to provide tax relief to a small segment of the population does not address this larger issue.
The Freebies Debate
Another major discussion point is the distribution of subsidies, or “freebies.” Many argue that providing free electricity, water, or bus travel burdens taxpayers and strains government resources. However, the reality is that the majority of voters support these policies, as they provide immediate benefits.
The issue arises due to a lack of long-term trust in government programs. People have seen little improvement in their lives despite years of economic promises, leading them to favour immediate, tangible benefits. This creates a cycle where political parties compete by offering more subsidies, increasing government debt. For example, the central government’s debt has surpassed 70% of GDP, while states like Punjab have debts exceeding 50%.
A Better Approach
Instead of focusing on tax cuts that benefit a small section of society, the government should invest in sectors that create jobs and boost incomes at the lower end of the economic spectrum. This includes:
- Increasing investments in education and healthcare, particularly in rural areas.
- Strengthening micro and small enterprises, which employ the majority of the workforce.
- Enhancing local transportation and connectivity for small businesses.
- Promoting rural industries and services to slow urban migration and improve quality of life.
China’s economic success began with strengthening its village industries, which later led to large-scale industrialization. India should adopt a similar model by focusing on grassroots development rather than prioritizing large corporations.
Final Thoughts
While tax relief provides some financial ease for the middle class, its impact on the overall economy remains limited. By reducing public expenditure on critical sectors, the government may unintentionally slow down long-term growth. A more effective strategy would be to enhance employment opportunities, support small businesses, and boost rural demand. Only by addressing the needs of the majority—rather than a select few—can India achieve sustainable economic growth.
Sources:
- https://www.reuters.com/world/india/indias-modi-seek-boost-growth-ease-cost-living-budget-2025-02-01/
- https://www.reuters.com/world/india/india-budget-indias-tax-relief-may-not-be-enough-boost-economic-growth-moodys-2025-02-01/
- https://www.ft.com/content/1d76cc7f-0f84-4dbb-9c17-0ecd29eb6340
- https://apnews.com/article/02d8af3bc495ea3e6d8ff25764772fd1
- https://timesofindia.indiatimes.com/business/india-business/union-budget-2025-gains-and-pains/articleshow/117849728.cms
- https://www.hindustantimes.com/business/budget-2025-26-how-india-s-tax-rate-changes-will-impact-middle-class-spending-101738411819478.html
- https://pib.gov.in/PressReleaseIframePage.aspx?PRID=2098352
- https://www.ey.com/en_in/technical/alerts-hub/2025/02/budget-2025-consolidated-tax-and-policy-alerts
- https://macrofinance.nipfp.org.in/PDF/PatnaikPandeySane-impact_of_tax_breaks_on_household_financial_saving_in_India.pdf
- https://www.aljazeera.com/news/2025/2/1/indias-budget-gives-tax-relief-to-middle-class-to-boost-spending-growth
