The Price of Progress: How India’s 2025 Budget Reshapes Taxation

A Quick Look at India’s 2025 Budget

India’s 2025 Union Budget, announced by Finance Minister Nirmala Sitharaman, is an important plan to help the country grow economically. The budget includes ₹10 trillion for improving infrastructure, ₹2.5 trillion for healthcare, and ₹1.5 trillion for green energy projects. The government also aims to reduce the fiscal deficit (the gap between the government’s income and spending) from 6.4% in 2022-23 to 4.5% by 2025-26. Tax changes are a big part of the budget, including making taxes simpler and reducing corporate tax rates.

Why Taxation Matters

Taxes are crucial because they fund government projects that help improve the economy and public services. The government’s new tax policies aim to make the system easier, encourage people to pay taxes, and raise more money to support India’s growth. These changes will help India reach its goal of becoming a $5 trillion economy. Taxes also help address income inequality and ensure fair growth for all.

Comparing India’s Tax System with Other Countries

The following graph provides a comparative analysis of taxation structures in India, the USA, the UK, Germany, and Singapore. It presents three key tax indicators: the highest personal income tax rate, the corporate tax rate, and the tax-to-GDP ratio. Developed economies such as Germany and the UK exhibit significantly higher tax-to-GDP ratios, indicating a greater reliance on tax revenue to fund public services. In contrast, India and Singapore maintain relatively lower tax-to-GDP ratios, reflecting different fiscal policies and economic structures. By analyzing these trends, we can understand how various tax policies align with broader economic priorities and social welfare models.

Source: Generated by the author.

The graph highlights key contrasts in global taxation strategies. Countries like Germany and the UK impose higher personal and corporate taxes, contributing to a robust tax-to-GDP ratio and extensive welfare programs. The USA, while maintaining a high personal income tax, has a lower corporate tax, fostering a business-friendly environment. India, with a relatively low tax-to-GDP ratio, suggests limited revenue mobilization despite moderate tax rates, pointing to structural inefficiencies in tax collection. Singapore, with the lowest corporate tax rate, exemplifies a pro-business tax model. These variations indicate the trade-offs between revenue generation, economic competitiveness, and social spending across different economies.

Let’s observe how India’s tax system compares to some developed countries in a more descriptive way:

Key Insights:

• Lower Tax-to-GDP Ratio: India’s tax income (about 11% of GDP) is much lower than developed countries like the USA (26%) and Germany (38%). This shows India has a smaller tax base and faces challenges in raising money through taxes.
• Corporate Tax Competitiveness: India’s corporate tax is higher for older companies (30%) compared to Singapore (17%), which might make foreign companies hesitant to invest in India. The 2025 budget lowers taxes for new manufacturing companies to 22%, trying to make India more attractive for investment.
• Complex Tax System: India’s tax system is more complicated than countries like Singapore, which have simpler, flat-rate taxes. The new tax system in India tries to simplify things, but more changes could make it even easier for businesses.

Old vs. New Tax Regime: Who Benefits?

Here’s how the two tax systems compare:

Who Benefits from the New System:

• High-Income Earners: People earning a lot of money, like ₹20 lakh per year, can save up to ₹50,000 with the new system because it offers lower rates without needing to save in special tax-saving schemes.
• Middle-Class Salaried People: For middle-income earners, the old system might still be better because it allows deductions for things like insurance and savings plans, which can save a lot of money.
• Self-Employed & Investors: People without many tax-saving investments might prefer the new system because it’s simpler and reduces their tax burden. However, they may miss out on saving opportunities in the long run.

Source: Generated by the author.

The graph compares the tax impact under the old and new regimes, showing how deductions influence the final tax paid.

• The faded bars represent the full tax rates before deductions, while the blue bars show the actual tax paid in the old regime after deductions, and the orange bars represent the tax paid in the new regime, which remains unchanged since deductions are not allowed.
• The green dotted line illustrates the available deductions in the old regime—the higher it goes, the more tax is reduced, making the blue bars shorter.
• Before recent tax changes, the old regime was more beneficial for all income levels because deductions significantly lowered taxable income, reducing the tax burden, which is evident from the graph.
• For individuals earning ₹12 lakh or less, the new regime is now more beneficial since no tax is required, making deductions irrelevant. For those earning above ₹12 lakh, the old regime remains better if they claim substantial deductions, as it lowers their effective taxable income.

In summary, the new tax regime favors middle-class taxpayers who do not maximize deductions, while high-income individuals with major tax-saving investments like home loans and insurance still gain more from the old regime.

The Role of Opportunity Cost in Tax Decisions

When taxpayers choose between the old and new tax regimes, they are essentially facing an opportunity cost—a trade-off between two different benefits. The decision isn’t just about how much tax one pays, but about the broader economic choices each individual faces when it comes to saving, investing, and spending.

For those opting for the old regime, the key advantage lies in tax deductions like those for home loans, insurance, and investments in retirement funds (e.g., PPF, ELSS). These deductions reduce taxable income, which, for some taxpayers, means paying less in taxes and saving more for the future. The opportunity cost here is the benefit foregone from not being able to access a simplified tax process—the old regime requires keeping track of numerous deductions and investments to ensure tax savings, which can be time-consuming and complex.

