A decidedly mixed bag

Last year, when I was writing this page on the evening of budget day, I was a little worried that there was nothing much to say. Then, reflecting upon this, I realised that if I don't have anything much to say then that's a good thing, more or less. Since my remit is mostly investment and taxation, nothing to say means no changes and that's mostly fine.

This year, there's much to say. The biggest (negative) surprise is that the concept of cost indexation in capital gains tax has been eliminated. A few years ago, the then finance minister Arun Jaitley had reintroduced long term capital gains tax on equity investments, and that too without indexation. At that time, I had written that the minister had made "this tax deeply unfair by not allowing inflation indexation. Inflation indexation is allowed for every other form of long-term capital gains in India - bonds, real estate, unlisted equity to name just a few. It is a cornerstone of fair taxation that the government cannot ask you to pay a tax on values that increase because of inflation. Why is this principle being ignored for this tax? There is no justifiable reason."

Little did I know that far from bringing in indexation to the equity tax, within a few years indexation would basically be abolished for all forms of capital gains tax, even real estate. This is a huge change and it's hard to justify it on the grounds of principle. Moreover, for many investments, it could mean that all real returns are consumed by tax. Think of it with the example of equity, where returns are rarely more than three to four per cent above inflation. The 10 per cent tax on full returns could actually amount to 20-30 per cent or more of your real, inflation-adjusted gains. This means that for each transaction, you might be losing a fifth to nearly a third of your actual profits to taxes. In fact, this estimate may be conservative. There's a real possibility that even when your inflation-adjusted returns are negative, you could still owe this tax. Consider a scenario where your investment yields an 8 per cent return, but inflation is at 10 per cent. In this case, you've effectively lost purchasing power. When investments allowed indexation, you wouldn't owe any tax in such a situation. However, under this new policy, you'd still be taxed despite the fact that in reality, your real worth has been lost.

Another complaint I have in budgets now is the gradual move towards the new income tax system. I fully expect the new tax system to become mandatory in the near future, especially with the FM promising a complete redo of the Income Tax Act. In theory, the new system is simpler with no exemptions and lower tax. However, the lack of tax-saving options has a terrible side effect. While exemptions can be both beneficial and detrimental, those that promote saving habits are unquestionably positive. My perspective is clear: the new tax regime's reduced incentives for saving will likely result in less overall savings and, consequently, more financial challenges for many individuals later in life.

Without tax incentives for investments, many people - especially younger, lower-income individuals - may not save at all. Our consumer-driven society is structured to encourage spending rather than saving. The tax rebate for savings stands out as the sole counterbalance to this trend. Moreover, its impact extends beyond the immediate tax-saving investments. These savings often serve as a gateway, encouraging individuals to save more broadly. I've frequently observed this pattern among young people in my acquaintance, even in my own family. They begin with tax-saving investments and, due to the mandatory lock-in periods, see good returns. For many, this initial experience becomes the foundation for lifelong saving habits and financial security.

I do hope that despite the drive for simplicity, the new tax law will retain some form of tax-based incentivisation to save.

Also read: Save your savings from the new tax system