There is no doubt that the tax exemptions offered till now did act as a powerful incentive to encourage saving
You already know that Budget 2020 brought in an option in the personal income tax structure. The old one stays as it is, unchanged, and still has all the exemptions and deductions. The new option offers lower tax rates, but does away with the exemptions available in the old structure.
As of now, the tax-payer has the option of staying with the old system or shifting to the new alternative (with lower taxes and no exemptions). And from what I understand (and I am no tax expert), the choice of which is better for whom has become individual-specific. That is, the old tax system may work better for some, and the new option for many others.
Before I say a word more, let me tell you that I am all for simplification of the tax structure. After years of tweaking by various governments, it was high time that someone put a stop to this and cleaned it up. And simplification in the new system comes at lower tax rates.
Phasing out exemptions
The government has also hinted (quite clearly) that it will gradually do away with all the exemptions. It’s not clear by when, but that seems to be the intent. And assuming that the government doesn’t backtrack on this intent, it is more or less clear that the new low-tax-no-exemption regime will be the new normal in the years to come.
While lower tax rates are always welcome, I also feel that the removal of exemptions from income tax will have other consequences as well.
Lower tax (of the new regime) means higher disposable income. But it also means that the ‘nudge’ to save and invest by wrapping it in ‘tax-saving exemptions’ will also go away. And that means people will have reduced incentive to save.
Of course, tax-saving should not be the reason to save – your goals should define how and where you invest. But how many people actually think like that?
Only a few and those that are financially aware.
I am not trying to paint everyone with the same brush. But the fact is that a majority of the population is used to setting aside funds (in savings) as it got tax benefits!
In some ways, the old tax regime with its exemptions was a blessing-in-disguise for such people as it, in some ways, forced people to save for their future.
The financially aware will invest, tax-saving or not
As and when the tax exemptions are phased out, the financially prudent ones will still be saving and investing. But others who do not prioritize saving will be free to choose as to how they spend their money. A few of them will still be savers at heart and continue to do the same. But many others won’t. And that is the issue.
If due to lack of incentives (such as tax exemptions, etc.), these people don’t save, then they will remain financially vulnerable. And rising consumerism further reduces the desire to ‘not spend today but save for future too.’ Also, they will not be able to accumulate enough savings for long-term goals such as retirement. And we don’t have much in the name of social security in India. So, this reduced savings will mean less money/income during retirement. And that will be disastrous. More so because people these days live much longer after retiring at 60. They, in fact, need more money. Do you see the problem?
I cannot blame the government here, as the intent of tax simplification is in the right spirit. But it will have an adverse impact on many who aren’t financially disciplined. They still need that nudge. They still need that push to save something.
I don’t know what the best solution here is. May be, in due course, people will adjust to the new reality and begin saving on their own.
But there is no doubt that the tax exemptions offered till now did act as a powerful incentive to encourage saving. More importantly, these nudges helped to gradually and unconsciously convert the non-savers at heart into savers and investors in the long term. And that was one desirable side effect of the old system.(The writer is the founder of StableInvestor.com)
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