Government Plans to Boost Middle-Class Spending by Lowering Personal Income Tax Rates

In an effort to boost the country's impressive GDP growth and address weaker levels of spending by the middle class, the government is considering lowering certain personal income tax rates. This move, according to multiple government officials, aims to leave more disposable income in the hands of individuals, particularly those in the lower earning bracket.

Proposed Changes in the Upcoming Budget

The Centre is looking to increase the income limit for individuals before any tax is levied from Rs 3 lakh to Rs 5 lakh in the upcoming budget, likely to be presented in mid-July. This change will apply only to those filing returns under the new tax regime. The final decision on this proposal will be made closer to the presentation of the budget.

Comparison of Old and New Tax Regimes

Budget 2020 introduced a choice for individuals between the existing tax structure, which includes built-in provisions for a lower tax incidence via specified investments, and a new system offering blanket lower tax rates while forgoing most deductions and exemptions.

Under the old tax regime, taxpayers can avail of deductions against investments under certain sections as well as exemptions like house rent allowance and leave travel allowance. Despite this, the new tax regime encourages simplicity by offering lower tax rates without these benefits.

Highest Income Tax Slab Rate

A second government official stated that the Centre is unlikely to entertain requests from industry representatives to reduce the highest individual income tax slab rate under the new tax regime from 30 percent to 25 percent. Changes in higher income tax slabs are considered unlikely because the current focus is on boosting consumption among lower-income groups.

Additionally, the government may not adjust the rates under the old tax regime, despite requests to increase the threshold for the highest income tax rate of 30 percent from Rs 10 lakh to Rs 20 lakh. This strategy aims to incentivize more people to switch to the new regime that discourages exemptions and rebates.

Focus on Lower Income Groups

Those earning more than Rs 15 lakh a year fall under the highest 30-percent tax bracket in the new tax regime, while under the older regime, the highest slab applies to earnings above Rs 10 lakh. The Centre's priority is to potentially lower personal income tax rates rather than sharply increase spending on subsidies and other schemes prone to wastage.

A third official emphasized that tax rate cuts are a better way to boost consumption in the economy rather than increasing welfare schemes, which are often affected by leakages, preventing the full benefit from reaching those in need.

Addressing Lower Consumption Levels

The discussion around measures to aid consumption has emerged due to the country's lower levels of private consumption growth, currently around 4 percent—a 20-year low outside the pandemic year—despite a world-beating GDP growth rate of 8.2 percent in FY24.

Detailed Analysis of the Proposed Tax Changes

Income Limit Increase

Raising the income limit for tax exemption under the new tax regime to Rs 5 lakh is expected to provide significant relief to taxpayers in the lower income brackets. This change is anticipated to increase disposable income, encouraging higher consumption and contributing to economic growth.

Unchanged Higher Income Tax Slabs

Despite calls to reduce the highest tax rates, the government's focus remains on benefiting lower-income groups. Maintaining the highest tax rate at 30 percent under both the old and new tax regimes underscores the priority of enhancing consumption among the broader population rather than providing relief to higher income earners.

Emphasis on the New Tax Regime

Encouraging taxpayers to shift to the new regime aligns with the government's objective of simplifying the tax structure and reducing reliance on deductions and exemptions. By offering lower tax rates without these benefits, the new regime promotes transparency and ease of compliance, which can ultimately lead to a more efficient tax collection system.

Economic Implications

The proposed tax changes are expected to have several positive economic implications:

1. Increased Disposable Income: Raising the tax exemption limit will allow individuals, particularly those in lower income brackets, to retain more of their earnings, boosting consumption.
2. Economic Growth: Higher consumption levels can drive economic growth, as increased spending typically leads to higher demand for goods and services.
3. Tax Compliance: Simplifying the tax system and offering lower rates without deductions may encourage more people to comply with tax regulations, broadening the tax base and increasing overall tax revenue.

Long-Term Benefits

In the long term, the proposed tax changes could lead to a more balanced and sustainable economic growth model. By focusing on increasing disposable income and simplifying the tax structure, the government aims to create a more inclusive economic environment where the benefits of growth are widely shared.

Conclusion

The government's consideration of lowering personal income tax rates reflects a strategic move to boost middle-class consumption and sustain economic growth. By increasing the income limit before tax is levied and maintaining the highest tax rates, the focus remains on benefiting lower-income groups and simplifying the tax system. These measures aim to leave more disposable income in the hands of individuals, encouraging spending and driving economic growth.

As the country grapples with lower private consumption growth despite robust GDP performance, these proposed tax changes offer a targeted approach to enhance consumption and support economic stability. With a final decision expected closer to the budget presentation, the potential impact of these measures on the economy and taxpayers remains a critical area of interest for policymakers and citizens alike.

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