Missing the Mark: Why Tax Cuts Will Not Solve India's Aggregate Demand Problem

On August 15, Prime Minister Narendra Modi used his Independence Day speech from the Red Fort to unveil what he called a “Double Diwali gift” for the poor and middle class. “In the last eight years we undertook a big reform in GST (goods and services tax), simplifying the tax system. Now it is time for a review,” Modi said, announcing a shift to a simpler two-slab structure that promises to make several crucial items more affordable.

“We have consulted states and are bringing next-generation GST reforms,” he added. The proposal, if approved by the state governments, will replace the current four-tier GST with just two rates—5% and 18%, shifting nearly 90% of items currently taxed at 28% to 18% and almost all goods from the 12% bracket to 5%. 

This proposed GST overhaul is not a standalone measure but part of a broader effort to boost household spending. Earlier in the year, the Union Budget for 2025–26 raised the income-tax exemption limit from ₹7 lakh per annum to ₹12 lakh per annum, effectively removing a large share of salaried consumers from the tax net. Together, the twin steps are aimed at increasing disposable incomes and nudging consumption at a time when demand remains uneven. 

India’s consumption story has been under intense debate ever since the Covid-19 pandemic squeezed the pockets of millions of households. It turned out private final consumption expenditure, which accounts for nearly 60% of India’s GDP and is the key measure of household spending, lagged overall growth. In the last three fiscal years it expanded at an average of 6.7% while the economy grew at 7.7%. In other words, households have been spending far more cautiously than the economy’s topline numbers suggest. 

The fiscally conservative Centre had long acknowledged the pain points of salaried consumers, yet it avoided any significant direct intervention until the Union Budget this year. Instead, it relied on public capital expenditure to stimulate the economy, hoping the multiplier effect would also draw in investments from the private sector. Now it hopes to achieve the same with demand and consumption. But importantly, the plan also requires companies to play their part as the government itself acknowledges that tax relief alone will not do the trick. 

“If incomes are not rising, then there is something wrong. This is why we are also indirectly telling corporates that they should raise wages,” Tuhin Kanta Pandey, then finance secretary, had told Outlook Business in a post-Budget interview. “The corporate sector should also participate in demand creation by giving more money to their employees or hire more.” 

Low on Income and Confidence 

If government policy is trying to put more money in people’s pockets that is because it recognises that there has been no improvement in the incomes of workers for a long time. Over the decade to 2022, the average monthly real earnings of regular salaried workers fell by about 1% a year, according to a joint report by the International Labour Organisation and the Institute for Human Development. The decline points to the persistence of poor-quality employment and the lingering impact of the Covid-19 pandemic. 
 
In rupee terms, the average real monthly wages slipped from ₹12,100 in 2012 to ₹10,925 in 2022. Urban workers have borne the sharper cut with wages dropping to ₹12,616 in 2022 from ₹13,616 in 2012. In rural India too, earnings edged down from ₹8,966 to ₹8,623 over the same period. The India Employment Report 2024, which compiled this data, suggests that while the tax cuts are expected to revive demand, incomes themselves have been moving in the opposite direction. 

“When we analyse real income, it becomes clear that salaried workers have seen no meaningful increase in their earnings for the past 14 years,” Surjit Bhalla, economist and former executive director at International Monetary Fund representing India, Bangladesh, Bhutan and Sri Lanka, told Outlook Business in an earlier interview. 

Since 2011, the average consumer price index inflation has been around 5%. In most countries, especially developing ones, taxation is based on nominal incomes not real incomes. As a result, individuals may see their nominal incomes rise, pushing them into higher tax brackets even though their real incomes have not increased. This means people across the board are paying higher taxes despite no real growth in earnings, he explained. 

This long spell of stagnant wages has also affected how households view their financial health. For spending to truly revive, people need not just money in hand but also confidence about tomorrow. The RBI’s consumer confidence survey captures this gap well. Urban households, though better off than during the pandemic slump, still see their situation in bleak terms and remain in pessimistic territory. Rural sentiment has only just clawed its way back to neutral. Even so, the survey shows that despite recent improvements, income perceptions of both rural and urban households remain weak. 

“Only when households are confident of their earnings prospects over the foreseeable future will we see a pick-up in consumption spending that is both robust and durable,” says Rajani Sinha, chief economist, CareEdge Ratings, a credit rating agency. 

For now, much of the spending visible in the economy rests on borrowed time. Non-housing retail loans, largely taken for consumption purposes, made up 55% of total household debt as of March 2025, according to the RBI’s recent Financial Stability Report. Their share has been climbing steadily with growth outpacing that of housing, agriculture and business loans. This tilt shows how even the demand that is there is being propped up by borrowing rather than income growth, a fragile base for any sustained recovery. 

