Tax benefits remain uneven for various investments in ways that are unfair to the voiceless
It’s that time of the year when the noise around the central government’s budget reaches its peak. The media is interested in whether the minimum taxable income level, income-tax slabs and the deductions allowed will go up.
These can easily be automated by linking them with average retail inflation, so that the slabs as well as deductions rise automatically every year to account for the rising cost of living. But that would take the drama out of the equation and not allow any government in power to show its benefactory nature.
Given that India’s income tax law changes with every budget, insurance companies, mutual funds, real estate companies and stock market brokerages have all put out their list of demands. They want the tax benefits available for the specific kind of investment they represent to go up.
Real estate companies want the interest deduction available on home loans to go up. The stock market guys don’t want to pay any tax on the long-term capital gains they make. Of course, they have cloaked this intention under the euphemism of the government needing to encourage stock-market participation across the country.
In all this, no one seems to be batting for depositors. While all other forms of income get favourable tax treatment, those with deposits in banks don’t.
Let’s start with gold. If this metal is sold after a period of holding of more than three years, any gain is subject to long-term capital gains tax of 20% after indexation. Indexation allows investors to take the inflation that prevailed during the holding period into account while calculating the investment’s cost of acquisition. This brings down the effective gain made, and, as a result, the total tax that needs to be paid. This indexation benefit while calculating capital gains is also available to those who invest in debt mutual funds and homes.
So, what’s the economic use of investing in gold and why should there be tax benefits provided for it? Further, people invest in homes and simply keep them locked. When they sell property, they get indexation benefits. Why should that be the case?
When it comes to interest earned on deposits, tax needs to be paid at the marginal rate and there are no indexation benefits available. Does inflation not impact Indian depositors in any way?
In recent years, the government has allowed senior citizens, or those aged 60 years and above, to deduct interest earned on bank and post-office deposits from their taxable income up to a maximum of ₹50,000. This partly softens the blow of inflation by introducing an exception to the rule. But, in doing so, it also further complicates the income tax law, which taxes different forms of income in different ways and at different tax rates.
When it comes to listed stocks and equity mutual funds, long-term capital gains of up to ₹1 lakh are tax free. Beyond that, they are taxed at 10% with no indexation. Capital gains in this case are considered ‘long-term’ if an investor has stayed invested for a period of more than one year. The term required for these gains to be considered long-term in nature is longer in the case of other investments.
One defence of this leniency for shares is that by investing in initial public offerings (IPOs), investors provide entrepreneurs with capital to expand their business. There are two counterpoints to this. Not all investment in listed stocks is in IPOs. Also, many IPOs these days serve to provide an exit route for venture capitalists. Hence, the money going into IPOs does not always help in the expansion of a business.
Interestingly, there was no tax on long-term capital gains on stocks until a few years ago. But that did not encourage retail participation in stocks in all those years. Nonetheless, despite the tax, over the last two years, retail participation in stocks has grown by leaps and bounds. In 2019-20, on an average 400,000 demat accounts were opened every month; this has jumped to 2.6 million accounts in 2021-22.
Over the years, the government has often talked about simplifying the income tax law. In fact, in 2009, the previous government even introduced a direct taxes code, which tried to simplify the income tax law by proposing to largely tax different forms of incomes at the same rate. It was said that the code got scuttled on account of lobbying by chartered accountants and income tax officers, both of whom benefit from an overly complicated law. And every exception made to the income tax law essentially complicates it even further.
In fact, when it comes to personal income tax, every exception is backed by a strong lobby, from insurance companies to mutual funds to real estate companies and so on. Of course, bank depositors do not have a lobby simply because such individuals do not have enough of an incentive to organize themselves, as is the case with firms.
Also, most exceptions to the law help the rich and better-off pay tax at lower rates. This explains the demand for scrapping personal income tax completely and replacing it with an expenditure tax. One needs to remember, however, that the marginal propensity to consume tends to drop as incomes go up. Hence, any shift to a total expenditure tax system is likely to benefit those who pay income tax at higher tax rates.
To conclude, India needs a more equitable and simpler personal tax system. And for that to happen, depositors might have to start organizing themselves.
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