Taxation breaks

In the rest of the world to encourage people to save for their old age, the part of income that is set aside as savings is given tax exempt status at the time of saving. This is also allowed to be tax exempt at the time of accumulation and so interest on it is not taxed. However, at the stage of withdrawal, the income gets taxed. In India, one way is to tax the withdrawal at a low rate 8212; say at 20 per cent, the rate at which long-term capital gains are taxed. Another way is to tax withdrawals above a limit 8212; say, Rs 5 lakh. But rules should ensure that there is no incentive for people to break up their withdrawals into smaller amounts to avoid being taxed.

Among the major benefits of the change in tax treatment of instruments currently enjoying benefits under Section 88 would be the reduction in distortions. Today these instruments offer double benefits. They continue to have administered interest rates and more often than not, receive an interest subsidy from the government. In addition, the tax exemption acts as a further subsidy. Thus the flow of savings to these instruments increases, raising the fiscal burden. This leads to a redistribution of income in favour of people who own these savings instruments. As often pointed out by this newspaper, the major beneficiaries are the rich who own, for example, 85 per cent of the assets in the EPF. Budget 8217;04 took the first step towards a proper tax treatment of savings by treating deposits in the new pension system for civil servants as EET exempt, exempt, taxed. Budget 2005 must take the next step. To prevent those with current savings from feeling cheated, the tax treatment should be grandfathered. All further savings should be made EET while current savings should be allowed the existing EEE status.