We need a simpler and fairer personal tax system

These can easily be automated by linking them to average retail price inflation, so the slabs as well as the deductions automatically increase each 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 benevolent nature.

Since India’s income tax law changes with every budget, insurance companies, mutual funds, real estate companies and stock brokers have all released their list of demands. They want the tax benefits available for the specific type of investment they represent to increase.

Real estate companies want the interest deduction available on home loans to increase. The stock market guys don’t want to pay tax on the long-term capital gains they realize. Of course, they cloaked this intention with the euphemism that the government must encourage participation in stock markets across the country.

In all of this, no one seems to be at bat for depositors. While all other forms of income receive favorable tax treatment, those with deposits in banks do not.

Let’s start with gold. If this metal is sold after a holding period of more than three years, any gain is subject to long-term capital gains tax of 20% after indexation. Indexation allows investors to take into account the inflation that prevailed during the holding period when calculating the cost of acquiring the investment. This reduces the actual gain realized and therefore the total tax payable. This indexing benefit when calculating capital gains is also available to those who invest in mutual funds and houses.

So what is the economic benefit of investing in gold and why should there be tax benefits? Also, people invest in houses and just keep them locked. When they sell a property, they benefit from indexation. Why should this be the case?

For interest earned on deposits, tax must be paid at the marginal rate and no indexing benefit is available. Does inflation have no impact on Indian depositors?

In recent years, the government has allowed the elderly, i.e. those aged 60 and over, to deduct from their taxable income interest earned on bank and postal deposits 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 income tax law, which taxes different forms of income in different ways and at different tax rates.

For listed shares and equity mutual funds, long-term capital gains of up to 1 lakh are tax free. Beyond that, they are taxed at 10% without indexation. Capital gains in this case are considered “long-term” if an investor has remained invested for a period of more than one year. The length of time required for these gains to be considered long-term in nature is longer in the case of other investments.

One defense of this equity leniency is that by investing in initial public offerings (IPOs), investors provide entrepreneurs with capital to grow their business. There are two counterpoints to this. Not all investments in listed stocks are in IPOs. Additionally, many IPOs these days serve to provide an exit route for venture capitalists. Therefore, the money invested in IPOs does not always contribute to the expansion of a company.

Interestingly, there was no long-term capital gains tax on shares until a few years ago. But that hasn’t encouraged retailer participation in stocks all these years. Nevertheless, despite the tax, over the past two years retail equity participation has grown by leaps and bounds. In 2019-2020, an average of 400,000 demat accounts were opened each month; this figure increased to 2.6 million accounts in 2021-2022.

Over the years, the government has often talked about simplifying income tax law. In fact, in 2009, the previous government even introduced a direct tax code, which attempted to simplify income tax law by proposing to tax different forms of income largely at the same rate. The code was said to have scuttled itself due to lobbying by chartered accountants and income tax officials, both of whom profited from an overly complicated law. And each exception made to the income tax law complicates it further.

In fact, when it comes to personal income tax, every exception is backed by a powerful lobby, from insurance companies to mutual funds to real estate companies and more. Of course, bank depositors do not have a lobby simply because these individuals do not have enough incentive to organize themselves, as is the case for companies.

Also, most of the exceptions to the law help the rich and wealthy pay taxes at lower rates. This explains the demand to completely abolish personal income tax and replace it with an expenditure tax. It should be remembered, however, that the marginal propensity to consume tends to decrease as income increases. Therefore, any move to a total expenditure tax system is likely to benefit those who pay income tax at higher tax rates.

In conclusion, India needs a fairer and simpler personal tax system. And for that to happen, depositors might have to start getting organized.

Vivek Kaul is the author of “Bad Money”.

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