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Does the new tax regime do more damage than good by disincentivising savings?

Many people who don’t understand the need to save for the future, may decide not to save anything at all, if they have the option to pay lower taxes without deductions under the new tax regime. For such people with little to no savings, the negative fallout from this issue will manifest in the next decade or two.

March 20, 2023 / 11:56 AM IST

Budget 2023 made it clear that the government eventually wants everyone to move to one tax regime, i.e., the new one. There has been a clear push to increase the adoption of the exemption-less new tax regime.

As a reminder, the bag of goodies for those who opt for the new system included increasing the personal income tax rebate threshold to Rs 7 lakh, lowering the effective tax rate, cutting down the number of tax slabs to five, and reducing the highest surcharge rate to 25 percent. And I am sure the government will keep tinkering with the new regime to push its adoption till they phase out the old regime.

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While a simpler, easy-to-comply and lower-tax system is what the government clearly targets, there are still no deadlines for the removal of the old system. But it’s obvious that its days (or years) are numbered.

Personally, I like the idea of having a simple tax system with low rates and no exemptions. But does such a system do more harm than good in the long run?

Also read | Budget 2023 | Old vs new tax regimes: Who should make the switch?

Disincentivising savings?

Why? That’s because, to date, the majority of tax exemptions in India have been an important incentive (in disguise) for people to save, insure and invest for their future. Consider savings and investment options under Section 80C like PPF, ELSS, NPS, etc, deductions for life insurance premiums, and exemptions for health insurance under Section 80D.

When the new regime was introduced, the government had conveyed that it should be the taxpayers who should get to decide where they’d like to invest their money (or spend) and not be forced due to tax nudges. But for a majority of Indians, saving taxes was the big nudge they needed to begin their financial journey.

Under the new tax regime, many people who still don’t understand the need to save for the future may decide not to save anything at all if they have the option to pay lower taxes without deductions. More specifically, those in the low-income slabs and those who prioritise spending. Readers like you may be financially wise to still save and invest and insure. But everyone isn’t. And this is undoubtedly a problem that will become uglier in the future for such people, who have little to no savings.

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Savings-oriented tax exemptions perfect nudges to save

Household savings have been declining in India for years now. And migration to the new tax regime will further reduce the need to save. In my view, at least for a section of the population, the savings-oriented tax exemptions were the perfect nudges that forced them to save, at least something, and cover risks by buying insurance.

I know, it’s ideally wrong to do these things due to tax-savings benefits. But at least, there was something right being done by people because of these tax incentives. If you look at it objectively, some tax exemptions are good and some aren’t. But the exemptions that forced people to save and insure, in my view, are good.

It is natural human behaviour to be driven by incentives. And tax exemptions in the old regime were doing exactly that ― forcing people to save and invest because they were incentivised to pay lower taxes.

All said and done, a lower-tax system is best for everyone. But whether such a system is made no-exemption or low-exemption is something to be debated upon. The idea of leaving more money in the hands of the people and making them ‘Atmanirbhar’ has a good vibe to it. But the new tax regime should not disincentivise savings. It will hurt people a lot after a decade or two.

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Lower rates a plus, but some exemptions needed too

It is best, in my humble and unsolicited view, to take a middle path. Have lower tax rates as provided by the new tax regime. But at least provide some exemptions for retirement-oriented savings (such as EPF, NPS Tier 1, etc) and insurances (life and health), if nothing else.

Dev Ashish is a SEBI Registered Investment Advisor (RIA) and Founder, StableInvestor
first published: Mar 20, 2023 11:56 am