An unfortunate side-effect

After two years of what might be called COVID budgets, this year marks a return to near-normalcy. During the years when the world was reeling under the impact of the pandemic, the goal for most countries in the world was to spend-spend-spend without getting the fiscal situation too much out of whack. Some succeeded, many didn't, but India certainly did.

In a normal budget, one always expects some tweaks to taxation and specially to what I'm personally most focussed on, that is, how taxation impacts savings and investments. On this count, this is the most ambiguous budget that we have had for many years. On the one hand, we are now moving emphatically towards a new, simplified tax system. There are a slew of tax measures in the budget, and practically all of them are targeted at making the new tax regime more attractive compared to the old one. It's quite clear that this process will continue until we can say goodbye to the old tax regime sooner or later.

Fundamentally, there's nothing wrong with this. What the old 'Direct Tax Code' attempted failed more than a decade ago; the new tax regime has given operational shape. A simple system, with lower rates and drastically few exemptions, is better in theory and practice. Exemptions are inherently biased towards the well-off being able to game the system and pay less than what they should be doing. Moreover, the parallel system, under which the two systems will run side-by-side for some years, is the best way to do this.

However, I'm deeply ambiguous about the new deal's impact on people's savings and investment habits. In principle, it's good to have the option of paying less tax without using exemptions, but taxpayers who do so will have less incentive to save. There are good and bad exemptions, but exemptions that create the habit of savings are unequivocally good. My take on this is clear - the reduced incentive to save in the new optional tax regime will mean fewer savings and, later in life, more financial problems for most people.

Without tax-saving investments, many people, specially those who are younger and have lower incomes, will not save at all. Our whole consumerist society is designed to encourage people to spend, not save. The tax rebate that one gets for saving money is literally the only place that the reverse is true. Actually, it goes beyond the actual saving used for tax savings. The tax investment becomes a gateway that eventually encourages savers to save more. I've seen this happen countless times with young people whom I know. You start with these and get good returns because of the lock-in period. For many, this becomes the foundation of a lifelong saving and financial security habit.

Completely doing away with tax-saving investments is an unfortunate side-effect of the new tax regime and one that I hope the Finance Minister will take a close look at.