The Hindu Business Line : Give savings a break

THE Kelkar Task Force report dealing with personal taxation has analysed in detail the historical problem of inducing individuals to invest in savings instruments with tax breaks being the driving force. Tax concession for savings is an international issue and not necessarily India-centric. Ever since the Income-Tax Act was legislated, the decision to save has always been incentive-dictated, with yield or return on investment taking a backseat.

The classic example is the case of life insurance premium, which has over the years been Section 80C driven. The problem of savings in India has to be analysed in the context of the inability of the state to provide social security to its teeming millions.

Therefore, investment in savings instruments is an insurance for the future, particularly for the retired who cannot look to the state for any support.

Analysis in the report

The case for support to savings for social security is built around several logical arguments.

First, individuals will save for social security only if they are provided with the immediate carrot of tax savings. Whether the tax system is efficient enough to achieve this is another matter.

Second, `moral hazard'. This means individuals will not provide for themselves if they know the state will provide the income in any case. The best example is that of pension which is partly or wholly "means-tested" in a number of countries.

Third, incentives built into the Act for pension increases the quantum of pension savings. Whether this increases the overall savings is difficult to ascertain, but pensioners depend mainly on tax incentives during their service period to take care of their post-retirement life.

Fourth, tax incentives for savings swing in favour of long-term retirement savings than short-term investments. This point has to be understood in the context that individuals in the high-income bracket have the necessary resources to take advantage of large quantum of investment, by utilising tax incentives and, thereby, taking up long-term investments.

And, the most compelling case for providing tax incentives for savings arises from the fact that there is double taxation of savings under a comprehensive income-tax — first at the point of contribution and again when the benefits are received.

To neutralise this aspect and bias, tax incentives for savings are considered appropriate and useful.

The ideal model

Different countries use different models to suit their own requirements and, more importantly, take into account the interests of their taxpayers. No comprehensive tax system dealing with savings can be described as a perfect system. The Task Force analyses this issue on the following lines: Generally, there are two distinct types of tax — a comprehensive income-tax and an expenditure tax.

Under the former, all sources of income are explicitly taxed. An expenditure tax, on the other hand, only taxes consumption. Effectively it exempts from tax the returns from savings until they are consumed. There are two main forms of expenditure tax. The first involves giving tax relief on income that is saved, exempting from tax any interest and gains accumulating on those savings, but then taxing the total proceeds as and when the savings are withdrawn for consumption. This form is often described as EET (exempt exempt taxed)

In any scheme of incentives for savings, it is desirable that the investments to be encouraged have broadly similar rates of return. Any variation in these rates should only be due to differences in the holding period, underlying risk or some other overriding consideration of priority for a particular sector. An ideal income-tax design entails full exemption for savings either on a TEE (taxed exempt exempt) or EET method.

After discussing the pros and cons, the Task Force concludes that "given the potential for instability inherent in the TEE method, the EET method is the most preferred option. However, the shift from the existing EEE method to the EET method is likely to impose transitional administrative problems though not insurmountable."

The suggestion to tax savings accumulations at the time of withdrawal is no doubt a departure from the present model. Subsidies and exemptions will slowly get phased out.

In a savings dominated nation such as ours, there are strong feelings about tax incentives for individual savings continuing notwithstanding market dynamics and a borderless world. Issues such as this can be argued hours on end, but who is to take up the cudgels on the question of providing social security for all?

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

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