The Income Tax Act of 1961 is a keystone of India’s direct taxation system, governing the levy of taxes on individuals and corporations. Over time, this Act has evolved significantly, largely in response to the socio-economic needs of the country. The intricacy of the tax code, with numerous deductions, exemptions, and concessions, has led to a situation where taxpayers often struggle to fully comprehend their liabilities. In an effort to simplify the tax system and reduce administrative burdens, the Union Budget 2020-21 introduced an alternative personal tax regime, providing taxpayers the choice between continuing with the existing, deduction-laden tax regime or opting for a new structure with lower rates but without most exemptions.
This reform presents an opportunity to revisit fundamental questions about tax policy: What should be the objective of taxation in India? Should it serve as a tool for social welfare and investment promotion, or should it primarily focus on revenue collection with simplicity and compliance in mind? This paper aims to answer these questions by comparing the new and old tax regimes under the Income Tax Act, 1961, from multiple perspectives—economic, social, and legal.
By diving into the comparative analysis of the two regimes, we aim to evaluate their respective merits and demerits, focusing on taxpayer equity, administrative simplicity, compliance, and the broader macroeconomic impact. Additionally, constitutional perspectives on fairness in taxation, especially in light of Article 14 (Right to Equality), will be explored to assess whether the new tax regime aligns with India’s constitutional principles.
This paper is particularly relevant in the current socio-economic context, where India aims to simplify taxation while promoting investments in key sectors such as housing, insurance, and infrastructure. The introduction of the new regime represents a watershed moment in tax policy, and it is essential to scrutinize its long-term ramifications.[1]
The income tax act, 1961: historical evolution
The evolution of taxation in India reflects its socio-economic aspirations and the challenges it has faced as a developing nation. The Income Tax Act, 1961, replaced the Indian Income Tax Act, 1922, to better address the needs of a growing economy. Its enactment was the result of several years of deliberation, with recommendations from the Law Commission and extensive reviews by committees appointed to modernize India’s tax administration.
The Act introduced several innovative measures aimed at creating a more structured tax system that could accommodate India’s unique financial and social landscape. While revenue generation was a primary goal, equally important was the use of tax policy as a tool for social engineering. Sections like 80C, 80D, and 80G were designed not merely to reduce taxable income but to encourage socially desirable behaviour, such as saving for retirement, insuring health, and contributing to charitable causes. The Supreme Court’s decision in
The Income Tax Act has undergone numerous amendments, particularly following economic reforms in the 1990s when India liberalized its economy. The globalization of Indian markets necessitated a more robust and flexible tax system, leading to the introduction of several investor-friendly provisions. These amendments have been crucial in shaping the landscape of Indian taxation, where both direct and indirect taxes are used as instruments to promote economic stability and growth.[2]
Despite these reforms, the old tax regime grew increasingly compound, as successive governments added more exemptions and deductions to meet the socio-economic objectives of the state. For instance, tax benefits for housing loans under Section 24(b) and deductions for educational expenses under Section 80E were introduced to address key concerns of the middle class. However, these provisions also complicated the tax code, leading to challenges in compliance and increasing the scope for litigation.[3]
The old tax regime: key features and rationale
The old tax regime under the Income Tax Act, 1961, is characterized by its numerous exemptions and deductions, aimed at promoting savings, investments, and social security. Some of the key sections under this regime include:
- Section 80C: The most widely used section, it allows a deduction of up to ₹1.5 lakh on investments in specified instruments such as Public Provident Fund (PPF), Employee Provident Fund (EPF), National Savings Certificate (NSC), Life Insurance Premiums, and Equity-Linked Savings Schemes (ELSS).
- Section 80D: Deductions for health insurance premiums, including medical insurance for senior citizens. This is crucial for promoting health security.
- Section 24(b): A deduction on interest paid on home loans, up to ₹2 lakh per annum for self-occupied property. This section has played a significant role in promoting the real estate sector.
- Section 80E: Deduction on interest paid on educational loans, encouraging higher education and skill development.
