We need a personal tax system that is simple and fair

These can be easily automated by linking them with average retail inflation, so that the slabs and deductions automatically increase every year according to the rising cost of living. But it will take the drama out of the equation and will not allow any government in power to show its benevolent nature.

Considering that India’s income tax law changes with every budget, insurance companies, mutual funds, real estate companies and stock market brokerages have all prepared their own lists of demands. They want the tax benefits available for the specific type of investment they represent to go up.

Real estate companies want the interest deduction on home loans to increase. The stock market people do not want to pay any tax on the long-term capital gains made by them. Of course, they have hidden this intention under the government’s euphemism to encourage stock market participation across the country.

In all this, no one seems to be batting in favor of the depositors. While all other forms of income get favorable tax treatment, those with deposits in banks do not.

Let’s start with sleeping. If this metal is sold after a period of more than three years, any gain after indexation is subject to a long-term capital gains tax of 20%. Indexation allows investors to take into account inflation prevailing during the holding period when calculating an investment’s cost of acquisition. This reduces the effective profit made, and, consequently, the total tax required to be paid. This indexation benefit while computing capital gains is also available to those who invest in debt mutual funds and households.

So, what is the economic use of investing in gold and why should tax benefits be provided for it? Also, people invest in houses and just keep them closed. When they sell the asset, they get indexation benefit. Why should this be the case?

When it comes to interest earned on deposits, tax has to be paid at marginal rate and no indexation benefit is available. Does inflation not affect Indian depositors in any way?

In recent years, the government has allowed senior citizens, or those aged 60 and above, to deduct interest earned on bank and post office deposits from their taxable income, up to a maximum of Rs. 50,000 It partially softens the blow of inflation by introducing an exception to the rule. But, in doing so, it further complicates the income tax law, which taxes different types of income in different ways and at different tax rates.

When it comes to listed stock and equity mutual funds, long-term capital gains of up to 1 lakh is tax free. In addition, they are taxed at 10% without any indexation. Capital gains in this case are considered ‘long term’ if an investor remains invested for a period of more than one year. The period required for these benefits to be considered long-term in nature is longer in case of other investments.

One hedge against this softness towards stocks is that by investing in an initial public offering (IPO), investors provide entrepreneurs with capital to expand their business. There are two counterarguments to this. Not all investments in listed stocks result in IPOs. In addition, many IPOs nowadays provide an exit route for venture capitalists. Hence, the money going into an IPO does not always help in the expansion of a business.

Interestingly, till a few years back, there was no tax on long term capital gains on shares. But it didn’t encourage retail participation in stocks all those years. Nonetheless, in spite of the tax, over the past two years, retail participation in stocks has grown rapidly. On an average 400,000 demat accounts were opened every month in 2019-20; It has reached 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 tax code, which attempted to simplify the income tax law by proposing a massive taxation of different forms of income at a single rate. It was said that the code was rigged due to lobbying by chartered accountants and income tax officials, both of whom benefit from an overly complex legislation. And every exception made in the income tax law inevitably makes it even more complicated.

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. Of course, bank depositors do not lobby simply because such individuals do not have enough incentive to organize themselves, as is the case with firms.

Plus, most exceptions to the law help the wealthy pay taxes at lower rates. This clarifies the demand for the complete abolition of personal income tax and its replacement with expenditure tax. However, it needs to be remembered that as income increases, marginal propensity to consume decreases. Therefore, any change in the 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 may have to start organizing themselves.

Vivek Kaul is the author of ‘Bad Money’.