In fact, Indians are pulling back from traditional savings and stepping into riskier territory. RBI Governor Sanjay Malhotra in a recent media interview acknowledged that the share of savings flowing into banks has fallen from 43% to 35% over the last nine years. With incomes lagging, retail investors continue to pour money into volatile high-return assets, hoping for a reversal of fortune. In the first quarter of the current financial year, ₹20,255 crore flowed into mid- and small-cap mutual funds alone accounting for 30% of total equity inflows. This shift from safe deposits to speculative bets economists believe reflects desperation borne of the stress and uncertainty in the job market. 

In the Name of Productivity 

The jury is still out on what the proposed GST rejig could mean for the economy. State Bank of India’s economists for instance expect the reduced indirect tax burden to translate into a ₹2 lakh crore consumption boost though at the cost of an average annual revenue loss of ₹85,000 crore. Emkay Global, a financial services firm, is more cautious pegging the loss higher at ₹1.2 lakh crore and warning that states might take a disproportionate hit. Even if consumption does rise, Emkay points out that any pullback in public spending on capital expenditure or social spending or rural welfare could quickly blunt aggregate demand. 
 
Another layer of concern is that both the government and corporate sector are deleveraging at the same time. Public debt has eased from its pandemic peak of 88% of GDP to 82% by December 2024, while corporate debt has slid from 66% in 2017 to around 50% now. Where the government’s fiscal consolidation has been rewarded with a long-overdue credit rating upgrade from S&P, a global credit ratings agency, after 18 years, the simultaneous pullback in corporate debt is more troubling. Economists warn that such a cycle could further weigh on household incomes especially when families themselves are carrying higher loan burdens. The deleveraging, partly a fallout of the 2019 corporate tax cuts, is now seen as a drag on growth explaining why the Ministry of Finance is pressing India companies to pay and hire more. 

Yet when India’s largest software services firm, Tata Consultancy Services, announced in late July that it would shed 2% of its workforce, which is over 12,000 employees, over the next year to become more agile and future-ready amid rapid technological disruptions, it signalled that the situation is about to get worse. 

The IT sector, one of India’s biggest organised employers, has already started to further drag down income growth in the country. In its August 2025 report, CareEdge revealed that the top five domestic IT firms, which were expanding headcount at a healthy 11.5% a year between 2019–20 and 2022–23, saw a 4% cut in 2023–24. Employee costs in the sector rose only by 5% in the previous fiscal compared to the peak of 19% in 2022–23, due to weak salary growth and muted headcounts. In CareEdge’s sample of 669 listed non-financial companies, the IT sector accounted for nearly 44% of employee costs and it was found that labour costs in nominal terms have grown by just 7.2% last year compared to the 10.7% average growth seen between 2018–19 and 2023–24. 
 
The fear that artificial intelligence (AI) will deepen India’s persistent skill crisis is fast turning real. Outdated universities and training institutes remain ill-equipped to prepare workers for the future even as companies grow their fascination for AI adoption. For firms, the promise is higher productivity; for the government, it is growing unease. The latest Economic Survey warned that if businesses fail to phase in AI with sensitivity, the demand for policy intervention will be “irresistible.” It even floated the idea of taxing profits earned from replacing labour with machines to fund social costs of displacement. 

That anxiety was echoed by former finance secretary Pandey when he spoke about the government’s larger worry of rising productivity without rising pay. “When we provide tax benefits to businesses, we also expect them to pass on some of those gains to their employees,” he said in the interview. “If you are raising productivity, then wages must also reflect that growth. You cannot say I will increase productivity, but I will not increase the wages.” While careful not to judge isolated cases and mindful of firms’ need-based hiring and compensation decisions, the government is pushing for a shift in corporate attitudes. Indian companies must share more of their gains with workers. Observers however say global uncertainties including Donald Trump’s presidency in the US will make that more difficult. 

Ever since the US President announced reciprocal tariffs on trade partners, Indian industry has been bracing for turbulence. A near-war with Pakistan, China’s stranglehold over rare earth supplies to the automotive sector and now Trump’s push to force India into cutting oil trade with Russia through a 50% tariff hike have only heightened uncertainty. Estimates suggest around three lakh jobs to be at immediate risk just from the tariffs in the US, with labour-intensive small businesses likely to take the hardest hit. 
 
Against this backdrop, Chief Economic Advisor V Anantha Nageswaran has recently urged Indian companies not to be consumed by short-term shocks but to focus on “more important challenges”. In remarks aimed at the private sector, he stressed the need for long-term thinking. He had flagged the same concern earlier while presenting the Economic Survey, noting that firms have often prioritised profits over wages and calling out the short-sightedness of corporate India in an era of rising strategic challenges. 

The government’s tax cuts, and a GST rejig may ease pressure on households in the short run, but they cannot mask the deeper fault lines in India’s job market. Stagnant wages, slowing hiring in once-reliable sectors like IT, the disruptive force of AI and the added strain of global uncertainty all point to a bigger challenge of how to build an economy where productivity gains translate into rising incomes and durable demand.