Low Tax , But High Revenue For Govt.

The recent tax relief of no income tax up to ₹12 lakh has brought great joy to the middle class, but many are wondering how the government will generate revenue if taxes are reduced. Let's break this down:

In the previous financial year, income tax was the second-largest source of government revenue with 22 % of total revenue, and some are concerned that this new tax regime might lead to a loss in revenue. However, this isn't entirely the case.

Here's why:

When people have more disposable income, they have two main options for what to do with it: either spend it on goods and services or invest it in places like mutual funds, banks, or other investments.

Spending money: If people decide to spend their extra income, they will be paying indirect taxes like GST. This money will flow to sellers, who will also use it to make purchases, generating further GST payments. This creates a cycle of spending and taxation, known as the multiplier effect, where money keeps circulating, increasing overall tax revenue.

Investing money: Alternatively, if people invest their money in banks or other financial avenues, the cycle continues. For example, if someone deposits money in a bank, the bank now has more funds to lend. The borrower will use that loan to buy goods or services, thereby paying GST and contributing to the tax cycle. This creates additional economic activity and tax revenue.

In both cases—whether through spending or investing—the money continues to flow through the economy, generating indirect taxes and stimulating economic growth. This is the power of the multiplier effect at work.

I hope this helps clarify how the government can still earn revenue despite the tax cuts!

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