Amid a move to lower interest rate on small savings schemes to reduce cost of funds, the Economic Survey today advocated scrapping tax benefits for savings like PPF and taxing investments at time of withdrawal saying the incentives are availed mostly by the well-offs.
It said the income tax is inherently biased against savings and it leads to double taxation in so far both the savings and the earnings are taxed.
"While there should be no tax incentive for savings, the question is what should be the tax treatment of savings so as to eliminate the inherent bias under income tax. The emerging wisdom is that savings should be taxed only at the point of contribution (TEE) or withdrawal (EET); the latter being the best international practice on several counts," the Survey said.
Currently, a deposit in 15-year Public Provident Fund is exempt from taxes both at investment stage, at the time of getting interest as well as withdrawal.
Besides, annual investments up to Rs 2 lakh in life insurance and NPS under Section 80C and 80CCD are exempt from taxes.
Giving reasoning for preferring EET (Exempt-Exempt-Tax) methods for taxing of savings, the Survey said it is extremely simple in terms of compliance and administration.
When a savings is exempt at the time of deposit and interest earnings and taxable at the time of withdrawal, it does not require a saver to maintain details of savings and earnings to claim tax benefit.
"India should move in a phased manner to the EET method of taxation of savings. Interestingly, the New Pension Scheme (NPS) is already being subjected to the EET method of taxation. Therefore, deductions under Section 80C and 80CCD should be reassessed to move towards a common EET principle for tax savings," the Survey added.
It also made a case for taxing post office small savings deposits according to the EET principle.
It said when the Budget 2014-15 hiked the investment limit in PPF by Rs 50,000, data analysis showed that mostly the tax payers in the top income brackets availed off the benefit.
"The effective returns to PPF deposits are very high, creating a large implicit subsidy which accrues mostly to tax payers in the top income brackets. The magnitude of this implicit subsidy is about 6 percentage points-- approximately Rs 12,000 crore in fiscal cost terms," it added.
Giving the disadvantage of taxing savings under the TEE (Tax-Exempt-Exempt) method, the Survey said there is no incentive for consumption smoothening since withdrawals are exempt irrespective of the amount.
However, the EET method allows for consumption smoothening particularly in old age since taxation of withdrawals incentivises postponement of consumption.
"Under a progressive personal income tax rate structure, there is an in-built incentive to restrict withdrawals to meet necessary consumption only since lower withdrawals imply taxation at lower marginal tax rate and hence, lower tax liability. Consequently, the potential for old-age poverty is minimised," it said.
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