Budget 2025-26 must address middle class; their disposable incomes have fallen: Surjit Bhalla

Finance minister Nirmala Sitharaman will present the Union Budget on February 1 amid a challenging environment. The country is grappling with a consumption crisis and there is widespread uncertainty over US President Donald Trump’s policies and slowing growth. Surjit Bhalla, economist and IMF's Former Executive Director, hopes that this year's Budget should bring in 1991-like reforms. In an interview with Moneycontrol’s Shweta Punj, he said that there hasn’t been a substantial change in the nature of reforms since 1991. He also called for a rationalization of Income tax rates and highlighted falling disposable income of Indians as the key challenge to address in Budget for FY2025-26.

Here's the full text of the QnA:

Dr Bhalla, I want to begin by asking you the most fundamental question -- you conducted a poll on Twitter, you left it open to the people of the X world so to speak on what their expectations are from the Budget. Will it be a big bang Budget or will it be just another Budget?

Yeah, so thank you for having me and it was this Twitter poll I phrased it as will it be a "business as usual Budget" or will it be a "big bang Budget"? Now what one means by a big bang Budget is and you correctly refer to 1991 which is substantially different and especially in terms of reforms from what has happened before. Now since 1991 India is a proud country which has continued the system of reforms but and I should emphasize continued but there hasn't been any substantial change.

Now the question is do we need a substantial change and on that score my answer is yes and we need substantial change in our policies in terms of our tax rates which have a tax collection more appropriately and we can note the distinction between tax rates and tax collection as well as our policy towards foreign direct investment. Now you know there are three or two policies that have been well known for decades as very, very important for policy make for reforms for developing countries.

One is infrastructure and the second is technology foreign investment you know industrial growth with technology that's where so we have done a fantastic job on infrastructure and it started with what one interesting feature of the Indian economy as since 1991 is that there have been only two prime ministers who really devoted a lot of effort expenditure and thinking towards infrastructure development and both of them have been BJP leaders. Vajpayee with the starting with the road network and Mr. Modi starting from 2014 onwards and especially over the last five years or six years. So absolutely no change is needed in infrastructure policies. So what's gone wrong? What's gone wrong and I do think if I say that we need a substantial change we there are two policies that are needed to correct what has gone wrong.

The first is our policies towards foreign direct investment and you know this started with 2015. So while the government was reforming on various fronts and bringing in the GST, bringing in bankruptcy codes, etc. and even demonetization why I believe maybe one of the few economists believe was substantially oriented towards reform or in terms of taxation which I'll come to now. So in 2015 what the government did was that it said that there will be no new bilateral investment treaty.

Now what's a bilateral investment treaty? For decades and by all the countries, they are involved in foreign direct investment and just as happens in a foreign direct investment is different than portfolio investment because it's actually for infrastructure, for industry or for goods not for portfolio allocation or manufacturing. And so countries around the world whether it's China, whether it is the US, whether it is any other country have policies when nations are involved in foreign direct investment not money managers. So therefore there are rules of the game that are set up for foreign direct investment and the rules of the game allow for divorce.

Very important your partners in a big enterprise you know if I make investment in any country I can withdraw it at a moment's notice but foreign direct investment is different. You change your mind, well you are already committed legally to do this enterprise but you should be allowed to change your mind. So what countries have done in bilateral investment treaties is that they said okay first six months or so you try and negotiate amongst yourselves and you reach an agreement. If you don't then we'll have to go to a judge or an adjudicator or third party and a third party is a different country than involved in the FDI. So if India has, England has an FDI with India or let's take the US has an FDI with India, we have a disagreement then we'll go to a non-Indian non-American judge court and they will decide as to what is the correct policy. Just like in divorce you want to go to a neutral person.

So what did the Indian government do starting 2015? Oh in the new bilateral investment treaties that we will sign that if there is a grounds for divorce you will go to an Indian judge. Now Indians don't go to an Indian judge and you're telling me this guy or this investor FDI this firm needs to go to an Indian judge. So you know if you are the US or if you are England or if you are Switzerland I think most people will go in total agreement, let's go to an English judge, let's go to the US judge but you know this is after 200 years of jurisprudence or whatever.