- Section 80G: Deductions for donations made to specified charitable institutions, promoting philanthropy and social welfare.[4]
These provisions reflect the government’s intent to use tax policy as a means of encouraging individuals to invest in their future and contribute to nation-building efforts. For instance, the housing loan deduction under Section 24(b) not only incentivized individuals to purchase homes but also helped boost the real estate sector, which is a major contributor to the Indian economy. Similarly, deductions for health insurance under Section 80D have had a positive impact on the diffusion of health insurance in India, which remains low compared to other developing nations.
The old tax regime’s primary rationale lies in its ability to direct individual financial behaviour toward sectors and activities deemed socially beneficial. Tax incentives have historically been used as a tool for social engineering, promoting savings, investments, and expenditures in areas like education, housing, and healthcare. By providing deductions for these activities, the government not only reduces the immediate tax burden on individuals but also encourages them to make long-term financial decisions that benefit both themselves and the economy at large.
For example, the deduction for education loans under Section 80E reflects the government’s desire to promote higher education and skill development, which are critical for India’s transition to a knowledge-based economy. Similarly, the tax incentives for home loans under Section 24(b) have played a significant role in increasing home ownership in India, particularly among the middle class.
The old regime, therefore, can be seen as a tool for economic and social development, where tax incentives are aligned with broader national goals. However, this approach has its limitations. The multitude of deductions and exemptions has made the tax system increasingly complex, leading to higher compliance costs and greater scope for disputes between taxpayers and the authorities.
The new tax regime: objectives and simplification
The new tax regime, introduced by the Finance Act of 2020, marked a significant shift in India’s approach to income taxation. The key objective behind this regime was to simplify the tax system, reduce litigation, and increase compliance by offering taxpayers a more straightforward tax structure with lower tax rates. However, in exchange for lower rates, taxpayers were required to forgo most of the exemptions and deductions they could previously claim under the old regime. This move was intended to address several longstanding issues in India’s taxation system.[5]
The new regime’s simplicity stems from its structure, which is designed to be more transparent and easier to comply with. Under this regime, the government offers a flat set of tax slabs without the need for taxpayers to maintain detailed records of their expenditures or investments to claim deductions.
The policymakers behind the new regime aimed to achieve several goals:
1. Improving Compliance: By eliminating the need for multiple deductions, the new tax regime simplifies the process of filing income tax returns. This is expected to reduce errors and disputes between taxpayers and authorities, thereby improving compliance.
2. Reducing Litigation: The old tax regime, with its numerous exemptions and deductions, has often been a source of legal disputes. By simplifying the tax code and removing many areas of contention, the new regime seeks to minimize litigation.
3. Widening the Tax Base: The new regime is designed to attract taxpayers who previously fell into lower-income categories but opted for tax-exemptions that allowed them to reduce taxable income. By offering a simplified structure with lower rates, it is hoped that more individuals will come under the tax net, thereby increasing the overall tax base.
4. International Alignment: As India becomes a more globally integrated economy, the need for a more straightforward tax system that aligns with international standards has become evident. The new tax regime reflects this aspiration, mirroring tax structures seen in countries with more simplified taxation models.
Under the new regime, taxpayers are provided with lower rates across income slabs, but they must forgo the majority of exemptions and deductions available under the old regime. This shift fundamentally changes the approach to tax planning. Here is a breakdown of the tax rates:
| Income Bracket | Old Regime (with deductions) | New Regime (with deductions) |
| Up to ₹ 2.5 lakh | Nil | Nil |
| ₹ 2.5 lakh to ₹ 5 lakh | 5 % | 5 % |
| ₹ 5 lakh to ₹ 7.5 lakh | 20 % | 10 % |
| ₹ 7.5 lakh to ₹ 10 lakh | 20 % | 15 % |
| ₹ 10 lakh to ₹ 12.5 lakh | 30 % | 20 % |
| ₹ 12.5 lakh to ₹ 15 lakh | 30 % | 25 % |
| Above ₹ 15 lakh | 30 % | 30 % |
This table illustrates the key difference: while the new tax regime offers a lower rate for income brackets between ₹5 lakh and ₹15 lakh, it requires the taxpayer to forgo the deductions that were previously available. This creates a trade-off between opting for a simpler, lower-tax rate regime and maximizing deductions under the old system.
