Tax: The Middle Class Momentum

COME AUGUST, AND every year India watchers begin to sift through income tax returns (ITR) data with a fine comb. De­pending on your perspective, these sta­tistics can be the continuing story of the country’s skewed income distribution while others discern the inexorable rise of India’s middle class even as the country reaches for higher positions on the league table of global economies.

Whatever your perspective, the data is clear. The number of income tax fil­ers in all income taxpaying categories is going up. All income tax assessment brackets—from 5-10 lakh all the way to the ‘super rich’ category of more than ₹1 crore—have, on average, shown a three­fold increase in tax filers between 2013- 14 and 2022-23. Even as economists were debating the import of these numbers, Prime Minister Narendra Modi shared these summary statistics in a LinkedIn post on August 18. His words betrayed his joy at watching these numbers.

In his post, the prime minister noted: “This shows that not only have incomes risen but so has compliance. And, this is a manifestation of the spirit of trust which the people have in our government.” He went on to say: “These findings not only reflect our collective efforts but also reit­erate our potential as a nation. Growing prosperity augurs well for national prog­ress. Undoubtedly, we are standing at the cusp of a new era of economic prosperity and are on course towards fulfilling our dream ‘Viksit Bharat’ by 2047.”

At one time, ITR filers were concen­trated in a handful of urban districts and metropolises. Not anymore. In his post, Modi noted that data shows increased tax participation between 2014 and 2023 across all states. In particular, he noted: “For instance, ITR data analysis shows the state of Uttar Pradesh has emerged as one of the top-performing states when it comes to ITR filings. In June 2014, Uttar Pradesh reported a modest 1.65 lakh ITR filings, but by June 2023, this figure had skyrocketed to an impressive 11.92 lakh.”

Uttar Pradesh (UP) is just one part, but an important one, of this story of the rising number of income taxpayers. While fierce debates rage on poverty and inequality in India, there is a steady increase in taxpayers. Research by the State Bank of India (SBI), highlighted in a recent research report ti­tled ‘Deciphering Emerging Trends in ITR Filing: The Ascent of the New Middle Class in Circular Migration’, shows that the num­ber of ITRs with zero tax liability has gone down by 20 percentage points in returns filed between Assessment Year (AY) 2012- 13 and AY2022-23. These ‘zero tax’ returns are often pointed out as a ‘failure’ of India’s economic growth story. But the reality is complicated by the fact that governments over time have given extensive tax breaks at lower income levels even as they insist ITRs be filed. This leads to ‘zero tax’ returns. But as in­comes go up, individuals begin to move out of this zone. In AY2012- 13 this figure was as high as 84.1 per cent but by AY2022-24 this fell to 64 per cent.

The SBI report used the ITR data to calculate the weighted mean income and how it has changed over the years. The re­port notes that in AY2013-14 the weighted mean income was ₹4.4 lakh; by AY2022-23 it had shot up to ₹13 lakh. It is interesting to note that per capita income in FY23 was just ₹2 lakh. This is expected to go up to ₹14.9 lakh by 2047. When it comes to higher reported taxable incomes, two factors are at work in the increase in the income reported. For one, there is a transition from lower to higher income groups. For another, tax return filings are now buoyant and unlike in the past, when many people did not file returns, compli­ance levels are much higher now.

These figures are harbingers of a po­tential middle-class ‘bulge’ in the years ahead. The SBI report notes that threshold middle-class income is expected to touch ₹50 lakh by 2047. By that year there will be an estimated 482 million income tax filers compared to the roughly 70 million in 2023. Again, by 2047, 25 per cent of those who file income tax returns are expected to exit the lowest income bracket. This is in contrast to the period from AY2012 to AY2023 when only 13.6 per cent of the fil­ers left the lowest income bracket. While some of the projections in the report may be rosy, the direction of change is unambig­uously towards rising incomes over time.

