Dr Ashwani Mahajan
Finance Minister Nirmala Sitharaman in her budget proposals 2020-21 has proposed a new optional tax regime, whereby the lower tax rates have been proposed in the new optional regime, with the condition that the deductions and rebates, which were so far available, will cease to be available to the personal income tax payers, opting for new regime, henceforth. The proposed rates of personal income tax would be 5 percent between incomes of 2.5 lakhs to 5 lakhs, 10 percent on incomes between 5 lakhs and 7.5 lakh, 15 percent on incomes between 7.5 lakhs and 10 lakhs, 20 percent on incomes between 10 lakhs and 12.5 lakhs and 25 percent on incomes between 12.5 lakh to 15 lakh and all income above 15 lakhs at 30 percent. The tax so calculated will continue to attract cess as applicable. Prior to this, the only tax regime, which was earlier applicable was such that income between 2.5 lakh and 5 lakh had income tax of 5 percent while income between 5 lakh and 10 lakh had tax rate of 20 percent and 10 lakh and above had income tax rate of 30 percent, along with applicable cess. The rates have been so designed that the salaried tax payers who were generally saving 1.5 lakh annually and availing a standard deduction of rupees 50 thousand and are not availing any other rebate or concession would be paying lower tax than what he/she would have paid even after availing the tax rebate on savings. For instance an income tax payers having an income of rupees 15 lakhs, would be paying a tax of only rupees 3,37,500 under the new regime, while he would be paying rupees 3,45,000 as tax even after availing the tax benefit on savings invested in specified schemes.
The Government claims, and perhaps rightly, that with this new option 80 percent of the tax payers would opt for new regime. They are seemingly correct because it is beneficial for them to not avail tax benefit on savings invested in specified schemes and standard deduction. This may be painted as a relief to the tax payers offered in the new tax regime. However, the new proposal has implications on the saving culture, overall saving in the economy and also on the growth in the economy.
Disrupting the Saving Culture
It is well known that people in India believe in culture of saving. Generally people save for securing their future, purchase of real estate and gold and also for the future needs such as marriage and settlement of their offspring. For the past so many decades the Government has been encouraging savings in specific formats, such as LIC premium, Public Provident fund (PPF) and some other, by giving tax concessions on the same. For the last few years in addition to these saving the government has also been giving rebate on contribution in National Pension Scheme up to rupees 50 thousand annually. These measures have helped the government to make use of these resources to finance its fiscal deficit, and building infrastructure and capital investment. This action of the government is likely to discourage the savings in the country. Though some people may continue to save even after the withdrawal of concessions, however, this act of the Government is likely to impact the saving culture in the country.
Much of Capital Formation comes from Household Savings
It is notable that the rate of capital formation in the country has been increasing over time and it reached 39.6 percent by the year 2011-12. This capital formation has been largely financed by domestic savings and up to 2007-08 the foreign savings has never crossed 2 percent of the GDP. Recently, foreign saving as a source of capital formation has increased, however, it never exceeded 4 to 5 percent of the GDP in a single year.
Since 2011-12 we find that rate of capital formation has come down to merely 30.9 percent in 2017-18. The major reason for decline in capital formation seems to be decline in saving of the household sector declining from 23.6 percent of the GDP in 2011-12 to merely 17.2 percent of GDP in 2017-18. The tendency of the household sector to save has been coming down especially in the last 7-8 years after 2010, which is also dragging the rate of capital formation down. We understand that for capital formation plays an important role to lift GDP growth upward. Therefore, declining trend in household saving should be a matter of great worry.
Changes in the income tax rates under new optional scheme, which incentivise people to save less in specified scheme and also saving under National Pension Scheme is likely to reduce the household saving further. Under such circumstances our capital formation as a percentage of GDP may further go down.
Dependence on Foreign Capital may Increase
Urge towards increasing capital formation, with lesser resources available domestically, may increase our dependence on foreign capital. In the past, though the contribution of foreign capital has been increasing over time, however, if we take the average in the past one decade, average foreign capital as a percentage of GDP has been nearly 2 percent of GDP only. Therefore, one can conclude that foreign capital can play only a limited role in our capital formation. Foreign capital also causes pressure on our foreign exchange because interest, dividends, royalty payment etc. impact our foreign exchange outgo and therefore cause depleting our foreign exchange reserves, which in turn may cause depreciation of Indian rupees. India has so far been fortunate to have significant domestic saving, which could finance increasing rate of capital formation. This could be considered as an important factor to make India emerge as fastest growing of the world.
Difficulty for Public Exchequer
In case tax payers adopt new optional regime (foregoing incentives, including incentives for savings), the tax revenue will also get a hit. It is notable that a person having income of 15 lakhs will pay rupees 7,500 less as income tax, than he/she would be paying in the earlier regime. This would incentivise the tax payer to not go for saving and pay even lower tax.
Further, it may be noted that the fiscal deficit is financed by borrowing from financial institutions and funds (insurance companies, provident funds, pension funds etc.), finances of which would be hit by disincentives to saving. As a result the sources of financing fiscal deficit would shrink and Government will have to raise funds from other sources including monetising the deficit (by printing more currency notes).
Perhaps, Government wanted to make tax regime simple to make people have more after tax income to be spent to take care of slowdown in the economy. However, we must understand that slowdown is a short term phenomenon, while decline in households’ saving may cause permanent damage to the economy.
Therefore, we can understand that the new tax regime would not only attack our saving culture, but also impact revenue and borrowings of the Government. This would make it difficult to fulfil fiscal requirement, and would indirectly cause dominance of foreign capital in the country, which may be detrimental to our development aspirations.
The author is Associate Professor, Department of Economics, P.G.D.A.V. College (University of Delhi)
feedbackexcelsior@gmail.com
Trending Now
E-Paper
Follow our WhatsApp channel