The reduction in rates is especially beneficial for taxpayers without significant investments or large deductions, such as younger professionals or individuals with simpler financial situations. However, for those with substantial home loans, insurance premiums, or educational expenses, the old regime’s deductions often lead to a lower effective tax burden despite the higher nominal rates.
Comparative analysis of both regimes
A direct comparison of the old and new tax regimes highlights the core distinctions between the two in terms of incentives, compliance, and fairness. Both systems have their merits, but they cater to different types of taxpayers, making the choice of regime a critical one depending on individual financial situations.
One of the most significant differences between the old and new regimes is the way they incentivize saving and investment behaviour. The old regime’s reliance on deductions encourages taxpayers to save for their future and invest in areas that contribute to economic development, such as housing, insurance, and retirement savings. These incentives are particularly important in a country like India, where long-term financial security is often uncertain due to insufficient social security systems.
Example 1: housing
Under the old regime, taxpayers can claim a deduction of up to ₹2 lakh per annum on home loan interest under Section 24(b). This deduction has been a significant driver of home ownership in India, as it reduces the effective cost of borrowing for individuals who take out loans to purchase a house.
In the new regime, this deduction is not available, which may discourage homeownership, particularly in urban areas where housing prices are higher. A middle-income taxpayer with a home loan is likely to find the old regime more beneficial, even with the higher nominal tax rates.
Example 2: health and life insurance
The old regime allows deductions for health insurance premiums under Section 80D and life insurance premiums under Section 80C. These deductions provide an incentive for individuals to secure their health and the financial future of their families.
In contrast, the new regime removes these deductions, which could result in fewer people purchasing health or life insurance, leading to greater financial vulnerability. For a taxpayer with high medical insurance costs, the old regime may provide greater tax savings.
Compliance and administrative efficiency
The new tax regime’s simplicity is one of its key selling points. By eliminating most exemptions and deductions, it simplifies the process of tax calculation and filing. Taxpayers no longer need to maintain detailed records of investments, expenses, or loans to claim deductions, which reduces the risk of errors and disputes with tax authorities.
Administrative burden
Under the old regime, taxpayers must submit a range of documents to justify their claims for deductions. This can be burdensome, particularly for individuals with complex financial situations, such as those with multiple sources of income or significant investments.
The new regime removes this burden by offering a flat tax rate with no deductions. For individuals with relatively simple financial affairs, this regime provides a more straightforward, hassle-free approach to filing taxes.
However, the downside of this simplicity is that it does not account for the varying financial responsibilities of taxpayers. For example, a family with substantial education or medical expenses may find it unfair to be taxed at the same rate as an individual without such obligations, even though their effective disposable incomes are vastly different.
The constitutionality of both tax regimes can be analysed through the lens of Article 14 of the Constitution, which guarantees the right to equality before the law. A taxation system must be both fair and equitable to all classes of taxpayers.
The old regime, by offering a wide range of deductions, ensures that taxpayers with greater financial responsibilities—such as home loans, medical expenses, or education costs—are taxed at a lower effective rate. This creates a more personalized tax system that recognizes the varying needs of different taxpayers, and arguably promotes fairness.
In contrast, the new regime’s uniform tax structure may violate the principles of equity for taxpayers with significant financial obligations. For example, a middle-class taxpayer with high education costs or healthcare expenses may feel disadvantaged under the new regime, as they are required to pay a flat tax rate without any recognition of their higher living costs.
The doctrine of legitimate expectation, a principle in administrative law, holds that individuals have a right to expect consistency in policy, particularly when they have acted based on prior incentives. The old tax regime has, for many years, provided incentives for savings and investments through deductions for specified financial instruments. Taxpayers who have structured their financial affairs around these deductions may reasonably expect that these incentives will continue, or that any changes will be gradual.
The sudden removal of these deductions under the new regime could be seen as a violation of this legitimate expectation. For example, taxpayers who have taken out long-term home loans or invested in life insurance policies may feel unfairly penalized by the removal of these deductions, particularly if they were counting on these tax savings to offset their financial obligations.[6] [7]
Policy implications and sectoral impact
The introduction of the new tax regime has significant policy implications, particularly for middle-class taxpayers and key economic sectors such as housing and insurance. While the new regime’s simplicity is attractive, it may have unintended consequences for sectors that have historically relied on tax incentives to drive demand.
