Budget sends mixed signals on savings

| Updated on February 02, 2020

There is a basic conflict between tax breaks on savings and the need to raise the savings rate

There has been a lot of critical comment about Budget 2020’s proposals, or the lack of them, to provide a meaningful stimulus to India’s consumers who are on a belt-tightening spree. But the clutch of Budget proposals that affect domestic savers and investors send out very mixed signals too on government intent on encouraging domestic savings. Considering that India’s household savings rate has been in secular decline, with an urgent need to revive it, three sets of Budget proposals have inbuilt conflicts that need thinking through.

Traditionally, Indian governments have used tax concessions as a potent tool to nudge low- and middle-income earners to prefer financial assets over physical ones. But the 2020 Budget proposes to materially alter this dynamic. To avail of the lower personal income tax rates offered under its new regime, taxpayers will now be required to opt out of the entire gamut of exemptions on financial instruments under Sections 80C, 80CCC, 80CCD, 80D and 80TTA. Today, the new tax rates are so unappealing that most savers are unlikely to make the switch. But with the Finance Minister indicating that this is just the first step in a transition to an exemption-free regime, taxpayers may need to brace for negligible tax breaks on their financial savings in future. This can deal a material blow to India’s financial savings. While there is merit in the view that mutual funds or market-linked insurance plans need to be marketed on their own merits, doing away with tax breaks on small savings schemes, the Employees Provident Fund, Public Provident Fund and National Pension System appears drastic, especially when India is staring at a social security crisis in the not-too-distant future. A proposal has also been quietly slipped in to withdraw EEE benefits to the EPF by making employer contributions taxable beyond ₹7.5 lakh/year. In its bid to lower market borrowings, the Centre hopes to sharply increase its reliance on the National Small Savings Fund. But relatively high rates on these schemes amid low market rates, make this a high-cost route. To rein in its costs, the Centre may need to re-align small savings rates with lower market yields. But doing so especially without tax breaks, can leave the government short of funds.

The proposal to list LIC on the bourses is a reformist move that can infuse transparency into the black-box operations of the insurer. Recent decisions by LIC to engage in gratuitous acts of rescue have led to investor disquiet on safety of their funds. Listing can allay these fears, by subjecting LIC to more stringent IRDA investment norms and public scrutiny. But any LIC IPO will need to be preceded by a repeal of the LIC Act and corporatisation of the insurer, which will likely require the Centre to withdraw the sovereign guarantee backing LIC polices. Selling this proposition to LIC’s policyholders, employees and agent force will not be easy, without tax breaks to sweeten the deal.

Published on February 02, 2020

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