Breaking India’s tax squeeze

The Indian middle class is in a financial squeeze. Overwhelmed with increasing tax rates and low disposable incomes, its consumption patterns seem to be slowing — a troubling trend for an economy where domestic consumption demand accounts for 60% of gross domestic product (GDP).

The Indian government has faced severe criticism for its inability to reduce this burden, particularly as GDP dipped to 5.4% in Q3, a significant slippage from 6.7% in Q2, 7.8% in Q1 and 8.6% in Q4 2023. But can the Indian middle class’s tax burden be reduced without compromising fiscal stability?

Many experts, including Thomas Piketty, have advocated for higher taxes for the richest 1% to ease the strain on the Indian middle class. While this proposal has its merits, two key issues emerge.

First is the longstanding conundrum over whether higher taxes on the rich might lead to reduced capital formation, potentially affecting job creation and long-term economic growth.

Second, even with increased taxation on high-income groups, the scope for significantly reducing taxes on the middle class remains limited given the fiscal constraints and the government’s reliance on transfer payments to support vulnerable populations.

Theoretically, higher personal income taxes or wealth taxes for rich individuals should negatively affect financial markets or businesses directly, as their willingness to invest in these areas should decline.

However, extensive economic research, including studies by Emmanuel Saez and others, finds little evidence that high-income earners were discouraged from investing due to increased taxes.

For instance, despite top income tax rates dwindling from 70% in 1965 to under mid-30% in 2024, drastic changes in growth rates have not been