MAKING FINANCIAL SAVINGS LESS TAXING
Author: Aarati Krishnan
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Bumping up the household savings rate and nudging savers to park their surpluses in financial assets can have a profound effect on the economy.
However, the tax rules for investors are complex. The tax rules could be reworked keeping the following in consideration:
- Providing more options to invest
The Income Tax Act, under Section 80C, creates incentives by allowing savers to deduct up to Rs. 1.5 lakh upfront from their taxable income each year towards investments. However, for availing the benefits, the investments can be made only from a restrictive list of ‘approved’ 80C investment. The list has grown over time; however, it distorts choices for savers. Some savers lock into risky ULIPs or ELSS (equity linked savings scheme) products for 80C tax breaks, when bank fixed deposits would better suit their risk profile. Others buy larger homes than they can afford to avail of home loan tax breaks.
It would be good if the Finance Minister did away with the approved list and offered just one fixed deduction of say, Rs. 2 lakh a year, for financial investments. This would allow savers the freedom of choice based on individual goals.
- Providing tax exemptions and deductions on financial assets
Indian savers prefer to bet their surpluses on physical assets such as gold or property, instead of in productive financial assets such as deposits, bonds and shares. Income tax rules, however, continue to offer handsome tax breaks on property investments, which are denied to many financial investments.
- Similar principles and taxation rules for equities and interest income
Indian investors prefer fixed income avenues that safeguard their capital, even if they earn lower returns. This is logical given that the population is dominated by low to mid-income earners. Present tax laws ignore individual risk-taking ability, and try too hard to push investors towards equities. Tax rules for both equity and interest incomes must be uncomplicated and similar. This would make financial products more appealing to savers by giving them a freedom of choice.