A sharp decline in India's tax buoyancy in FY26 has tightened trade-off for GoI between growth support and fiscal discipline. But big questions are why tax buoyancy has declined so sharply, and whether this holds lessons for FY27. The answers may indicate a need for more conservative tax forecasts in the future.
India's long-term tax buoyancy typically hovers around 1, meaning aggregate taxes usually grow in line with nominal GDP. A buoyancy factor below 1 indicates that economic growth is not translating into tax revenues in proportion.
When tax buoyancy falls short of the target in any year, it creates fiscal stress. All else equal, GoI can either rein in spending or relax fiscal deficit. FY26 has become such a year.
In February 2025, GoI assumed gross tax buoyancy of 1.1 for FY26. However, buoyancy has dropped to 0.5-0.6, implying a tax gap of around 0.6% of GDP compared to the target. This shortfall means that, even with a large central bank dividend, GoI will need to cut spending to meet the fiscal deficit target of 4.4% of GDP.
Two factors explain part of the slowdown in tax buoyancy:
Nominal GDP growth has weakened due to low inflation. Real GDP grew at 8% in the first half of FY26, but the GDP deflator rose only 0.7%. Lower inflation reduces the value of the tax base and drags tax revenue growth.
GoI provided tax relief. The personal I-T cut announced in February 2025 is likely to reduce fiscal revenue by $1 tn annually. The impact of the GST cut that took effect in September 2025 is harder to quantify, but given sluggish nominal GDP growth, it is unlikely to be revenue-neutral.
These two factors, however, cannot fully explain the sharp fall in tax buoyancy. Real tax growth has fallen even faster than nominal tax growth, which shows that inflation alone cannot account for weak collections. The decline in tax buoyancy is also broad-based, extending beyond categories where GoI lowered tax rates.
In addition, a third, largely overlooked reason in India's context may lie in the interaction between financial and fiscal cycles. A financial cycle captures co-movement of variables, including bank credit, equity prices and property prices. Recent public finance research identifies financial cycles as major contributors to volatility in fiscal cycles, especially in economies with rapidly deepening or mature financial systems.
In India, Covid synchronised resets of financial and business cycles. After lockdowns ended, economic growth surged, with equities, property prices and bank credit following suit. The post-pandemic economy displayed strong momentum in the property sector, rising household investments in equities, and higher household debt as credit intensity in private consumption increased. Financial deepening accelerated.
When financial and business cycles rise together, they amplify each other. During these joint upturns, economic agents experience stronger sentiment and wealth effects, driving them to riskier investments and higher consumption. The reverse also holds - weakening financial cycle can dampen pockets of economic activity even if overall real growth stays satisfactory.
India's financial cycle weakened in 2025, with all three major financial variables softening, even as real GDP growth strengthened. This divergence raises the question of whether financial conditions have begun to influence fiscal revenues. Analysis confirms this suspicion.
In models that included financial variables alongside nominal GDP, tax buoyancy attributed solely to nominal GDP fell by 20-40% compared with models that excluded financial variables. This indicates that part of buoyancy usually linked to nominal GDP reflects the economy's financial cycle. In other words, tax buoyancy relative to nominal GDP is lower than we tend to assume. This pattern holds for both direct and indirect taxes. As expected, equity markets exerted a smaller influence on taxes compared with property prices and bank credit.
If financial conditions do not improve in 2026, tax growth may continue lagging nominal GDP growth, keeping buoyancy below its long-term average. With such a risk, the planned shift to a medium-term debt target will demand stronger fiscal credibility to signal discipline amid bond market pressures.
After a significant miss in FY26, conservative tax forecasts will be essential to reinforce that intent.
The writer is an economist, ANZ
India's long-term tax buoyancy typically hovers around 1, meaning aggregate taxes usually grow in line with nominal GDP. A buoyancy factor below 1 indicates that economic growth is not translating into tax revenues in proportion.
When tax buoyancy falls short of the target in any year, it creates fiscal stress. All else equal, GoI can either rein in spending or relax fiscal deficit. FY26 has become such a year.
In February 2025, GoI assumed gross tax buoyancy of 1.1 for FY26. However, buoyancy has dropped to 0.5-0.6, implying a tax gap of around 0.6% of GDP compared to the target. This shortfall means that, even with a large central bank dividend, GoI will need to cut spending to meet the fiscal deficit target of 4.4% of GDP.
Two factors explain part of the slowdown in tax buoyancy:
Nominal GDP growth has weakened due to low inflation. Real GDP grew at 8% in the first half of FY26, but the GDP deflator rose only 0.7%. Lower inflation reduces the value of the tax base and drags tax revenue growth.
GoI provided tax relief. The personal I-T cut announced in February 2025 is likely to reduce fiscal revenue by $1 tn annually. The impact of the GST cut that took effect in September 2025 is harder to quantify, but given sluggish nominal GDP growth, it is unlikely to be revenue-neutral.
These two factors, however, cannot fully explain the sharp fall in tax buoyancy. Real tax growth has fallen even faster than nominal tax growth, which shows that inflation alone cannot account for weak collections. The decline in tax buoyancy is also broad-based, extending beyond categories where GoI lowered tax rates.
In addition, a third, largely overlooked reason in India's context may lie in the interaction between financial and fiscal cycles. A financial cycle captures co-movement of variables, including bank credit, equity prices and property prices. Recent public finance research identifies financial cycles as major contributors to volatility in fiscal cycles, especially in economies with rapidly deepening or mature financial systems.
In India, Covid synchronised resets of financial and business cycles. After lockdowns ended, economic growth surged, with equities, property prices and bank credit following suit. The post-pandemic economy displayed strong momentum in the property sector, rising household investments in equities, and higher household debt as credit intensity in private consumption increased. Financial deepening accelerated.
When financial and business cycles rise together, they amplify each other. During these joint upturns, economic agents experience stronger sentiment and wealth effects, driving them to riskier investments and higher consumption. The reverse also holds - weakening financial cycle can dampen pockets of economic activity even if overall real growth stays satisfactory.
India's financial cycle weakened in 2025, with all three major financial variables softening, even as real GDP growth strengthened. This divergence raises the question of whether financial conditions have begun to influence fiscal revenues. Analysis confirms this suspicion.
In models that included financial variables alongside nominal GDP, tax buoyancy attributed solely to nominal GDP fell by 20-40% compared with models that excluded financial variables. This indicates that part of buoyancy usually linked to nominal GDP reflects the economy's financial cycle. In other words, tax buoyancy relative to nominal GDP is lower than we tend to assume. This pattern holds for both direct and indirect taxes. As expected, equity markets exerted a smaller influence on taxes compared with property prices and bank credit.
If financial conditions do not improve in 2026, tax growth may continue lagging nominal GDP growth, keeping buoyancy below its long-term average. With such a risk, the planned shift to a medium-term debt target will demand stronger fiscal credibility to signal discipline amid bond market pressures.
After a significant miss in FY26, conservative tax forecasts will be essential to reinforce that intent.
The writer is an economist, ANZ
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
Dhiraj Nim
The writer is economist, ANZ Research