The 2025 Budget and Its Impact on India’s Tax Base

India’s 2025 budget came at a critical juncture, as the government was navigating the dual challenge of sustaining economic growth while expanding its tax base. In an effort to boost domestic demand, The fifth-largest economy slashed tax rates in the annual budget, a move driven by concerns over slowing Real GDP growth estimated at 6.4% in FY25—well below the 8% target and the slowest pace in four years since the pandemic—this move reflects efforts to counter the economic slowdown.

Illustration by The Geostrata

The Indian economy suffered from subdued urban demand and private investments, alongside high inflation during and after Covid which impacted disposable incomes for the middle class. These factors prompted the government to implement several tax reforms that were designed to not only expand India’s tax base but also provide relief to the lower middle-class tax bracket. India still grapples with a paradox wherein although the nation ranks among the top five economies, a relatively low percentage of the population pays direct taxes, owing to factors like tax avoidance, tax evasion, and the existence of a large informal sector.

COMPOSITION OF TAX BASE IN INDIA 

It is widely acknowledged that India's tax base is relatively narrow. The bulk of the income tax burden is held by a small fraction of the population. Less than 7 percent of the total population accounted for income taxpayers in the last year. In this group of people, a substantial number paid taxes or paid a trivial sum because of the advantages of deduction and exemption. Approximately 63 percent or 47 million of those who filed their returns paid no taxes at all. 

The middle class—which sees itself as India's spine—bears the harshest tax burden. It supports the other 80 percent of personal income tax collections, that is, anyone who could sway the elections and the economy. On the other end of the spectrum are the "super-rich," a mere 40,000-odd high-net-worth individuals (HNIs) responsible for about one-fifth of all tax revenues. Meanwhile, the Indian farming community, still numbering nearly 600 million people, remains untaxed, as income from agricultural operations is exempt from taxation. Informal workers, forming a substantial part of the labor force in India, are also negligible contributors to direct taxes.

NEW TAX SLABS AND PERSONAL INCOME TAX CHANGES

While presenting the Union budget 2025-26 in the parliament on the 1st of February,2025 Finance Minister Nirmala Sitharaman announced a host of measures aimed towards a tax-payer-friendly system that makes compliance easier and enhances the spending power of India’s rising middle class. The most significant one is that no income tax would be payable for annual incomes up to rupees 12 lakh, a hike from the previous limit of rupees 7 lakh.

This would result in one crore more taxpayers now having a zero tax liability, except incomes from sources like capital gains that have their distinct rates. For salaried taxpayers, the threshold has been set to Rs 12.75 lakhs with a standard deduction of Rs 75000. Overall, the new tax regime expands the total number of slabs to seven with an additional tax bracket. While those earning up to ₹4 lakhs annually are fully exempt from taxation, incomes between ₹4 lakhs and ₹8 lakhs, have a tax rate of 5%, those earning between ₹8 lakh and ₹12 lakh are taxed at 10%, those ₹12 lakh to ₹16 lakh bracket the tax rate lies at 15%, 20% for ₹16 lakh to ₹20 lakh, and 25% for incomes between ₹20 lakhs to ₹24 lakhs. Incomes exceeding ₹24 lakh have a tax rate of 30%.

Apart from personal tax reforms, the direct tax measure also includes rationalisation of TDS/TCS, encouragement to voluntary compliance along with reduction of compliance burden, ease of doing business, and incentivising employment and investment. The budget doubles the limit for a tax deduction on interest earned by senior citizens from the present ₹ 50,000 to ₹ 1 Lakh. Further, the TDS threshold on rent has been increased to ₹ 6 Lakh from ₹ 2.4 Lakh per annum. 

The budget emphasises formalising gig economy workers, improving their access to healthcare and welfare initiatives, thereby enhancing social security measures.

Furthermore, to encourage voluntary compliance, the Budget extends the time limit to file updated returns for any assessment year, from the current limit of two years to four years. Small charitable trusts/institutions have been given the benefit of increasing their period of registration from 5 to 10 years, reducing their compliance burden. Overall. The proposed new tax structure is aimed at substantially boosting consumption, savings, and investment by putting more money in the hands of the middle class.

OVERALL IMPACT 

The new tax regime implemented in Budget 2025, by raising the basic exemption limit from ₹3 lakhs to ₹4 lakhs and the rebate threshold under Section 87A from ₹7 lakhs to ₹12 lakhs, has further reduced an already constrained tax base. While these measures indeed provide some relief to the middle class, they reduce the taxpayer numbers, which may stretch government revenues. In an environment of low tax compliance, the benefit of such policies would be to result in a greater reliance on indirect taxes, such as GST, which conceivably hit the poorer masses harder, who pay a greater portion of their earnings on consumption.

Indeed, having a diminished tax base may end up creating fiscal stress for government spending on infrastructure, healthcare, and welfare programs. Large-scale investment by the government in infrastructure is critical for India's sustained high growth; hence a smaller tax-paying population might require policymakers to increase borrowing or shift the burden elsewhere. 

In a long-term context, the logical alternative would be to consolidate rather than contract the tax base. Formalising the informal economy, eliminating exemptions availed by high-income earners in untaxed areas, and establishing equitable wealth distribution could formulate a taxation system well-balanced and sustainable. Otherwise, because of a shrinking tax base that relies too much on the middle class, the government might invest little in infrastructure and growth for the future.

CHALLENGES 

India’s fiscal framework is transforming, however, gaps persist. There are attempts at streamlining tax structures and rationalising GST, but taxpayers continue to grapple with excessive tax burdens, inadequate exemptions, inflationary pressures, a substantial rise in the cost of living, indirect tax burdens, as well as social security and retirement difficulties. This budget addressed these challenges by enhancing benefits under the new tax regime and placing more people within the tax-exempt category to ease financial pressure on taxpayers while promoting sustainable growth.

Relaxing compliance terms, reducing GST on essential commodities, and setting up a framework for long-term tax clemency are policies that will help to increase the willingness of the public to pay taxes.

This Union Budget 2025-26 demonstrates how the government seeks to adopt a more efficient system of taxation that reduces the burden on the middle class while cultivating long-term economic growth and prosperity. A watershed moment confronts India’s tax policy. Budgeting for 2025, the trend is towards offering a measure of tax relief to the middle class by way of increasing tax exemptions and restructuring tax slabs. This, however, threatens to constrict an already narrow tax base.

With fewer taxpayers, the burden in terms of indirect taxes like GST would increase, making it more skewed against the poorer section of society. Lower tax revenue means the government will have less to invest in infrastructure, welfare, and social security, all of which will slow long-term growth down.

To avoid these dangers, India should seek to broaden the tax base instead. Possible direct measures are the formalisation of the informal economy, taxing high-income farmers, and improvements in voluntary compliance through simplification of the processes. Progressive taxation must be complemented by incentives for entrepreneurship, investment, and job creation. Also, the concurrent reduction of tax evasion through digital tracking and AI audits can ensure a fair tax system.

An economically sustainable tax structure should be one that equally distributes the burden of tax in a way that promotes rather than inhibits economic growth. The challenge for the government then is to ensure that concurrent relief measures do not hinder longer-term developmental agendas without compromising fiscal stability. Increased focus on compliance, rationalisation of exemptions, and building a culture of tax responsibility will thus result in the evolution of a resilient and inclusive fiscal system.

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BY MALAVIKA & PEEHU

TEAM GEOSTRATA

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