The Interplay Between Tax Exemption Limits and Inflation: Insights from India's Union Budget 2025-26

 

The Union Budget 2025-26, presented by Finance Minister Nirmala Sitharaman, has introduced significant changes to the tax exemption limits, aiming to provide relief to taxpayers and stimulate economic growth. However, these changes also raise important questions about their potential impact on inflation. In this article, we will explore the relationship between increased tax exemption limits and inflation, drawing on historical data and examining consumer behavior.

Historical Context: Tax Exemption Limits and Inflation

Over the years, the Indian government has periodically adjusted tax exemption limits to provide relief to taxpayers. For instance, in the Union Budget 2023, the basic exemption limit was increased from ₹2.5 lakh to ₹3 lakh under the new tax regime. Similarly, in the Union Budget 2014, the exemption limit was raised from ₹2 lakh to ₹2.5 lakh under the old tax regime. These changes have generally been aimed at increasing disposable income for taxpayers, thereby boosting consumer spending and economic activity.

However, the impact of these changes on inflation has been mixed. For example, in the years following the 2014 tax exemption increase, inflation rates in India saw a moderate rise. This can be attributed to the increased disposable income leading to higher consumer spending, which in turn drove up demand for goods and services, contributing to inflationary pressures.

Union Budget 2025-26: Increased Tax Exemption Limits

In the Union Budget 2025-26, the full tax exemption limit has been increased from ₹7 lakh to ₹12 lakh. Income tax is applicable only for those earning more than ₹12 lakh. Even in this scenario, basic exemption limit under the new tax regime has been increased from ₹3 lakh to ₹4 lakh. This means that the first ₹4 lakh of income will not attract any income tax. Additionally, the threshold for Tax Deducted at Source (TDS) has been rationalized, further improving cash flows for taxpayers.

The Budget proposes revised tax rate structure under the new tax regime as follows;

Total Income per annum	Rate of Tax
₹ 0 – 4 Lakh	NIL
₹ 4 – 8 Lakh	5%
₹ 8 – 12 Lakh	10%
₹ 12 – 16 Lakh	15%
₹ 16 – 20 Lakh	20%
₹ 20 – 24 Lakh	25%
Above 24 Lakh	30%

Key Points:

• Basic Exemption Limit: Increased to ₹4 lakh under the new tax regime.
• Standard Deduction: ₹75,000 under the new tax regime.
• Tax Rebate: Increased to ₹60,000 under Section 87A for incomes up to ₹12 lakh.
• No Change in Old Regime: The old tax regime remains unchanged, except for the NPS Vatsalya scheme now qualifying for a tax deduction under Section 80CCD(1b).

Impact on Inflation

The increase in tax exemption limits is expected to put more money in the hands of consumers, potentially leading to increased spending. When consumers have more disposable income, they are likely to spend more on goods and services, which can drive up demand and, consequently, prices. This increase in demand can lead to inflationary pressures, as businesses may raise prices to meet the higher demand.

Historical data suggests that similar tax exemption increases have led to moderate inflationary pressures in the past. For example, after the 2014 tax exemption increase, inflation rates in India saw a slight uptick. While the impact may not be drastic, it is important to monitor inflation trends closely to ensure that the economy remains stable.

Consumer Behavior: Spending vs. Investing

With more disposable income, consumers face a choice: spend or save. Increased spending can boost economic growth but can also contribute to inflation. On the other hand, saving and investing the additional income can lead to long-term financial stability and growth.

It is crucial for consumers to be mindful of their spending habits and consider investing the extra money left in their hands due to increased tax exemptions. By investing in financial instruments such as mutual funds, stocks, or fixed deposits, consumers can not only secure their financial future but also contribute to the overall economic stability of the country.

Conclusion: Balancing Growth and Stability

The Union Budget 2025-26's increase in tax exemption limits is a welcome move for taxpayers, providing much-needed relief and potentially stimulating economic growth. However, it is essential to balance this growth with measures to control inflation. Consumers should be encouraged to invest their additional income wisely, rather than falling into the spending trap.

By making informed financial decisions and focusing on long-term investments, consumers can contribute to a stable and prosperous economy. The government, too, must remain vigilant and implement policies that ensure economic stability while fostering growth.

In conclusion, the relationship between increased tax exemption limits and inflation is complex and multifaceted. While tax exemptions can boost consumer spending and economic activity, they can also lead to inflationary pressures. It is crucial for both consumers and policymakers to strike a balance between growth and stability to ensure a healthy and sustainable economy.