The heartening feature of this change is that it is less uneven compared to earlier when most filers came from metros and rich states. In contrast, the most growth in ITR filed in AY2023 came from Maharash­tra, followed by UP, Punjab, Gujarat, and Rajasthan. Of these, there was no surprise in higher filings from Maharashtra, Punjab and Gujarat as these states are known high per-capita-income territories. What is inter­esting is the presence of UP and Rajasthan, two states that have been near-permanent fixtures in the acronym BIMARU symbolis­ing northern India’s status as an economic laggard when compared to the western and southern states. The top six states with the most change in ITR filings when AY2015 and AY2023 are compared were Maha­rashtra (64 lakh more filings), UP (52 lakh), Gujarat (42 lakh), Rajasthan (34 lakh), and Tamil Nadu and West Bengal with 29 lakh filings each. Between these two assessment years, there were 481 lakh more filings and these six states alone accounted for 52 per cent of these increased filings.

That is not all. As Modi noted, there has been a 20 per cent increase in filings from small states like Manipur, Mizoram, and Nagaland. These are special category states that require extensive economic support from the Centre. A 20 per cent increase in filings in these remote and geographically challenged regions shows that economic progress is spreading across India.

Another factor that seems to be at work in the rising number of returns being filed is the correlation between these rising numbers and the formalisation of the econ­omy. The SBI report says that in June 2020, in midst of the Covid-19 pandemic, the Cen­tre changed the definition of micro, small and medium enterprises (MSMEs) based on their investment in plant, machinery and reported turnover. The UDYAM regis­tration portal was launched in July of that year for registering these MSMEs after defi­nitional changes were brought in.

The report says: “[W]e mapped these state-wise UDYAM registrations with ITRs filed in respective states. We believe (based on our findings) that these 21.8 million MSMEs have also helped in in­creasing tax filings in India, which has in­creased by around 10 million to 78 million in the last four years. The top five states that accounted for 60% of total incremen­tal increase in ITR filings also accounted for 45% of total UDYAM registration, sup­porting our contention.”

THERE IS PLENTY of debate on what constitutes the middle class in India. If one leaves apart sociological features from definitions, rough economic markers of the Indian middle class are an annual aver­age household income that ranges from ₹5 lakh to ₹30 lakh. In per capita terms, this ranges from ₹1.08 lakh to ₹6.46 lakh. This is quite a spread and even these markers are contested at times.

When this is compared with the ITR data for 2022-23, an interesting picture emerges. The number of people in the ₹5- 10 lakh income bracket, roughly the lower limit of the definition of the middle class, is around 1.10 crore. If one adds the num­bers in the upper brackets (up to ₹50 lakh), this number swells to around 1.75 crore. In contrast, these numbers in 2013-14 were 37 lakh and 53 lakh, respectively. There is an upward bias—beyond the middle class— in these numbers because the ₹20-50 lakh bracket is included in these numbers.

These numbers are liable to subjective interpretations. Naysayers can say that the Indian middle class is a tiny reef in a vast ocean of poor people. While that is true, it is also a fact that the size of the middle class is expanding. The changes in these numbers between 2013-14 and 2022-23 are testimony to this process. It should be remembered that these were not rosy years of 7-8 per cent economic growth seen dur­ing the boom years of globalisation in the early 21st century. By 2013-14, the world had entered a protectionist phase and free trade and seamless flows of goods, money and people were undergoing a major change, for the negative. Yet, during these years (2013-14 to 2022-23) India managed to increase the absolute number of people in what can be called a middle class.

This process is likely to continue. People Research on India’s Consumer Economy (PRICE)—a think-tank—noted this change in a recent report (‘The Rise of India’s Middle Class’, July 2023). The PRICE report said: “With the upper-income class­es rising faster than the lower ones and the ‘Destitute’ class shrinking, by the end of the decade India’s income demographics will be transformed. In 2004-05, around 30% of the country’s population was classified as ‘Destitutes’ and declined to below 14% in 2020-21. By 2030, their numbers are pro­jected to fall to a little over 5% and further to less than 2% in 2047. The Indian Middle Class will grow from 14% in 2004-05 to as much as 31% in 2020-21, 47% in 2030-31 and 61% in 2046-47, and the Rich will grow from 0.5% to 4%, 11% and 26%.”

The numbers hinted at by PRICE may well turn out to be true. But that requires a single-minded focus on economic growth and checking the redistributive instincts so pronounced and powerful in the Indian polity. The economics of the change and the roadmap to that end are clear. It is the politics of the country that needs careful charting.

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