We are a young nation of 27, we aren't there yet. Inshallah, we'll get there in 25 years. It's certainly not there yet. So what did the foreign investors do? They voted with their feet. They said okay we will not do any FDI in India anymore and the impact has been very very strong and very, very high that you had and, you know, these treaties had to expire before. So if you are committed in 2015 you sign a 10-year treaty in 2010 you continue according to the old rules of the game at least thankfully we didn't change that except now there is a Nestle story we can perhaps discuss later.

So basically now with the numbers the FDI as a percent of Indian GDP was somewhere around 2.5%. In 22-23 after these various FDI treaties had expired it was down to 0.8% GDP, a level last seen in India in the mid-1990s. So we have and technology why is FDI important? It brings in technology. Technology is what we need at this time you know all countries need technology. You see the whole fight on DeepSeek and so on so forth but you can't have that, you know, we are not there yet. We're there in space maybe but we're not there in various other items. So you need FDI and so therefore I think the first order for the government is to reverse its policies on and which don't make sense to me and hasn't made sense to the foreign investor, hasn't made sense to the Indian investor because the Indian investor that Indian firm is also not willing to go to the Indian judge because of the suspicion or the fear that the Indian judge will not act in the best interest of the law will act according to some other motivation. So that's the first big policy that needs correction.

You know Dr. Bhalla you said that you know our FDI has come down substantially. This has happened despite the fact that we have opened up more sectors for FDI. So from a policy point of view the intention seems to be that we want more FDI in.

Yes, but you know, there's other thing that's hurting the Indian economy and that is the increase in protection which makes domestic products. Remember you know people compare and correctly compare. Okay, the government and the firms were in collaborating the chaebols in Korea were collaborating together and you just had a few firms operating and we want you know our Indian stars and the government to cooperate the Indian jewels the big industrial firms collaborate with the government. Absolutely right but what's the difference in the case of Korea it was that they had to go and export. They had to be internationally competitive.

In India it seems we are in a reverse gear that we will protect the Indian firm so that it can stay an infant for much longer. You know this whole infant industry argument they need protection in the early stages as Jagdish Bhagwati said long long time ago and this is a policy you know infants just become geriatric, they don't grow old, they become geriatric, so we need to, you know, my big what I don't understand is that we are practicing in many ways and I'll give you another example policies or the method of doing policies that we did in 1800 and haven't changed. So take for example who makes economic policy in India. The ministry of finance. Who does the ministry of finance who via the ministry of finance makes policies IAS Babus. They are, you know, they go through where your rank matters and all these other stuff and your seniority is based on your rank on an exam you took 30 years ago. I mean this is bizarre but this is what we have and another item on policies since we're coming up to Budget day. You tell me which other country in today's day and age even 20 years ago where made the Budget in secret.

So as I've said several times and perhaps on your show earlier also for several years the secrecy in the Budget only helps media, TV performers etc. and the senior IAS Babus who make policy. Now one other item here is important to know that the, you and I and all of us agree that 1991 was a breakthrough Budget. Well, 1991 Budget was not made by the IAS Babus. It was made by technocrats, by specialists, which is the way it's done in the rest of the world. You get the best people for the job not somebody who graduated from IAS with a rank of one or two or three. So we need, and no need for secrecy. We had very good farm laws which were not passed for very very bad performance by the opposition but not in the interest of the country. But at the same time so why not just like any policy have open consultations where all the interest groups are brought together openly discuss and then you decide. So I think these are the method of making policy news changes and a couple of policies are drastic need for change.

Right. So Dr. Bhalla you know you spoke about how protectionism will only ensure that infants become geriatrics and not competitive and the Korea example is not exactly what is being panned out in India at this point. Are we saying that the Indian government has been following a protectionist policy which would benefit the Indian industry. However the implication of that is or at least that's what's assumed that if Indian industry prospers which means more jobs, more investments and so on.

No, no exactly, you know, look, I worked on in the background for the corporate tax cut was much needed when we brought the corporate tax cut down from 30% to 22% in 2019. Much needed absolutely but you know it's now what is interesting is that the argument is made that in order to address the slowdown—actually, let's come to what is bothering India. We're growing at 6%, 5.5% or whatever okay and we are the fastest growing country in the world. That is another I would say completely inappropriate claim that we are succeeding, we are the fastest growing country in the world but your growth has to be measured with respect to the international environment and with respect to your potential. So while the government can and does and should take credit that we are growing at let's say 6%. What is bothersome and what bothers you and what bothers every other Indian is that we are capable our potential is to grow at a much faster rate than what we are growing.

