In the first part of this series, we discussed the sharp fall in Consumer Expenditure indicating a fall in the standard of living of people of India. A return to earlier Consumer Expenditure levels would require growth to accelerate and employment and household incomes to rise. In second part, we discussed on the decline in household savings. Households are running down saving buffers to support consumption and a desire to rebuild saving could hold back spending even as the economy reopens. India’s middle class have seen their assets dropping and the class itself seems to have shrunk with their incomes most badly hit due to the first wave.
We further discussed that the Indian Government needs to incentivise households that invest their tax-paid money in long-term investment instruments. Household income, savings and investments are the mainstays of the Indian economy and the government must do everything in its power to empower and revive this sector. However, we are seeing more & more taxes increasing burden on the middle class, especially the salaried.
In earlier discussions, we talked about the instances of fuel taxes and high personal income tax rates. We saw that with around Rs. 5 Lakh crores tax revenue from fuel which is much better for the country as a whole and around Rs. 15 Lakh crores GST collection estimated for FY 22, it is high time, the Government rationalises direct taxes. While reduction of corporate tax from 22-25% was a welcome move last year followed by nullification of retro tax last month; biggest pain point remains around personal income tax.
The stubborn attitude of Government to get the maximum out of Golden Goose, 4% tax payers meeting more than 1/4th of the total tax revenues including indirect taxes; will kill the goose altogether as evident from the demand softening happening in the country aligned with pandemic situation. For the economy battered by pandemic, lots of people losing their livelihood, corporates holding back their capital spends, unemployment at a very high rate and even those who are employed have been taxed at the highest; ultimately leading to their propensity to spend dying out and we are in the vicious loop.
Now, there is this new tax on PF interest, with which the Government is looking to further tighten the noose. Following its Budget announcement in February, the Finance Ministry has now notified the rules for taxing interest income on contributions made to the Employees’ Provident Fund (EPF) beyond Rs 2.5 lakh (for private sector employees) and Rs 5 lakh (for government sector employees). Beginning this fiscal, the government will tax interest on contributions made in excess of these limits made by an individual.
The budget proposal had noted that the government has seen in many cases that some employees pay a huge sum of money towards the contribution and therefore get the benefit of tax exemption. It states further that, this benefit of tax exemption is enjoyed by them at every level- contribution, interest accumulation and withdrawal. However, the Government ought to introspect whether this is such a bad thing. Let’s consider following points:
1. The Employees Provident Fund (EPF) is one of the very few savings products in India that still enjoy an exempt-exempt-exempt (EEE) regime, that is contributions, interest and withdrawals are all exempt from tax. The proposed change now may prove a significant deterrent to employees using it as their default retirement vehicle.
2. Anyhow, Section 80C limits tax breaks on employees’ PF contributions along with other similar savings instruments to ₹1.5 lakh per year. Therefore, any further addition to PF contribution above this limit is always out of tax-paid income of the individual. In this case, PF contributions beyond ₹1.5 lakh will face taxation at the contribution stage and savings beyond ₹2.5 lakh will be taxed at the income stage as well.
3. Contribution of 12 per cent of salary is a statutorily recognised parameter of retirement fund under Provident Fund Act. To put a value cap on exemption would be very harsh on the private sector employees, as retirement fund is necessity and not a luxury, for people from all walks of life and from all economic background. And what becomes the basis for this Rs. 2.5 lakhs cap? There’s no logic involved. Experts have said that 12 per cent of salary is a sound financial principle to contribute to retirement funds, and hence measure to cap the exemption at ₹2.50 lakh is an extremely harsh measure. More so when on current incomes an employee is already paying high taxes.
4. PF as retirement fund can be accessed only post retirement and not earlier. It does not accrue to the benefit of an employee during his prime period of life. It is a fund to secure his post-retirement life. The Government has already levied heavy tax with surcharge (upto 37 per cent) on higher incomes. Further, contribution to retirement fund is not a current earning, but it is an "Earning for retirement" as there is no government funded social security benefits post-retirement.
5. Further according to the new rules, the tax will be imposed on the interest earnings from the Employee’s Provident Fund beyond the limit of Rs 2.5 lakh for private-sector employees and Rs 5 lakh for government sector employees. The Government further clarifies this discrimination by explaining that, there are two ways the contribution can be made — by the employer and by the employee. In case where the contributions are made by both of them, the employers’ contribution up to ₹7.5 lakh is exempt and for employees, it’s ₹2.5 lakh. So the total threshold for private sector employees is at ₹10 lakh.
6. Now, this is a vague argument and does not justify this gross discrimination. Firstly, all Government employees get guaranteed pension out of Government funds and PF is an additional savings for them. But, this is not the case for private sector employees and for them PF is the only source of retirement savings or pensions or social security post retirement, whatever we may call. So, how do you justify further discrimination?
7. The current generation of Indians is staring at a crisis of severely under-funded retirement as the government offers no social security cover to the retired or elderly. Those working in the private sector rely mainly on their own contributions to the PF to build up a retirement kitty. This makes the repeated backdoor attempts to withdraw EEE benefits on PF quite unfair, even if it impacts only 1% of PF members. After mooting and hastily withdrawing a tax on PF maturity proceeds a couple of years ago, last year’s Budget brought in perquisite taxation for employers’ contributions to provident funds that exceed ₹7.5 lakh a year. While the new ₹2.5 lakh a year limit appears to be an attempt to curb benefits to a creamy layer of employees earning over ₹20 lakh a year, even those well below this threshold will fall into the net if they make high voluntary PF contributions.
8. The argument that the PF’s high interest is subsidised by taxpayers is completely incorrect as the fund presently pays annual interest only out of its declared surplus. It is another matter that dodgy accounting often leads to its interest declarations being significantly higher than underlying portfolio returns. If the Centre wants to avoid the risk of taxpayers eventually being called upon to bail out the scheme, the focus must be on aligning PF interest to its portfolio returns, with a changeover to accrual accounting, mark-to-market investments and unit accounts.
9. Post retirement period constitutes 25 per cent to 30 per cent of life-time. Private sector employees are deprived of any social security and they have no choice but to "earn to retire" so that post-retirement he is free to live with decency, independence and self-respect. Only reasonable expectation from the Government is that the present exempt status of retirement fund should be retained as a private sector employee does not have any Government funded social security.
10. Retirement savings like PF being returned to the employees only upon retirement, are longer term investments and is the main domestic source of funds to finance capital investment, which is a major driver of long-term economic growth.
The Government should therefore retain the EEE status of retirement savings like PF or provide social security benefits like Government employees to all others as an alternative. Rather, in the current scenario, it should spend more money and cut taxes, which would increase consumer demand in the economy. This would, in turn, lead to an increase in overall economic activity and a reduction in unemployment.
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