The Impact of Direct and Indirect Taxes on Middle-Class Families: A Global Comparison, Case Studies, and Suggestions for Reform

Taxes form the backbone of a nation’s economy, funding development and welfare programs. However, in India, the burden of direct and indirect taxes, especially GST (Goods and Services Tax), often disproportionately impacts middle-class families. Rising inflation, high indirect taxes, and compliance complexities for businesses have underscored the need for reforms.

This blog explores the challenges, compares India’s GST with global models, presents real-life case studies, and provides actionable suggestions for policymakers and taxpayers to make the tax system more equitable.

Case Studies: The Human Element of GST Impact

Case Study 1: A Middle-Class Family’s Struggle with Rising Costs

The Patel Family from Gujarat earns ₹8 lakhs annually, with monthly expenses primarily on food, healthcare, and education. Post-GST implementation, the family reported:

• 30% increase in packaged food costs due to an 18% GST rate.
• Healthcare expenses rose by 20%, as medicines and diagnostic services attracted 12%-18% GST.
• Their savings dropped by 15% annually, leaving them vulnerable to emergencies.

Case Study 2: Compliance Burden on a Small Business

Ravi Kumar, owner of a textile SME in Tamil Nadu, struggled with GST compliance:

• Filing multiple monthly returns cost him ₹15,000 in consultancy fees.
• Delayed input tax refunds caused cash flow shortages, forcing him to take loans.
• Revenue dropped by 10% in the first year, as compliance costs offset profit margins.

These stories highlight the disproportionate burden of GST on India’s middle class and small businesses, amplifying the need for reforms.

Challenges in India’s GST System

1. Rising Cost of Living

   • Regressive Nature of GST: A uniform tax rate on essentials like food, healthcare, and utilities disproportionately impacts low- and middle-income groups, whose consumption-to-income ratio is higher than that of wealthy individuals.
   • Statistics: According to a 2024 NSO study, GST contributes to 20%-25% of middle-class household expenditure, while its impact on wealthy households remains below 10%.

2. Compliance Complexities

   • SMEs face high costs for digital compliance tools and struggle with delayed refunds.
   • According to FICCI, 45% of SMEs reported that compliance efforts have reduced their ability to reinvest in their businesses.

3. Political and Economic Hindrances

• State governments often resist reforms, fearing loss of revenue.
• Simplifying tax slabs could create ₹50,000 crores of short-term revenue deficits, as per CRISIL estimates.

Exploring Alternative GST Models

India’s GST reforms can benefit from global practices. While comparisons with Malaysia and Australia are insightful, looking at European models could further inform effective reform strategies.

1. European VAT System: Balancing Revenue and Welfare

   • Progressive Rates: European countries adopt tiered Value-Added Tax (VAT) systems. For instance, France taxes luxury goods at 20%, while essentials like food and medicine attract a reduced rate of 5.5%.
   • Revenue Sharing: EU countries allocate VAT revenue between central and local governments, ensuring balanced development.

   Lessons for India:

   • Adopt progressive GST rates for luxury goods and essentials to reduce inequality.
   • Strengthen state-level revenue-sharing mechanisms to address concerns about loss of revenue.

2. Australia’s Simplified GST Model

   • Flat 10% GST rate with exemptions for fresh food, education, and healthcare.
   • Emphasis on digital compliance tools reduced operational costs for SMEs.

   Lessons for India:

   • Simplify GST slabs to reduce compliance burdens.
   • Zero-rate critical services like education and healthcare.

3. Malaysia’s GST Challenges

   • Implemented a 6% flat GST rate, later replaced by SST due to public protests over inflation.
   • Public backlash highlighted the importance of communicating the benefits of reforms.

   Lessons for India:

• Conduct public awareness campaigns to improve acceptance.
• Introduce targeted subsidies for low- and middle-income groups.

Suggestions for GST Reform

For Policymakers:

1. Revise GST Rates and Exemptions:

   • Reduce GST on essentials like food and medicines from 18% to 5%.
   • Exempt education and healthcare services from GST, as seen in Australia and the EU.

2. Introduce Targeted Subsidies:

   • Offer direct cash transfers to middle-class families to offset GST on essentials.
   • Subsidize digital compliance tools for SMEs to reduce operational costs.

3. Simplify GST Compliance:

   • Reduce the number of GST returns to a quarterly system for SMEs.
   • Automate refunds to minimize delays and improve cash flow.

4. Strengthen Revenue-Sharing Mechanisms:

   • Create transparent systems for state revenue allocation to address resistance from state governments.

5. Public Awareness Campaigns:

• Educate citizens on how GST reforms can lower the cost of living and increase disposable income.

Tailored Recommendations for Stakeholders

For Policymakers:

• Leverage data-driven insights to quantify the impact of GST reforms.
• Address political resistance with robust state compensation mechanisms and public outreach.

For Taxpayers:

• Advocate for rebates and targeted subsidies to protect middle-class families.
• Encourage businesses to adopt digital compliance solutions, which can reduce operational costs.

A Path Toward Inclusive Taxation

India’s GST system has revolutionized taxation but requires significant reforms to balance revenue generation with equity. By learning from Australia’s simplified GST, Europe’s progressive VAT model, and Malaysia’s challenges, India can address compliance issues, reduce the tax burden on middle-class families, and ensure inclusive growth.

The inclusion of case studies, data-driven insights, and tailored solutions highlights the urgency for reform. A GST system that exempts essentials, simplifies compliance, and provides targeted relief will not only ease the burden on taxpayers but also ensure sustainable economic growth.

The future lies in bridging the gap between policy and people’s needs—turning taxation into a tool for empowerment rather than a burden.