After skimming through the new Income Tax Bill tabled in Parliament last week, many folks seem to be put out that it didn’t contain any ‘reforms’ on taxation. True, as the new Bill has focused mainly on cleaning up obsolete bits in the old Act, reducing legalese and improving its language and presentation.
But a big reform in India’s personal tax dispensation has already been underway for over five years now. Taxpayers may not have realised it because it has been introduced in stealth mode.
Enter — the new tax regime
When the new regime for personal income tax was first introduced in the 2020 Budget, it got brickbats from critics and a cold shoulder from taxpayers. After all, who would voluntarily surrender the plethora of exemptions they were enjoying to move to a Spartan new regime, with no exemptions? Five years on, the new lamp is looking much shinier than the old.
Under the old tax regime, taxpayers were entitled to exemptions of over ₹2 lakh from their income for saving, investing and donating under Sections 80G, 80C, 80D and so on. Mandatory contributions to the Employees Provident Fund (EPF) could also be used to claim the 80C quota. If one had a home loan, interest of up to ₹2 lakh a year could be straight-away deducted from taxable income.
In the four Budgets that followed FY21, these tax breaks under the old regime have remained untouched. But the new regime has been dramatically spruced up with a higher rebate and friendlier tax slabs and rates.
The latest Budget in February 2025 drove the final nail in the coffin of the old tax regime. It offered a rebate on all folks earning up to ₹12 lakh a year — a big chunk of the taxpaying population. Tax slabs were tweaked so that even folks with income beyond ₹12 lakh will get to pay much less tax.
From FY26 onwards, the new regime will impose a 20 per cent tax only on folks earning over ₹16 lakh a year. The 30 per cent tax rate will kick in at over ₹24 lakh. In the old regime though, the rebate threshold remains at ₹5 lakh, the 20 per cent rate applies at ₹5 lakh and 30 per cent at ₹10 lakh.
These changes are likely to act as a forceful nudge for fence-sitters to jump en masse into the new regime. Government data showed that by August 2024, 72 per cent (5.27 crore) of the 7.28 crore tax filers opted for the new regime. Next year, the numbers are likely to be much higher, turning the old tax regime into a relic.
Should this come about, India would have neatly bypassed its age-old income tax riddled with complexity to a simpler dispensation, where taxpayers will enjoy lower rates, but will have no place to hide!
While this exodus may be good for both taxpayers and the tax department (which can do less detective work), it is likely to have larger macro implications, which are not much discussed. Here are four clear implications that provide food for thought.
Goodbye to 80C products
Section 80C was initially conceived to nudge Indian households to save instead of splurging, and to steer those savings into ‘desirable’ avenues in the policymakers’ eyes. Over time though, not only has 80C turned into an instrument for micromanaging savings, it has also spawned sub-par products which don’t do the saver much good. 80C tax breaks are one of the main reasons why India’s insurance industry has found takers for its endowment, money-back and other sundry plans that deliver neither good returns nor adequate protection.
The ELSS (equity linked savings scheme) category, with no clear mandate or focus, stands out as a sore thumb in the mutual fund industry. 80C has prompted the bulk of India’s organised workforce to rely overwhelmingly on debt vehicles such as the EPF (Employees Provident Fund) and PPF for retirement savings, when they should be relying on equities or index funds.
With the new tax regime doing away with 80C and all other product-based tax breaks, investors will be free to choose products that really fit their financial goals. The insurance industry may be forced to pivot to pure term plans which provide life cover at economical costs. Mutual funds will hopefully retire ELSS.
New employees joining the workforce may get to negotiate with their employer about skipping EPF contributions and taking home larger pay cheques. Employees looking for a comfortable retirement may no longer max out their EPF contributions; they may switch to stocks, Exchange Traded Funds or mutual fund SIPs with better return potential.
Can the lack of 80C decimate the savings habit itself? This appears unlikely. RBI data shows that in FY24, over 54 per cent of household financial savings already flowed into non-80C instruments — bank and NBFC deposits, stocks and mutual funds. The end of 80C may accelerate this trend.
Less skew in asset choices
The absence of product-specific tax breaks along with the ₹12 lakh rebate, will also free investors to make their asset choices based on personal risk appetites. Today, many seniors go for equity funds because interest is taxed at slab rates, while equity returns enjoy lower capital gains taxation.
Under the new regime, interest income will be completely tax-free as long as a senior’s income is below ₹12 lakh. With the 20 and 30 per cent slabs kicking in at ₹16 lakh plus, low and middle-income earners may also go back to allocating to fixed deposits, bonds and debt mutual funds, instead of jumping into risky equities just for tax savings.
Rethink on govt vehicles
Along with promoting the savings habit, 80C served a secondary purpose too. It helped steer household savings towards government-backed vehicles such as Public Provident Fund (PPF), National Savings Certificate (NSC) and Senior Citizen’s Savings Scheme, apart from the EPF.
These vehicles either directly supported the government borrowing programme or invested big sums (as in EPF’s case) in Central and State government bonds.
With the 80C prop no longer available, government-backed vehicles such as small savings schemes and the EPF may need to compete with private sector products on their own merits. Post office schemes, which will compete with RBI’s Retail Direct Gilt Platform, online bond platforms and bank/NBFC deposits, may need to pull up their socks on ease of transacting. Hopefully, India Post will do away with its archaic processes that still entail physical visits, passbooks and physical signatures.
EPF, if forced to compete with the NPS or mutual funds, will need to diversify its investments for better returns, and adopt transparent unit accounting. In fact, given that equity vehicles are a far better fit for the accumulation phase of retirement, the government needs to seriously rethink its policy of forcing all organisations to offer EPF to their employees.
Change in home-buying habits
80C apart, another hot favourite is Section 24(b) which allows taxpayers to claim deductions of up to ₹2 lakh a year, towards a loan to purchase a self-occupied home.
This tax break has prompted many young earners to stretch their finances to acquire property rather early in their career. This restricts mobility and leads to an EMI burden that curtails both spending and investing for the young demographic.
With the Section 24(b) benefit also not available in the new tax regime, rent-versus-buy decisions can finally be made on their merits. A shift to the new tax regime could well see Indians delaying their decision to buy their first home and free up their earnings for consumption and financial assets.