On the other hand, the new regime offers lower tax rates across income slabs, but at the cost of losing deductions. This may benefit taxpayers who prefer a simpler, more predictable tax calculation process, and for those who may not have significant savings or investments that could yield tax advantages. The opportunity cost here is the potential loss of savings in long-term investments like retirement plans or tax-saving instruments. Without the incentive to save more, individuals may find themselves spending more in the short term instead of securing their financial future.

Ultimately, taxpayers must weigh the immediate benefit of lower taxes (with the new regime) against the long-term benefit of saving and investing for the future (with the old regime). It’s a personal decision influenced by financial goals, time investment in managing deductions, and how one balances the present with future needs.

Behavioral Economics: How Taxes Affect Decisions

Tax policies don’t just impact financial outcomes—they also shape the decisions people make and the way they perceive trade-offs. Behavioral economics explores how psychological, emotional, and social factors influence economic decisions, and it can provide valuable insights into the effects of tax policies like those in India’s 2025 budget.

Investment Choices and Risk
One of the key ways taxes influence behavior is through investment decisions. The old tax regime offers deductions for specific savings and investments, creating an incentive for individuals to engage in tax-saving investments (like PPF, insurance, or ELSS). This behavior aligns with the mental accounting theory—people tend to segregate their money into different “accounts” (such as savings or spending) and are more likely to invest when they know there’s a tax benefit attached. The opportunity to reduce taxes through such investments often encourages people to save more, even if they may not have otherwise prioritized long-term financial security.

On the other hand, the new regime might encourage more spending and less investment, as the higher disposable income can be used immediately, instead of being tied up in long-term investments. This shift can be explained through the present bias theory in behavioral economics, where individuals tend to value immediate rewards (such as extra income to spend) more than future gains (like savings or investments). As a result, taxpayers may prefer the new tax regime, which gives them more control over their income today, despite the long-term consequences of reduced savings.

Consumption vs. Savings
The change from a tax regime that encourages savings to one that focuses on disposable income can also alter individuals’ consumption patterns. With lower taxes and fewer savings incentives, people might lean more toward increased consumption rather than saving for the future. This aligns with the hyperbolic discounting model, which suggests people are more likely to make choices that benefit them in the short term rather than opting for more beneficial, but delayed, outcomes. In the case of the new tax regime, individuals may decide to spend their additional income now rather than invest it, possibly at the cost of their long-term financial well-being.

However, long-term savings can be influenced by nudge theory—the idea that small, non-coercive interventions can help people make better choices. For example, tax policies that provide clear incentives for savings or investment (like tax rebates or deductions) can nudge individuals toward healthier financial behaviors. While the new regime reduces these incentives, behavioral economists argue that introducing default saving programs or automatic deductions could help people make better long-term financial decisions, even without the direct tax breaks.

Labor Market Impact
In the labor market, the new tax regime might encourage higher participation, especially among younger individuals or women who may see lower taxes as a direct financial benefit. According to social preference theory, people make economic decisions based on not just their own financial situation, but also societal and peer influences. Lower taxes may make work more attractive to those who would otherwise stay out of the workforce due to high tax burdens. However, pensioners and those who rely heavily on tax-saving deductions may not benefit as much from the new system, potentially deepening inequality by exacerbating the financial divide between different groups.

Theoretical Insights and Real-World Implications
The Laffer Curve in behavioral economics suggests that there is an optimal tax rate that maximizes government revenue without discouraging people from working, saving, or investing. India’s reforms attempt to find this balance by lowering taxes to encourage more spending and investment, while still maintaining revenue collection.

At the same time, the nudge theory has practical applications in tax policy design. By offering people simpler tax choices or nudging them toward saving without feeling forced, policymakers can steer individuals to make better long-term choices without restricting their freedom. In this context, India’s 2025 tax reforms could benefit from incorporating more behavioral economics insights to not only simplify the tax code but also align incentives that promote both immediate financial relief and long-term economic stability for taxpayers.

Policy Recommendations & Conclusion

Simplifying the Tax System: India’s tax system is often seen as too complicated. A simpler system, like Singapore’s flat-rate tax, could make paying taxes easier and encourage more businesses to set up in India.

Corporate Tax Adjustments: To attract more foreign investment and create jobs, India could lower corporate tax rates even further, making it more competitive with countries like Singapore.

Balancing Direct & Indirect Taxes: India relies a lot on indirect taxes (like GST), which affect everyone, including lower-income people. Shifting more tax collection to higher-income groups through direct taxes could make the system fairer.

Conclusion: India’s 2025 budget is a step toward a more efficient tax system that balances growth with fairness. By simplifying taxes, making them more equitable, and encouraging investment, India can achieve its economic goals and grow in a sustainable way.

References:

1. Union Budget 2025-26, Ministry of Finance, Government of India. https://www.indiabudget.gov.in
2. OECD Tax Database, Organization for Economic Co-operation and Development. https://www.oecd.org/tax/tax-policy/tax-database/
3. World Bank Report on Tax-to-GDP Ratios, World Bank. https://www.worldbank.org
4. Singapore Tax Guide, Inland Revenue Authority of Singapore. https://www.iras.gov.sg
5. Behavioral Economics and Taxation, National Bureau of Economic Research (NBER). https://www.nber.org
6. National Savings Institute Report, Government of India. https://www.nsi.gov.in
7. Laffer Curve and Optimal Taxation, Journal of Economic Perspectives. https://www.aeaweb.org