Will India’s 2025-26 tax cut spur consumption and GDP growth?

No doubt, the relief was generally meant to ease the burden of India’s middle class, as defined by taxpayers—the vast bulk of whom are in tax brackets below the top-most slabs above annual incomes of ₹50 lakh that attract a surcharge. But it was also hoped that the extra money would be spent to drive demand and thereby help spin the wheels of India’s economy faster.

Also Read: Mint Quick Edit | Sitharaman’s income tax bonanza: Time to rejoice

Such an outcome is predicated on beneficiaries opting not to save the benefits of this fiscal stimulus, or at least not most of it. The Centre’s budget has rejigged our liability in a way that makes income up to ₹12 lakh exempt from tax and cut what other taxpayers must pay by as much as ₹1.1 lakh annually. Theory and studies show that households lower down the pyramid have a greater marginal propensity to consume, given their relatively constrained standards of living.

So, we can expect many homes to spend their gains, giving the fiscal injection a fair chance of taking effect. At upper levels, in contrast, the cut may be too small to influence their spending. The disposition of millions in between could well determine the extent of its stimulus effect.

In a way, it would behoove gainers for whom the gains are discretionary to honour the government’s gesture by spending it all. Doing so would fuel demand, get factories to produce more, help multiply incomes where needed and stir up investments held back by weak sales forecasts. If a spending jump creates sufficient feedback loops, it would support GDP growth, which we must not let sag any further.

Also Read: Vivek Kaul: The ‘fallacy of composition’ has left equity fund investors reeling

Saving the bonus would amount to what Keynes called the ‘paradox of thrift’: while saving is beneficial to an individual, if everyone does it, overall demand would weaken and push down both incomes and investment, resulting in less aggregate savings.

The trouble is that some of our middle class may be under a heavy debt burden, as the Reserve Bank of India’s (RBI) Financial Stability Report noted. Though the government has sought to underplay this risk, it complicates the country’s outlook on consumer spending. Combined with weak job creation and a sluggish recovery in consumer confidence (on RBI’s tracker), that could mean many mid-zone taxpayers lack financial security.

Welfare schemes for the poor tend to remind the hard-pressed middle class of how weak the state’s safety net for them is. This fosters an instinct for self-preservation that heightens their propensity to save. So middle-class thrift could yet deny the economy what it needs.

Also Read: PM-JAY: A successful model for both healthcare delivery and financial security

One way to tilt savings towards spending would be to lessen what Keynes called the ‘precautionary’ motive to keep money handy. Welfare benefits that cover emergency outgoes could do it. Most schemes are focused on the poor, which is a natural policy in a country of deep inequities and fiscal constraints.

For example, the government covers annual healthcare expenses of up to ₹5 lakh per family at the lowest socio-economic levels, well below those in tax-paying brackets. Public health services open to all, however, are deficient in quality and private care is expensive, which leaves hard-up taxpayers to fend for themselves.

State health insurance will soon cover all citizens aged above 70. If this coverage is made universal, it would be easier to ask all tax-cut beneficiaries to spend their benefits instead of saving them.