Budget 2020: New Optional Income Tax Rates
- chirajitpaul
- Jun 22, 2020
- 5 min read
Since the moment Finance Minister Nirmala Sitharaman read out that part of the speech which outlined the new income tax rates, mixed emotions started floating around among taxpayers. Many thought, until the experts started to decode the fine-print details on television channels and on news-portals, that the new rates would benefit all and would therefore effectively leave around 70k of surplus cash in the bank at the end of every year. What they had missed out was that it was ‘optional’ and that it would come with a ‘sacrifice of exemptions’. Once you start putting those two into perspective, much of the steam from the reform apparently evaporates.
I happen to be in a WhatsApp group of senior professional Chartered Accountants where I read a lot of instant angry messages. Words like ‘cheating’, ‘eye-wash’ were used liberally and abundantly.
But, has the government really cheated anybody? Actually, no. Contrary to what some popular news channels have been propagating about the potential loss in the hands of the taxpayer, one must remember the new rates are not binding. The old rates still exist in its current form and shape. The taxpayer would only shift to the new rates (let us call it the ‘New Method’) if under the New Method he stands to benefit in terms of lower ‘Net tax payable’ figures. Thus, either they stand to gain, or stay at a ‘no-loss-no-gain’ situation but would never incur a loss.
What is the rationale behind having this New Method at all, and who would stand to benefit from it (if at all anybody)?
Please remember that the ‘Old Method’ allowed many deductions and exemptions to the taxable incomes based on certain investments/ expenses made by the taxpayer. Some of the popular such items were: (1): Principal amount of home loan (paid through EMIs during the year) under section 24 (of the Income Tax act) (2): Contribution to Provident funds (EPF, PPF etc) u/s 80C, Insurance premiums u/s 80C (3): House rent paid (u/s 80GG), Interest of Education Loan (u/s 80E), Medical insurance (u/s 80D), Donations to charitable institutions (u/s 80G) and many more. All the above deductions helped a taxpayer to save on the tax outflow effectively reducing the real rate of tax that he needed to pay to the government. Many of these investments were not taken out voluntarily by the tax-payers because in most cases - especially on investments and some form of insurances the real benefit and the hidden costs associated with them would only be known to the investment consultant who had sold those instruments – a knowledge they would happily suppress to make the product look attractive. Thus, it would become a matter of forced (definitely unwilling) investment. This mandatory saving becomes an annual pain for those who found it difficult to make ends meet especially during high-inflation years. One would have to be in their shoes to understand how stressful savings could be for many.
Why did the government link tax-saving to investments in the first place?
To understand that we will have to dive a little deeper into Macro Economics. Savings and Spending are two important levers in economic planning. What the population saves are invested into banks or mutual funds or post offices or similar institutions. This money is then lent out by those institutions as credit to business who would use the loan taken to manufacture goods or render service. The value of the products and services will add to the GDP (gross domestic product) of the nation and will also provide employment to those who will engage in the process of manufacture and sales of those. The products and services will also have to be procured by somebody (consumer) in exchange of a price (either in the domestic market or in the export market). In the domestic market, it will have to be procured and used by the same population who has done the saving. Thus, it becomes a fine balancing act for any government to encourage savings and spending based on what is the need of the hour at that prevailing time.
Traditionally, in India, supply of credit has been a critical item, not demand. Whatever was manufactured in India generally found a buyer (seller’s market). At times of slowdown the consumption behaviour changes as consumers become more sensitive to avoidable spending. The more they become skeptical that their income sources might thin down or dry up completely, the more they contain expenditure. And this tendency triggers a chain reaction. The less they spend, the more manufacturers cut down on production and retrench employees, which in turn create loss of income for more people.
The current slowdown situation in India needs to be addressed in this light. At present the banks are sitting of heaps of cash but industry is not using those to set up new projects. That is because the overall demand situation in the economy is dull. To get the cycle reactivated the government could have done three things: (1) To reduce corporate taxes which would make the goods/ services cheaper and more attractive for purchases. (2) Spend more on infrastructure etc. so that more people are employed in those projects and hence they earn money to spend more. (3) Allow more money in the hands of the individuals (by a reduction of taxes) and encourage them to spend more.
The first has already been implemented in 2019 (refer to the reduction of corporate tax to 25% from 30%). The second is a continuous process (which is underway). And the third is the change in income tax rates which have been proposed in the Budget 2020 (hereby referred to as the ‘New Method’).
How is the New method going to encourage spending?
With the introduction of the New Method the government has made it clear that they want to free the taxpayers from the regime of compulsory investments. The New Method will be attractive to those who (1). Does not have a running home loan (2). Do not have enough disposable money to invest in fancy schemes (3). Risk takers who would rather invest in equity than settle for safe products. The freedom is a refreshing change. And it comes without prejudice to those who loves the Old Method or finds the Old Method more attractive from a tax computation perspective.
The government estimated that a sizable number of taxpayers would move to the Mew Method and avail the benefit of doing whatever they want to do with the surplus money (which was earlier locked inside tax-saving investments). A substantial amount of this money is likely to come back into the market as demand for goods and services thus speeding up the movement of the economic wheel.
Moreover, this method is extremely beneficial to retired people who do not need to make investments, neither buy a new house. Also, for the millennial generation who have not yet gone under the burden of EMI lifestyle.
Ancillary benefits of the New Method
With this India takes a big stride towards being a low-tax-rate, high-tax-compliance nation. Its income tax rates are now lower than most developed and developing nations (including USA, UK, Canada, China) and thus becomes an attractive destination for international investment and global professional talent.
So, net-net, it is a much-deliberated decision which trades off between various economic levers without compromising the tax collection potential of income tax. Because with the new ambitious pipeline water project for all, the government is not in a position to forego collections for anything.
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