Impact on middle-class taxpayers
Middle-class taxpayers are particularly affected by the choice between the old and new regimes. This group often has significant financial obligations, including home loans, medical insurance, and education costs. Under the old regime, these taxpayers could reduce their taxable income by claiming deductions for these expenses, which helped to lower their overall tax liability.
For example, a middle-class family with a home loan and medical insurance could claim deductions under Section 80C, 80D, and 24(b), effectively reducing their taxable income by up to ₹3.5 lakh. Under the new regime, they would lose these deductions but benefit from lower tax rates.
Scenario 1: a taxpayer with multiple deductions
A taxpayer with significant deductions—such as a home loan, medical insurance, and children’s education—would likely find the old regime more beneficial. For instance, a taxpayer earning ₹12 lakh per year with ₹2 lakh in deductions would be taxed at an effective lower rate under the old regime, despite the nominally higher tax rates.
Scenario 2: a taxpayer without deductions
In contrast, a young professional without major financial obligations or investments may find the new regime more attractive. With no deductions to claim, the taxpayer benefits from the lower tax rates offered under the new regime.
The new tax regime is expected to have a significant impact on sectors such as housing, insurance, and savings instruments, which have historically benefited from tax incentives. The removal of deductions under the new regime could lead to reduced demand for these products, which may have broader macroeconomic consequences.
Impact on the housing sector
The deduction for home loan interest under Section 24(b) has been a major driver of home ownership in India, particularly among the middle class. The removal of this deduction under the new regime could lead to a decline in demand for housing, particularly in urban areas where property prices are higher.[8]
Impact on the insurance sector
Similarly, the removal of deductions for health and life insurance premiums under Sections 80D and 80C could reduce the demand for insurance products. This could have broader implications for the insurance sector, which plays a critical role in providing financial security to individuals and families.[9]
Conclusion
The introduction of the new tax regime represents a significant shift in India’s tax policy, moving away from a system that incentivizes savings and investments through deductions to a simpler, more streamlined tax structure. While the new regime offers lower tax rates and reduces compliance burdens, it also raises important questions about fairness and equity, particularly for middle-class taxpayers with significant financial obligations.
As policymakers consider the future of India’s tax system, it is essential to strike a balance between simplicity and fairness. The old regime’s focus on deductions encourages long-term savings and investments, which are critical for economic growth. On the other hand, the new regime’s simplicity makes it easier for taxpayers to comply with the tax code and reduces the scope for disputes.
A potential solution could be a hybrid approach that combines the lower tax rates of the new regime with targeted deductions for critical sectors such as housing, healthcare, and education. This would provide taxpayers with the best of both worlds—simplicity and fairness—while ensuring that the government’s revenue needs are met.[10]
[1] Nani A. Palkhivala, *The Law and Practice of Income Tax* (9th edn, LexisNexis Butterworths Wadhwa Nagpur 2019).
[2] D. C. Srivastava, *Income Tax Act: A Critical Commentary* (4th edn, Thomson Reuters, 2018).
[3] V. K. Bhatia, *Interpretation of Taxing Statutes* (Eastern Book Company, 2020).
[4] Income Tax Act 1961 (Act 43 of 1961).
[5] Finance Act 2020 (Act 12 of 2020).
[6] Kanga & Palkhivala’s The Law and Practice of Income Tax* (10th edn, LexisNexis, 2021).
[7] P. G. Tandon, *Taxation Laws of India* (N M Tripathi Private Ltd, 2017).
[8] Kanga & Palkhivala’s The Law and Practice of Income Tax* (10th edn, LexisNexis, 2021).
[9] P. G. Tandon, *Taxation Laws of India* (N M Tripathi Private Ltd, 2017).
[10] Kanga & Palkhivala’s *The Law and Practice of Income Tax* (10th edn, LexisNexis, 2021).
Author: Anirudh VG, a 2nd Year BA LLB student at MIT WPU, Pune
