The Hindu Business Line : Exemption lulls, savings spur

Fearing a backlash from the aam aadmi, the Government is reportedly considering hiking the tax-free threshold to Rs 2.25 lakh now that the Direct Taxes Code Bill 2009 (DTC) has prescribed monetisation of all benefits and taxation of all allowances. While this is alright — as otherwise even low-level employees would be dragged into the tax net — the Government ought not to view all taxpayers alike — at higher levels, the tax exemption should be replaced by an impetus to savings. The DTC, like its predecessor-to-be, the Income-Tax Act, 1961, adopts a one-size-fits-all approach in the matter of exemption and savings as far as personal taxation is concerned.

Exemption should be given only to those whose propensity to save is either limited or non-existent. Therefore, while the proposed exemption of the first Rs 1.60 lakh is fine for those whose total income does not exceed Rs 10 lakh, for those with greater total income, the tax benefit must be related to savings. Thus, for those with total income in excess of Rs 10 lakh, there must not be any tax-free threshold.

Instead, what is denied by way of tax-free income must be added to the amount one can save and claim as deduction from the gross total income. In other words, the proposed upper limit of Rs 3 lakh should be increased to Rs 4.6 lakh once one’s total income is in excess of Rs 10 lakh. In short, while exemption should be the norm for the aam aadmi, for the relatively well-heeled, savings must be the norm.

Harness savings for capital formation

At higher income levels, the capacity and propensity to save is greater. And this must be harnessed by the government. An exemption offered on a platter offers no incentive to save. But it can dovetailed with savings to spur capital formation so crucial for a capital starved economy. In fact, apart from the fully deductible savings, there should also be deduction allowed on a sliding scale to those who can afford to save more, without seriously impairing the exchequer.

The additional Rs 1 lakh saved can be allowed a deduction of Rs 80,000, the next Rs 1 lakh Rs 70,000, and so on, so that a stage may come when the taxpayer will say enough is enough.

The point is tax-related savings must be encouraged and designed in such a manner that it is win-win for all concerned till the law of diminishing marginal utility makes it unviable for the taxpayer. The nation cannot take comfort from the fact that it enjoys a high savings rate — these savings must be channelled into desired directions. Some of them can be used for infrastructure development and some for social infrastructure.

In fact, the government can get cracking straightaway, there being a crying need for a heightened tax-related saving for the fiscal year 2009-10 now that the second and last instalment of the Sixth Pay Commission arrears is going to be released. There is no reason why the government cannot promulgate an ordinance increasing the limit of Rs 1 lakh to Rs 3 lakh so that what is given with one hand is not wrenched away with the other.

Warding off inflation

The Finance Minister did not endear himself to the working class when he awarded a measly Rs 10,000 increase in the tax-free limit this year in the Budget. He may not be inclined to increase the tax-free limit in a rear-guard action but he can certainly allow a much more liberal deduction for tax-related savings so that much of the money thus released into the system is sucked out, reminiscent of the RBI’s sterilisation operations on the forex front. This would ward off inflationary pressure.

The indulgence shown to savers may be counterbalanced with increase in the lock-in period or pruning of the interest rate, or both. Still, there would takers for such schemes, given that people are not averse to locking up their money, even rather unproductively, if that fetches them a reprieve from taxation.

The government ought not to make too fine a distinction between tax revenue and funds garnered for medium term at cheap rates. A positive fallout of the liberal tax-related savings regime would be a reduction in black money.

(The author is a Delhi-based chartered accountant.)

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