So what is inhibiting that performance and that what is inhibiting that performance is our policies to work you know and I believe in competition just like I hope you do and most Indians do and you allow the competitive spirits to flow you will see a much improved performance towards our potential. In this regard and I want to point out why is it you know let's think why did software and everything associated with software succeed to the degree it has you know the GCCs etc. These don't seem to be having any problems with competition.

They are not asking for protection and we are exporting more in services than we are in manufactured goods. Why? Because we don't have interest groups involved in affecting our policies towards protection in the case of software but we have major industrialists etc. who were keen to be protected. So I think you know this is what I call the deep state, our own deep state in India in a recent article and we need to recognize that we need to change policies become more competitive whether it's software, whether it is hardware, whether it is industry, whether it is services and whatever is not making us competitive is what we should address.

So protectionism is not making us competitive we've seen that and would you like to see in the Budget that the Budget should undo all the revisions that we have seen you know in the previous Budgets where import tariffs are concerned.

Look, Budget is the government itself claims that it is more of and correctly claims it's more of a vision statement what we should be doing on everything that affects the economy. So in that regard what the government can easily do along with this Budget announce that we are going to be apart from reducing tariffs that we are going import tariffs that we are going to get back to the bilateral investment treaties of the past so we can get attract FDI and which is much needed for our approach to be Viksit Bharat. This is necessary we won't get there unless we are competitive and we won't be competitive unless we allow technology to come in when it can, when it should and it does.

Making India competitive we've seen schemes like the PLI scheme that has been brought in. It has worked in some sectors. It's yet to take off in some other sectors. What's your assessment and what's holding that back?

No, look, I think the PLI is a good policy, production linked incentives, nothing wrong with it. Matter of fact, perhaps even needed, much needed. But when you want production, instead of calling it PLI, I would call it CPLI—competitive production linked incentives, that's all. So, you want every country in the world to give benefits, that's why I gave the example of Korea giving benefits to some industrialists or whoever. Every country in the world should do that; they do do that. The only problem is, in India, we don't link it with competitiveness, we link it with production.

Absolutely, let's talk about taxation Dr. Bhalla. You know, corporate tax rates have come down. Nomura came up with a report saying that the Budget needs to bring down corporate tax rates. Would you recommend that to the Indian government?

Look, I think our corporate tax rate is at 22%. Okay, and this was a much-needed policy back in 2019 when it was reduced from 30 to 22%. Now we are competitive. So, what should we do when we look at whether we are being internationally competitive? The most normal, natural thing to do is to compare it with what the tax rates are in other countries, right? And if you look at East Asia, which is our major competitor and which has shown the lead in terms of industrial growth for the last 30 years, and this is all countries in East Asia, not just China, their corporate tax rate—or let me put it this way—their, yes, their corporate tax rate is around 15%. Okay, which is why in 2019, you know, if you were a new firm, then the government said that for the first five years or so, your tax rate should be reduced—to I think 15%. Now, that's where we want to get to, and I think any approach towards getting to a competitive, defined as East Asia manufacturing corporate tax rates, or any corporate manufacturing or services, should be there. That's number one.

Now, the other unfortunate—and as you know, and there's been a lot of discussion in the literature, or in the press rather, which is the literature in India—is that I have been concentrating on not so much the corporate tax rate in my analysis and in my suggestion, but the individual tax rate. And the individual tax rate in India is very, very high, and it affects incentives. Individual incentives. And then you've got to ask, as to getting… So, why do countries tax? Countries tax because they need resources for infrastructure, they need resources for public goods, they need resources for technological development, for subsidies, etc. So, let's look at the countries that have really performed well, you know, they all—East Asia. The average tax to GDP ratio is around 13 to 15%. That means all taxes—on individual taxes, corporate taxes, value-added taxes, GST, etc. So, they find that they can do all of their objectives by having some deficits because, you know, no country has zero deficit.

So, you add three or four percent deficit for your expenditure. So, I'm just talking on the taxes. So, that's what is the norm, just like why do we need a corporate tax cut? Look, let's look at how other countries are doing. So, why do we need a personal income tax? Because our incentives of production for individuals are affected.

