The Hindu Business Line : Axing the tax incentive

THE recommendation regarding personal income-tax of the Task Force on Direct Taxes closely follows the recommendations of an earlier group headed by Mr Parthasarathy Shome. There is largely nothing new. However, compared to those of the Shome Committee, a few recommendations for individual taxpayers are friendlier:

The slabs recommended on personal tax rates are more liberal;

There is no recommendation to eliminate Section 80 CCC, which provides incentives for long-term savings;

Recommendation of no tax on long-term capital gains.

The only cause for concern is the recommendation relating to the withdrawal of deduction for interest on housing loans. In the interest of equity, the changes must have prospective effect. If this applies even for loans taken earlier, the impact on a sizeable section of the taxpayers would be disastrous and not in the fitness of things. Though it is said that there is no equity in taxation, it would be a retrograde step.

Lower incidence: Overall, for an individual taxpayer whose incomes are growing, the recommendations, if implemented, could reduce the incidence of tax. This is because incomes above Rs 1,50,000 are now taxed at 30 per cent. But the recommendations require only income above Rs 4,00,000 to be taxed at 30 per cent. Incomes between Rs 1,00,000 and Rs 4,00,000 will be taxed at 20 per cent, while incomes up to Rs 1,00,000 will be fully exempt. If your income is growing each year, the benefit will be sizeable and may compensate for the loss of tax rebates on specified investments.

More important are the benefits for equity investment. If the surplus from your income is invested in equity, the post-tax returns will be substantially high. Consider the stock of Bank of Baroda. It has been consistently paying a dividend of Rs 4 per share. The post-tax yield in its case would be 5.8 per cent under present laws.

This, however, would rise to 8.7 per cent if dividends were tax-exempt. Or, take BPCL. The pre-tax yield of 5.9 per cent would be the post-tax yield in BPCL if taxes were exempt. The exemption on capital gains is the icing on the cake. In other words, the Task Force has given the thumbs-up for equity investing in a big way.

In this backdrop, if `all' the recommendations are accepted and the removal of deduction for interest on housing loans is with prospective effect, the individual taxpayer may have no cause for complaint.

Positive externalities: Another positive fallout of the removal of tax rebates is that the individual need not chase riskier investments in order to reduce the incidence of tax. For example, investments in institutions such as IDBI and REC may not wholly suit conservative investors. More important, investments in small savings schemes, despite their tax incentives, are probably ill-advised as they are being diverted to finance the revenue expenditure of financially shaky State governments.

Even in the case of housing loans, the tendency to take a loan that is at variance with the ability to repay is increasing. Taxpayers want to make a big impact on the tax incidence and are, therefore, willing to take higher risks.

The liquidity situation that is forcing the banks to reduce their due diligence before granting loans is a contributory factor. The removal of tax incentives can effectively make a dent on both these issues. Individual taxpayers will only benefit over the long run.

The moot point, however, is if the recommendations of the Task Force will be accepted at all. Some of the recommendations could generate vociferous political opposition if accepted. So, the accent may be on selective or partial acceptance of recommendations. That, however, may cause more harm to the individual taxpayer.

In fact, it can increase the tax incidence disproportionately. The consistently high fiscal deficits also suggest that the tax incidence may increase in future. So, brace yourself to pay more taxes in future by saving more now.

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