Answer

The Budget is an annual financial statement presented by the government, outlining revenue and expenditure plans. According to Article 112 of the Indian Constitution, it aims to ensure financial stability. A tax cut refers to a reduction in the amount of taxes individuals or businesses are required to pay, often aimed at increasing disposable income and stimulating economic activity. The recent Budget’s decision to exempt incomes up to ₹12 lakh from taxation seeks to enhance consumer spending. 

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Current Scenario after exempting incomes up to ₹12 lakh in Budget 2025-26

• Exemption of incomes up to ₹12 lakh from taxation: The Budget has significantly altered the personal income tax structure by exempting incomes up to ₹12 lakh, offering substantial relief to middle-income taxpayers and increasing their disposable income.
• Reduction in tax liabilities across various income brackets: The revised tax slabs have lowered tax liabilities for a wide range of taxpayers, ensuring that individuals at different income levels benefit from these changes.
  For example: A taxpayer with an annual income of ₹15 lakh will see their tax outgo reduced significantly, allowing for greater financial flexibility and increased household consumption.
• Revenue loss of ₹1 lakh crore due to tax cuts: While these changes provide relief to taxpayers, they result in a direct tax revenue loss of ₹1 lakh crore, potentially constraining the government’s ability to fund developmental initiatives.
  For example: The government may struggle to finance infrastructure projects like roads and railways if tax revenues fall short, delaying economic growth and job creation.
• Tax-base erosion amid declining household savings: The decline in household savings (down to 18.4% of GDP in FY23, as per Economic Survey 2024-25) raises concerns about the sustainability of these tax cuts, as lower savings can affect long-term capital formation.
  For example: A continued reduction in household savings can limit capital available for bank lending, impacting sectors like housing and small businesses that rely on credit availability.

Long-term implications of such tax cuts on fiscal sustainability

• Increased fiscal deficit risk due to revenue loss: The ₹1 lakh crore revenue loss weakens fiscal consolidation efforts, making it harder for the government to achieve the 4.4% fiscal deficit target in FY26.
  For example: If tax revenue falls short, the government may be forced to increase borrowing, crowding out private investment and leading to higher interest rates in the long run.
• Reduced capacity for welfare and social programs: The reduction in tax revenues could restrict the government’s ability to fund social welfare programs such as healthcare, subsidies, and poverty alleviation, which are vital for equitable growth.
  For example: Programs like the PM-KISAN scheme or healthcare initiatives may face budget cuts, affecting vulnerable populations and widening the inequality gap in rural and economically weaker areas.
• Potential increase in government borrowing and debt servicing burden: To compensate for revenue loss, the government may need to borrow more, increasing the debt-to-GDP ratio and diverting funds towards interest payments instead of productive investment.
  For example: India’s net market borrowings of ₹11.54 lakh crore could crowd out private capital, reducing corporate investments in key sectors like manufacturing and technology.
• Risk of unsustainable consumption-driven growth: While tax cuts boost consumption, they may not necessarily translate into higher long-term economic growth, especially if investment in innovation and productivity remains low.

Long-term Implications of Tax Cuts on Public Investment

• Reduced Fiscal Space for Infrastructure Development: Lower tax revenues reduce the government’s ability to fund infrastructure projects like roads, railways, and energy, which are crucial for economic growth and job creation.
  For example: India’s fiscal deficit widened in FY21 due to lower tax revenues and pandemic-related spending, forcing the government to delay infrastructure projects under the National Infrastructure Pipeline (NIP).
• Strain on Social Welfare Expenditure: Public investment in healthcare, education, and social security may face budgetary constraints, affecting long-term human capital development and social mobility.
  For example: Similar to Brazil’s 2016 constitutional amendment that froze public spending on healthcare and education for 20 years, India’s fiscal challenges in recent years have led to restrictions on state spending for social welfare programs.
• Increased Dependence on Borrowing: A shortfall in tax revenue forces the government to borrow more, leading to rising public debt, higher interest payments, and limited funds for future investments.
  For example: The U.S. tax cuts in 2017 led to an increase in the fiscal deficit, constraining future federal spending on infrastructure and welfare.
• Pressure on State Finances: Lower central tax collections mean lower tax devolution to states, affecting their ability to fund local development projects and welfare schemes.
  For example: India’s GST revenue shortfall in 2020 forced states to borrow from the market to fund expenditures, affecting social sector schemes like PM-KISAN and rural employment programs.

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Long-term Implications on Economic Growth

• Lower Public Investment Reducing Productivity: Public investment in research, innovation, and infrastructure boosts long-term economic productivity. Reduced tax revenues limit such investments, affecting future growth.
  For example: India’s low R&D spending (0.64% of GDP) compared to Germany’s 3.1% has contributed to weaker manufacturing competitiveness and slower industrial innovation.
• Higher Inflation and Interest Rates: If the government compensates for revenue losses by borrowing, it increases public debt, potentially leading to higher inflation and interest rates, discouraging private investment.
  For example: Argentina’s fiscal deficits and reliance on external borrowing led to high inflation and currency devaluation in 2018, worsening economic instability.
• Lower Household Savings Affecting Capital Formation: Tax cuts increase consumption in the short term, but if they reduce household savings, they can limit domestic capital formation and investment.
• Trade Deficit Due to Weak Industrial Growth: Lower tax revenues limit government support for export-oriented industries, affecting competitiveness and increasing trade deficits.
  For example: South Africa’s underinvestment in manufacturing due to fiscal constraints led to a decline in industrial output, reducing its global trade competitiveness and widening the trade deficit.

Balancing fiscal sustainability and economic growth requires strategic measures. To offset revenue loss, the government must broaden the tax base, curb tax evasion, and enhance compliance. Redirecting resources toward high-impact public investments in infrastructure and human capital can drive sustainable growth, ensuring that increased disposable income translates into long-term prosperity.

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