RBI Governor Raghuram Rajan calling for a higher I-T exemption limit for investments in savings under Section 80C ahead of the budget on February 28 may please the taxpayers, but finance minister Arun Jaitley needs to focus on providing stability to the tax structure instead of tinkering with it every year. Given how savings levels have fallen from 36.8% of GDP in FY08 to 30% in FY13, Governor Rajan is probably motivated by the need to hike incentives for savers. But, apart from the fact that savings are not linked to tax breaks or returns on investment alone—they are more likely influenced by income levels—Jaitley needs to keep in mind that he gave considerable tax benefits in his maiden budget in July last year. The tax exemption limit was raised from R2 lakh to R2.5 lakh, Section 80C investment limits were hiked from R1 lakh to R1.5 lakh, and the deduction limit for interest on a home loan, from R1.5 lakh to R2 lakh. All of this, the revenue foregone statement next year will show, would have cost a pretty packet—while the minister said the net impact of his direct tax proposals would be a loss of R22,000 crore, the final numbers will be out only in the February budget. In FY14, the revenue foregone on account of Section 80C benefits added up to a tidy R28,000 crore out of the total of R33,000 crore for individual taxpayers.
What the finance minister should do instead of making changes in Section 80C limit and enhancing other tax benefits, is hike the overall exemption limit from the current R2.5 lakh to R4 lakh or R5 lakh, and subsume all tax benefits into it. This will clean up the personal income tax system in a big way and will also give taxpayers the freedom to choose where they want to invest their money. In any case, 90% of the taxpayers in FY12 reported an income of under R5 lakh and paid just 10% of the total tax collections. The real problem to address is that of the “missing middle” where tax collections are very low; in contrast, those showing an income of over R20 lakh comprised 1.1% of the tax base but paid 63% of the total tax. One part of the reason for low compliance levels in the middle income level could be the fact that the personal income tax rate of 30% kicks in at a low R10 lakh annual income, encouraging people to misdeclare their incomes. The finance minister has already said he will relook the Direct Taxes Code, but this would be a good start to the process of simplifying direct taxes at least at the level of individual taxpayers.