Why individuals don’t like Budgets: Business Line 11th Feb 2020

The changes in the tax system that are introduced in every Budget — the latest examples being the DDT abolition and new tax slabs sans exemptions — leave individuals scrambling to adapt and plan their financials for the future

There is an argument that Budgets are generally framed keeping in mind the lower income groups — which is ‘populist’ — and corporates, on the assumption that they bring about growth. Arguably, there could be some merit here.

Individual taxpayers are at the receiving end of tax reforms, which tend to be skewed against them. In the last five years or so, the changes in the tax structure that affect individuals have been quite demanding; and with the tax environment increasingly becoming volatile, it is also hard to take a decision on savings and investment. Most of these changes have been justified as following the principle of a ‘level playing field’, which is the clinching argument.

Change in criteria

First, individuals had to face the wrath of the imposition of LTCG on debt investments, where the fixed maturity plans (FMPs) were affected. From a situation where one year considered as long term, overnight, the criterion was changed to three years. As a result, there was a high tax outflow; and since the tax was imposed with a retrospective effect, it impacted past decisions taken.

Second, the LTCG on equity was introduced with the one-year condition, but an imposition of 10 per cent tax on gains. This time, however, there was a grandfathering clause which provided some relief to investors. There was also a condition that if LTCG was less than ₹1 lakh in a year, the gains would be exempted. Given the way tax rules are changing, it is a matter of time before this will be withdrawn, as the logic of the ₹1-lakh cap can be questioned at any time. Also, on grounds of a level playing field, there is nothing to stop future budgets to extend the time period of LTCG to three years for equity, as was the case with debt.

Structural reforms

Third, the biggest blow for individuals is the change in the dividend distribution tax (DDT). By abolishing the DDT, companies are better off, but it is very unlikely that they will pay higher dividends on the savings from this score. Now with the dividend being taxed at the level of the individual, it would generally mean a higher outflow. While it is said that the lower income groups will benefit, it would be naïve to accept that they are the big investors in the mutual funds or equity markets.

While this is the first loss for households, the second is in terms of planning for the future. Individuals who go in for dividend schemes do so on the premise that there will be a steady flow of income in future. The DDT was a notional loss for them, as higher tax, when paid, enters the financial ratios of the company but does not affect the shareholder in the real sense. Ideally, such a rule should apply for fresh investments made post-April 2020, like the grandfathering clause allowed for LTCG on equity gains.

Fourth, the new lower income tax slabs announced, which go with the removal of around 70 of the 100 exemptions that are currently available, is optional today. However, in subsequent interviews it has been clarified that this would soon cover all individuals, with all the exemptions removed. The ‘choice’ given today can be looked at as temporary. This raises an interesting question on the exemptions.

Exemption logic

All exemptions have been provided for a rational economic purpose. Interest on home loans was to enable people to borrow money to buy a house; Section 80C was to encourage savings for the long run, like with PPF or certificates; those on pension were to fill a lacuna for the absence of a social safety net in the country; health insurance is to ensure that individuals protect themselves, and so on. By removing these exemptions, all plans of individuals are disrupted and their purpose that was to be served.

The argument all along is that there has to be a level playing field and that tax laws have to be steered towards the direction of ability to pay. Higher income groups can pay higher tax and do not require benefits. In fact, even during debates on small savings, it is stated that as long as their returns are high, banks cannot lower their deposit rates. This has also been expressed in the Credit Policy Statement on February 6.

Interestingly, the size of the deposit component of small savings was around ₹6 lakh crore as of March 2019, of which time deposits were ₹1.2 lakh crore; bank deposits amounted to ₹129 lakh crore, of which ₹110 lakh crore were time deposits. Clearly, the argument that deposits would move from banks to small savings is not convincing.

The curious part here is that as people move away from small savings once exemptions are withdrawn, the government may find itself in trouble, as the NSSF provides a lot of support to maintain the government’s fiscal deficit. If people stop saving in these instruments, then the government will be forced to borrow from the market. Hence, small savings are important not just from the point of view of individuals, but also for the fiscal ecosystem. The government relies on this source (which will contribute 30 per cent in FY21) to ensure that there is no turbulence and crowding out in the financial market due to excessive market borrowings.

The main takeaways here are that individuals have consistently been at the receiving end of budget after-effects; this is one category which never can ‘manage’ the tax system as there is an audit trail for every transaction and there are no ‘escape clauses’, like the ones available for corporates. Second, it is hard to plan for the future when the tax regime changes continuously — it is a kind of regulatory risk. Third, rather than just withdrawing exemptions in a robotic manner, the ethos behind each one needs to be analysed before taking a decision. This would be a more just way of handling tax systems.