There are four ongoing economic trends. Prima facie, they seem disconnected. But the case could be made that they’re deeply connected—and they’re beginning to impact the individual salaried. Therefore, what happens at this Union Budget with income tax is deeply consequential. Allow me to explain
One: the optional new tax regime is introduced in 2020-21. It offers a lean tax code and no deductions. The pitch is undoubtedly attractive: forget the painful paperwork, enjoy higher disposable income, live freely. If you want to invest in your provident fund or buy life insurance, do it. But forget the tax savings from them. The adoption into the new regime is slow at first. But now, it’s the default option. Last year, 72% of taxpayers had moved to it. More will likely move this year.
Two: fast forward to 2025. Fewer people are buying life insurance. ELSS as a category is degrowing despite some tremendous years for equity. The BankBazaar Moneymood 2025 shows few takers for NPS. The urban salaried are expressing a declining interest in postal savings like PPF and NSC. Meanwhile, the RBI reports a drop in household savings. Studies point to rising indebtedness for consumption. Troubling delinquencies are seen in microloans under ₹10,000. The point could be made: with dipping savings and protections, the average household is now more vulnerable against adversities such as job loss or poor health, and more likely to slip into debt spirals
Three: there’s an ongoing freeze on the higher tax slabs. Pranab Mukherjee as finance minister last updated the 30% slab in 2012, pegging it at income over ₹10 lakh. Thirteen years later, it’s still stuck there. It has become part of the old tax regime which many taxpayers still favour due to its tax-saving provisions. Imagine going into the 1991 budget with the tax slabs frozen at 1978 levels. Similarly, the new regime itself has an ongoing bracket freeze at the 30% level. While rebates and deductions have been announced to make ₹7.75 lakh tax-free, the 30% slab is unchanged at ₹15 lakh since 2020.
Four: urban consumption is slowing down. The salaried lacks confidence in this economy. Should they save? Should they spend? Inflation is high, and the high income tax is also hurting.
The Middle Class & Its Burden
There’s much debate on what constitutes ‘middle class’ in India. Recently, one study put it as anyone earning between ₹5 lakh to 30 lakh. Of the 7.9 crore tax filers in AY2023-24, a whopping 48% or 3.8 crore reported income under the ₹5 lakh limit. Of the rest, less than 20 lakh taxpayers seem to report gross earnings of more than ₹30 lakh. This gives us a middle class of around 3.9 crore taxpayers.
Now, 4.9 crore taxpayers or 61% of the base pay no taxes. If you include the lower middle class and those with low income tax liabilities up to ₹1.5 lakh, we get to 89% or 7.1 crore taxpayers. This is most of the working population. But its contribution to the exchequer is low: it was responsible for 6% of the income tax payable.
But if incomes are so widely low, how are income tax collections at record levels exceeding ₹10 trillion? Sure, the tax is being paid. But the burden of the payment has fallen on a miniscule constituency—typically the urban salaried. Just 1.62% tax filers—around 13 lakh taxpayers—were responsible for 77% of all income tax in AY2023-24. Of them, 0.1%—just 91,000 people—accounted for 58%. In the absence of inflation adjustment of the slabs, the upper middle class seems to be bearing a disproportionate share of the direct tax surge.
Deductions—And Why We Need Them
There’s an ever-decreasing number of holdouts in the old tax regime. They’re still on it because, despite all that the new regime is offering, their tax liability is still magically lower on the old regime with Manmohan Singh era rates. This is purely due to deductions.
A typical urban family with salaried income are eligible for deductions for healthcare, education, rent, home loan payments, and insurance premia. So such taxpayers have remained in the old regime, even if the savings are declining. Health and education are also big expenses for many households for which the old regime provides deductions. There’s also the matter of setoffs and carry forwards that the new regime doesn’t offer.
The new regime started off without deductions. Now it has gradually increased the number of deductions. Now, you can claim deductions for NPS and home loan interest. There’s a standard deduction of ₹75,000, too. These help. But more is needed. The government must incentivise household savings and insurance again.
For decades, tax planning in India was a three-legged stool: invest, insure, save tax. Under the old regime, salaried professionals religiously parked ₹1.5 lakh in provident fund and ELSS funds, bought life insurance, or repaid home loans to claim deductions. The deductions weren’t just about tax savings. They also nudged millions into disciplined saving and investing.
But five years later, we see financial stress in the middle class. The link with the missing tax deductions is hard to miss. When fiscal incentives vanish, so does the urgency to save.
A 30%, ₹15 Lakh Fix
To revive savings, India needs a middle path. Here’s a proposal: allow taxpayers to claim a flat 30% deduction on income, capped at ₹15 lakh annually but without sub-limits, covering all avenues—Chapter VI-A deductions such as Sections 80C, 80D, 80E, NPS, home loan, and exemptions such as HRA and tax-free interest income. This simplifies compliance and allows taxpayers to focus on their preferred deductions.
How would it work? If you earn ₹20 lakh, you could save ₹6 lakh via a combination of NPS, insurance, and home loans. It’s a generous but reasonable limit. The ₹15 lakh cap prevents misuse by high earners. Crucially, it balances freedom with responsibility—taxpayers choose where to save, but save they must.
India’s tax regime must recognise a truth: incentives drive behaviour. By reintroducing deductions, the government can reignite the savings habit without complexity. Deductions aren’t nostalgia for the old regime but a smarter, data-driven reboot.
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