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The middle class in India is underpaid financially. Its consumption patterns appear to be slowing, which is troubling for an economy where domestic consumption demand accounts for 60 % of GDP. These trends are overwhelming due to rising tax rates and low disposable incomes.

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. However, is the tax burden on the middle class in India get reduced without compromising governmental stability?

Many experts, including Thomas Piketty, have advocated for higher fees for the richest 1 % to ease the strain on the Indian middle class. While this plan has its virtues, two important issues emerge.

First, there is the ongoing debate over whether raising taxes on the wealthy may cause lessening money formation, which could have an impact on job creation and long-term economic growth.

Second, despite higher taxes on high-income groups, the ability to substantially lower taxes on the middle class is still constrained by the president’s reliance on transfer payments to support the most vulnerable populations.

Technically, wealthy people’s higher personal income taxes or wealth taxes does directly impact financial businesses or organizations because they should be less likely to be willing to invest in these places.

However, substantial economic research, including reports by Emmanuel Saez and another, finds much evidence that high-income workers were discouraged from investing due to increased fees.

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 noted in the US. Over the past decades, economic growth, when measured on a ten-year moving average, has consistently hovered between 3 % and 4 % since 1974.

In the sense that lower taxes are supposed to lead assets, this contradicts the idea. It is thus natural to assume that higher tax rates didn’t act as disincentives, making the rich shy away from revolutionary investments. Strong and consistent need, especially from the center class, whose wasting energy progress across sectors, continues to be the real driver of expense.

But does the actions outlined above apply to India? According to the effect that commercial tax rates have had on investments, the answer is yes. Corporate rates in India were cut in September 2019 from 30 % to 22 % for existing companies and from 25 % to 15 % for new companies.

Despite a loss of tax revenue of around 1 lakh crore ( US$ 13.33 billion at prevailing rates ) in 2020-21 for the government, the net benefit from the cut in terms of increased employment and investment was minimal. Instead, tax cuts increased the earnings on existing funds, with virtually no benefits for wage-earners.

As per the Periodic Labor Force Survey ( PLFS), the regular wage employment across rural and urban India has fallen from 22.8 % in 2017-18 to 21.7 % in 2023-24. Rural workers ‘ real compound annual growth rate ( CAGR ) for real wages showed a slight decline of -0.18 %, while urban workers saw a marginal increase of -0.25 % over the same time period.

In contrast, top executives in American companies have experienced significant pay increases, surpassing the regular paid worker, with some companies ‘ CEO-to-median pay ratios increasing by up to four times between 2020 and 2024.

This also mirrors changes in many markets, including the United States, where the CEO-to-worker pay amount soared from about 20: 1 in 1965 to 354: 1 in 2012, even as income for both skilled and unskilled workers declined.

As the proof shows, a higher taxes on India’s wealthiest companies may not always damage capital formation. But, research has shown that higher taxes frequently outweigh higher tax compliance.

This becomes especially important when considering India’s income structure: in FY 2023-24, only 6.68 % of the people filed an income tax return, and almost 49 million people reported zero taxable income out of 80.9 million taxpayers.

Moreover, 6, 084 cases of tax evasion involving 2.01 trillion rupees ($ 24.2 billion ) in GST were recorded during the same time. The middle class is burdened disproportionately with maintaining fiscal stability because of how much of this evasion is carried by the government; this inequality could have been ameliorated by achieving better compliance rates.

Are higher tax rates, however, the only thing that causes more tax evasion? Data suggests otherwise. Tax evasion has continued to rise even with declining tax rates, both for personal income and for corporate income. For instance, despite a corporate tax cut in India in 2019, GST evasion seems to have surged<a href="https://economictimes.indiatimes.com/news/economy/finance/dggi-detects-rs-2-01-lakh-cr-gst-evasion-in-fy24-online-gaming-bfsi-most-prone-to-evasion/articleshow/113352911.cms?utm_source=chatgpt.com&from=mdr”> fivefold from 2017-18 to 2021-22.

This suggests that individual tendencies may contribute to tax evasion more than just tax levels. India must change its taxation system to reduce evasion significantly, rather than relying solely on lower rates to encourage compliance, in order to address this.

This brings us to the other important point, which is that even if the Indian government is able to collect more taxes from the wealthiest individuals, it may not be enough to significantly lessen the tax burden on the middle class.

For example, if a wealth tax of 2 % is imposed on Indians with assets above 100 million rupees, it would only raise around 1 % of&nbsp, GDP. This suggests that the middle class would still be responsible for the majority of the tax burden.

Average people typically make up the majority of government revenues in countries with high top-income tax rates and wealth taxes, as well as in several European countries.

Similarly, in India, food subsidy programs, including initiatives like the Pradhan Mantri Garib Kalyan Anna Yojana ( PMGKAY ), account for a significant portion of government spending, contributing roughly 1 % of GDP.

As such, tax reform like a 2 % wealth tax wouldn’t be sufficient to decrease the middle-class burden significantly, but would only provide marginal relief.

The answer lies not only in lowering the wealthy’s tax rates, but also in reforming India’s tax system to improve compliance and reduce evasion. Tax evasion is still rising despite measures like simplified e-filing options having a moderate increase in government revenue.

India needs to impose stricter penalties and strengthen its ability to detect and stop evasion in order to address this. The government could ultimately lower the middle class’ tax rates by expanding the tax base and improving compliance, giving taxpayers more tax relief in the future.

Utilizing informal mechanisms of enforcement, such as societal norms, is another promising method to improve tax compliance. Behavioral interventions, commonly referred to as “nudges”, have been shown by Saulitis and Chapkovski ( 2024 ) to be effective in encouraging individuals to pay taxes and reduce tax evasion.

These interventions work by subtly guiding people toward desired behaviors and reshaping the social contract in relation to tax compliance. Over time, as societal attitudes shift, a new norm can emerge where paying taxes is seen as a civic duty and a sign of social responsibility, rather than an obligation to be avoided.

A negative perception of taxes, which has roots in both historical and cultural traditions, may contribute to a large portion of tax evasion in India. The British imposed oppressive and stringent taxes during the colonial era, which led to distrust and resentment toward the system.

These feelings have persisted, contributing to the ongoing reluctance to comply with tax obligations. Over time, the tax system evolved into something more akin to oppression and exploitation than justice and civic duty.

While India struggles to balance its middle class’s tax burden, a combination of stricter penalties, more effective tax evasion detection, and the incorporation of behavioral insights, along with the use of social norms, might pave the way for a long-term, stable fiscal foothold.

Attrishu Bordoloi, a development economist with a Cambridge MPhil, is a. He is currently employed by the Centre for Effective Governance of  Indian  States as an economic policy analyst, and he has relationships with Futureworks Consulting and the World Bank as an economic consultant. &nbsp,

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