A Fiscal Stress Test before FY26

India’s budget arithmetic now depends more on taxpayers, dividends and discipline than windfalls.

In 2025 India crossed a subtle but important threshold. The year marked not merely a continuation of post-pandemic recovery but a transition towards structural realignment. Domestic demand remained resilient even as global trade tensions, tariff barriers and slowing external growth clouded the horizon. What stood out was not immunity from shocks but adaptability.

With real GDP expanding by 8.2 percent in the second quarter of FY2025–26, the economy gave policymakers room to pursue fiscal consolidation without choking growth. As the Union Budget for FY26 approaches, the state of the Centre’s finances offers a revealing snapshot of India’s evolving economic model.

Complex Story

Tax collections, however, tell a more complicated story. In the first three quarters of FY26, direct taxes failed to keep pace with nominal GDP growth. By December 17 last year, net collections stood at Rs 17.04 trillion, an increase of 8 percent year on year but far below the budgeted growth target of 16.1 percent. Mid-November data showed growth slipping closer to 7 percent. Gross collections rose by a modest 4.16 percent to Rs 20.01 trillion. Slowing refunds preserved liquidity and helped the government meet interim deficit targets, though it masked underlying weakness in revenue momentum.

Beneath these aggregates lies a deeper structural shift. For the first time in decades, personal income tax (PIT) overtook corporate tax (CT) as the primary driver of buoyancy. India’s tax-to-GDP ratio, long tethered to corporate profitability, is increasingly anchored in individual incomes. In 2025 corporate tax collections amounted to Rs 8.17 trillion, while PIT touched Rs 8.47 trillion. This is no anomaly. Since 2000–01, PIT has grown at an average annual rate of 16 percent, slightly faster than the 15 percent pace of corporate taxes.

The composition of corporate tax revenues exposes a growing fragility. Just 0.1 percent of companies (around 743 firms with profits exceeding Rs. 500 crore) accounted for over 53 percent of CT collections in 2025. Such head-heavy dependence leaves the exchequer vulnerable to profit cycles among a handful of conglomerates. Personal income tax, by contrast, rests on a broader and more stable base. Although only about 6 percent of Indians pay income tax, their collective contribution offers greater resilience over time.

Policy choices accelerated this transition. In a calculated trade-off, the government raised the zero-tax threshold to Rs. 12 lakh, sacrificing roughly Rs 1 trillion in FY26 revenues to stimulate consumption. By late 2025 nearly 72 percent of taxpayers had migrated to the simplified new regime. The result was a clear boost to demand: private consumption rose 7.9 percent in the second quarter. Not all tax heads benefited. Securities transaction tax, projected to grow 41 percent, faltered as segments of the capital market cooled in the second and third quarters.

Indirect taxes underwent their most dramatic overhaul since the launch of the goods and services tax in 2017. September 2025 saw the introduction of ‘GST 2.0’ which replaced the labyrinthine multi-slab structure with a simpler two-tier system of 5 percent and 18 percent. The reform aimed to reduce compliance costs, curb inflation and offset global trade pressures through fiscal stimulus.

Initial data offered mixed signals. GST collections peaked in April at a record Rs 2.36 trillion gross (Rs 2.10 trillion net), buoyed by seasonal demand and lingering inflation. Thereafter monthly collections settled into a range of Rs 1.70–1.95 trillion as price pressures eased and consumption normalised. November’s gross GST take of Rs 1.70 trillion provided the first clear glimpse of GST 2.0 in action. Domestic GST fell 2.3 percent, while import GST rose by over 10 percent. The divergence suggests that while demand for industrial inputs and capital goods remains robust, household consumption is cooling.

Shock Absorbers

As tax revenues strained, non-tax receipts became the fiscal system’s shock absorbers. By November they had reached Rs 5.16 trillion, or 88.6 percent of the annual target, far ahead of last year’s pace. The linchpin was the Reserve Bank of India’s record dividend of Rs 2.69 trillion. Public-sector banks added Rs 34,990 crore, lifting the Centre’s share to Rs 22,699 crore. By late 2025 total dividends had climbed to Rs 3.39 trillion, exceeding the budgeted Rs 3.25 trillion. These windfalls enabled aggressive capital spending without breaching deficit targets. Yet critics warn of a ‘dividend trap’ - reliance on episodic transfers may delay tougher reforms to strengthen recurring revenues, a concern long echoed by the IMF.

Disinvestment, once pitched as a pillar of structural reform, remained anaemic. Targets were repeatedly trimmed to match reality. A shift towards value optimisation over outright sales has slowed execution, leaving privatisation more promise than practice.

On the spending side, the government’s priorities were unmistakable. Total expenditure for FY26 was set at Rs 50.65 trillion, a rise of 7.4 percent. Capital expenditure stood at the heart of the growth strategy, with an allocation of Rs 11.11 trillion, equivalent to 3.1–3.4 percent of GDP. By the first half of FY26, utilisation had reached 51.8 percent, sharply higher than a year earlier, driven by infrastructure projects under the National Infrastructure Pipeline. Revenue spending, by contrast, was tightly leashed, rising just 0.03 percent between April and October. Subsidies amounted to Rs 2.88 trillion, with food subsidies declining even as fertiliser and petroleum costs rose between 14 and 41 percent amid global volatility. Interest payments remained the heaviest burden, absorbing 25 percent of total spending and 37 percent of revenue receipts.

All this fed into the central question of the year: the fiscal deficit. The government aims to reduce it to 4.4 percent of GDP in FY26, from 4.8 percent in FY25. By November the deficit had already reached Rs 9.76 trillion, or 62.3 percent of the budget estimate, compared with 52.5 percent at the same point last year.

Looking ahead, the FY26 budget will test the government’s balancing act. Spending may have to slow in the second half to meet deficit goals, potentially tempering growth. Deregulation will deepen, with stable income tax rates and a more attractive new regime. Targeted support for MSMEs and tariff adjustments aligned with free-trade agreements are likely as the impact of steep US tariffs unfolds.

India still leads the global growth table. The challenge for policymakers is to turn a year of fiscal improvisation into a durable framework that balances ambition with restraint.

(The author is a Chartered Accountant with a leading company in Mumbai. Views personal.)