Every year, the Union budget is preceded by a downpour of expectations. This time around, budget expectations of a taxpayer are fused with generous doses of hope for two reasons. First, the slowing economy needs a consumption push and second, corporate India already got a fillip in September when corporate tax got rationalized. The hope, therefore, is that an average taxpayer will also come off richer.
Given the revenue shortfall estimates, there may be little elbow room for tax sops but speculation is rife: sops could be introduced by reducing the tax rates in lieu of exemptions or by increasing deductions or by changing the tax slabs. Whatever be the outcome, the budgeting exercise as far as the taxes are concerned should be guided by three principles: it needs to de-clutter taxes for the common man, have a long-term vision and should be seen, beyond the revenue generating vehicle that it is, as a nudge for reforms and better consumer behaviour.
As someone who has poured over the budget documents year after year for more than a decade, it’s hard to recollect a year of status quo. Every year, the budget brings changes that puts an average taxpayer at the mercy of professionals. Of course, the government is taking many steps to simplify the process of tax filing, but an understanding of how incomes are taxed and the various deductions and exemptions available still eludes the average Joe. Therefore, the focus should be on de-cluttering the universe of taxes. It made a start in 2018 when it reintroduced standard deduction of ₹40,000 for the salaried individual in lieu of two exemptions, transport allowance and medical reimbursements, that totalled up to ₹34,200 in a year. But instead of being tax neutral, it ended up hurting taxpayers in the high-income segment as the government also increased the cess from 3% to 4%. Subsequently, the interim budget in 2019 increased the deduction by ₹10,000 to net some savings compared to previous year. Effective tax rates too have seen frequent changes in the form of cess and surcharge and this too can see some stability.
The other area that’s crying for government’s attention is the investment universe where taxation has created some unfair arbitrage. For instance, if you invest in equities via mutual funds, you pay capital gains tax, whereas if you invest via unit-linked insurance plans (Ulips), you pay no tax because Ulips come with a sliver of insurance. Such anomalies need to be addressed to create a level-playing field. Also, the world of capital gains tax needs to be simplified by making the holding period uniform. Taxes also need to be in sync with asset allocation and time horizons. If long-term investments such as Employees’ Provident Fund and Public Provident Fund (PPF) are tax-free, there is no reason why equity should be taxed and vice-versa. To read more on this.
Ultimately, the government needs to keep in mind that tax incentives shouldn’t be seen merely as tools to encourage investments where the government wants—for instance the short-lived extra ₹20,000 deduction on infrastructure bonds or the discontinued Rajiv Gandhi Equity Saving Scheme or the proposal to put CPSE ETFs on par with ELSS—because that would mean ending up with investments that may be out of whack with someone’s needs. Instead, tax changes should be seen more as a tool to nudge financial sector reforms. For instance, in 2012, the government defined the sum assured in a life insurance policy to mean the minimum amount assured in case the insured event (death) takes place. Before then, traditional plans were selling plans with no insurance cover. You can read about it here and here. The government can, therefore, look at tax nudges to bring in better discipline. For example, instead of a blanket increase in 80C deduction, the government could look at giving additional deduction for premiums that go towards buying a pure term plan.
Tax nudge could also clean up the way annuity products are sold. Currently, instead of being seen as a pension plan, immediate annuity plans get sold even to someone in the prime of her career only because the long-term lock-in of interest rate looks attractive and saleable when the interest rates see a downward trend. A tax deduction on annuity for senior citizens could make annuity more a pension product. For example, it could form the basket of Section 80TTB that gives a deduction of ₹50,000 to senior citizens for interest earned from bank deposits and Senior Citizen Savings Scheme (SCSS).
Hopefully, the upcoming budget will aim to address the big-picture issues and simplify income tax for the common man.
Deepti Bhaskaran is editor, personal finance, Mint