The second important reason why we should cut the—you know, we have had a substantial increase in individual taxation. The reason in actual tax collection, the reason that has happened is—and this I will now get to my major point—which is: why is the middle class so upset? Let's agree very simply that it's only the middle class and the really rich who pay taxes. That's fair. Now, if you look at the real disposable incomes of the middle class as well as the rich, but let's exclude the top one percent, etc., if you look at the real disposable income of the middle class, it has gone down since 2011 and gone down by about 20, 30, 40% in real terms.

Okay, so what data is this?

This is the government's own data, which I have been analyzing, etc. The government, very good, and the government should be complimented for this, the CBDT and the Ministry of Finance released, by the Ministry of Finance, across for how much taxes, how many individuals pay income tax, how many individuals pay capital gains taxes, total taxes, etc. and what their average incomes are in nominal terms.

So they graded by zero to one and a half lakhs, annual income, one and a half to three lakhs, three to five lakhs and so on and so forth, all the way to 500,000 lakhs or whatever the upper bound is, okay. So this is all published, all government's own data, which I have been asking the government for the last five, seven years, that they should release this on a unit level data rather than a composite. And let's hope that they will do that because it's very, very useful for analysis.

And that's where I get the result that the real incomes, disposable income of India, of the middle class has really gone down. So why is our tax collection up? We know that the tax collection has really exceeded, income tax collection, it's gone up because there's been a lot more employment and the government doesn't know how to present that data because they are succumbed to the opposition saying there's no employment, there are no jobs, etc. A substantial increase in jobs, salaried jobs has taken place.

And because the opposition is caught in a time warp, our government wants to, you know, placate them. I don't know why. So they should be announcing from the top of the world, which I'm going to be announcing, that look, we have succeeded very well in providing jobs, salaried jobs. Okay, so your tax revenue has gone up because salaried jobs which come in the formal tax net, because your tax gets deducted at source and so on and so forth, has the number of individuals has substantially gone up. But the wage hasn't. Okay, so there are more people earning a thousand rupees or a lakh of rupees a year or 10 lakhs of rupees a year. Take whatever level you want. There are more people doing that. So therefore, there is more tax revenue. And compliance has gone up. So the various, you know, that's a success story. And what is not a success story is that the real incomes have gone down, which is why they are unhappy.

Disposable income. Okay, and there's another story, perhaps another, that even for those salaried individuals around the world, skilled individuals around the world, and this I've discussed several times, are not going up at all, actually, because there is a global glut of college educated people. But that's besides the point. Simple point is that we have succeeded in providing a lot of salaried jobs. But we have taxed the hell out of our people, the middle class, which is why they are upset. And that I want to come to, that the reason the government should change policy on February 1st, first and foremost, it's good politics.

Okay, it's good politics to reduce tax rates because people aren't happy and we are taxing too much. It's also good economics. The third thing that will happen after the compliance increases, etc., there is less of this freebies that the government feels, oh, we've got so much tax revenue, let's go and give freebies. And the PM has been very explicit, has talked about the freebies. So there's no discipline. When you get an excess of surplus, right, you become inefficient or you become whatever adjective you want to use. But we are going ahead and competing with everybody. All the politicians are competing with each other because they have resources, your resources, my resources, which are not being put to efficient use.

So what do you recommend in the income tax reforms agenda of the government?

And in addition to that, you know, let's look at what is happening with GST, etc. So the middle class also has a lot of consumption taxes that it pays. Okay, so the aggregate for the middle class is a tax incidence of something like 40, 45% for the average person. If you add the consumption taxes for those earning more than 20 lakhs or more than 15 lakhs. OK, so they purchase refrigerators. They've got to pay a tax. They purchase, you know, most luxury goods 20 years ago are commonplace goods today. Cars, for example, for the middle class. So, you know, it is a very good point you raise what, and I think the angst for the middle class and why it is upset. And I link it to why my forecast for the election went wrong in June, as well as every other forecasters. But that's not enough compensation. One got it wrong, one got it wrong.

So now the idea is, not the idea. The question is, why did the BJP, why did a very popular prime minister like Mr. Modi lose the election in terms of he was supposed to get 330 seats and got about 90 seats less? Okay, so why did that happen? And I think it happened because of the middle class. You know, never, my old saying is never bet against the US and my new saying is never bet against the middle class. The middle class is the one that makes opinions. The middle class is the one that provides all of the inputs for decision making. The middle class is the one that provides all the taxes. And if they get upset, you're playing with danger.