Bounties for the Well-Off
- these schemes and policies provide a bounty to the well-off of about R1 lakh cror e
- The government spends nearly 4.2 per cent of GDP subsidising various commodities and services.
- created to mobilise saving by encouraging “small earners” to save, and offered abovemarket deposit rates in accessible locations like post offices for this purpose.
- small savings schemes offer high and fixed deposit rates (within year) and compete with banks, it is difficult for banks to reduce their own deposit rates and hence pass on policy rate cuts to consumers in form of lower lending rates.
- government has reduced rates on some small savings schemes to make them more responsive to market conditions.
- Ideally, savings schemes should be taxed according to the “EET principle”. The first “E” stands for tax exemption of the contribution, the second E for exemption of interest income, while T stands for taxation of the principal (and interest) when it is withdrawn.
- effect of all these special treatments can be summarised into one metric
- the effective rate of return on these instruments compared with the return on a comparable savings instrument, say saving account deposits in the case of post office savings, and 15-year G-Sec in the case of PPF and tax-free bonds
- Roughly 62 per cent of total 80C deductions in FY 2013-14 were accounted for by taxpayers with gross taxable income more than R4 lakh (47 per cent by those earning more than R5 lakh). These individuals are at the 97.3rd and 98.4th percentiles of the income distribution respectively – hardly “small”.
- the effective returns to PPF deposits are very high, creating a large implicit subsidy which accrues mostly to taxpayers in the top income brackets. The magnitude of this implicit subsidy is about 6 percentage points – approximately R12,000 crore in fiscal cost terms.
- Gold is a strong demerit good: the ‘rich’ consume most of it (the top 20 per cent of population account for roughly 80 per cent of total consumption) and the poor spend almost negligible fraction of their total expenditure
- on it.
- Yet gold is only taxed at about 1-1.6 per cent (States and Centre combined), compared with tax of about 26 per cent for normal goods (the central government’s excise tax on gold is zero compared with 12.5 per cent for normal commodities.)
- About 98 per cent of this subsidy accrues to the better-off and only 2 per cent to the bottom 3 deciles.
- Railway- mostly similar to both sides
- 91 per cent of these subsidies are accounted for by the better-off as their share of consumption of LPG in the total consumption is about 91 per cent; while the poor account for only 9 per cent of LPG consumption and hence only 9 per cent of
- subsidies go to them
- In the case of electricity, like railways, tariffs vary on levels of consumption, so there is de facto targeting of the subsidy.
- Aviation fuel is taxed at about 20 percent (average of tax rates for all states), while diesel and petrol are taxed at about 55 per cent9 and 61 per cent
- Kerosene makes up about 1 per cent of the consumption basket of the poor; however about 50 per cent of the Kerosene given under PDS is consumed by the well-off and the rest by the bottom 3 deciles, showing that half of the subsidy benefit goes to the well-off section.
- Goods that account for a large share of expenditures of poorer households, such as food, will typically be merit goods, and should therefore be taxed at low rates, made exempt from taxation, or even subsidized.
- Conversely, from an equity perspective, if a large share of expenditure on a good is by the better-off, then the good should be taxed at higher rates
total suBsIdy approprIated By the well-off
- The implicit effective subsidy to the well-off is not just the actual subsidy or tax (which may be lower than what it should be) on that commodity, but the difference between what the tax burden on that commodity should be on the rich and the actual subsidy/ tax rate.
- average tax on normal commodities to be the standard rate recommended by the Subramanian panel on a Revenue Neutral Rate (RNR) for GST 19 per cent, and average tax on energy related commodities to be 50 per cent (an appropriate carbon tax).
- Then the implicit effective subsidy rate for the well-off is calculated as the difference between this normative rate (19 per cent or 50 per cent) and the actual subsidy (measured as a negative number) or the (positive) tax rate on that commodity/service.
Box 6.1: Tax Treatment of Savings
- the tax system provides for a mechanism to eliminate this bias and promote savings in the economy
- exempt-exempt-exempt (EEE) method of taxation i.e. they are exempt at all three stages of contribution, accumulation and withdrawal.
- The case for concessional tax treatment of savings is built on the consideration that a tax concession for savings leads to higher post-tax return for the investor. The higher returns, in turn, create a positive substitution effect whereby, in favour of savings rather than current consumption.
- they provide relatively higher tax benefits to investors in the higher tax bracket; in fact, the real “small savers”, who are largely outside the tax net, do not enjoy any form of tax subsidy on their savings.
- tax incentives for savings, more so as designed in India, are economically inefficient, inequitable and do not serve the intended purpose.
- emerging wisdom is that savings should be taxed only at the point of contribution (TEE) or withdrawal (EET); the latter being the best international practice on several counts.
- India should move, in a phased manner, to the EET method of taxation of savings. Interestingly, the New Pension Scheme (NPS) is already being subjected to the EET method of taxation. Therefore, deductions under Section 80C and 80CCD should be re-assessed to move toward a common EET principle for tax savings.