It will encourage people to save more.
The government does not provide any social security cover or monetary benefit after retirement. Only government employees, who constitute just a fraction of our population, enjoy post retirement benefits. The rest depend on their savings accumulated during the employment period.
Tax rates are very high. The government straight away takes approximately a third of our income ad income tax. Interest rates have fallen very sharply and that has negatively impacted the general propensity to save in Secured funds. Tax exemption on interest incomes was meant to be doubly beneficial. It was, first, meant for people earning extra income; and second, for the government, which received funds for development.
Tax free income from savings encourages people to save for a rainy day. Reduction in interest rate is compensated by exempting such interest from tax. We must also realize that majority of our savings schemes depend on tax exemptions. If we completely abolish such exemptions, it would surely affect many government organizations that garner most of their funds through tax saving schemes, and their employees. The government is going to implement the kelkar panel recommendations, which calls for gradual abolition of all tax exemptions. But the tax rates are still pegged high. New kind of taxes, like the fringe benefit tax and withdrawal tax, are being levied. And that's pushing professionals hard against the wall.
All these new taxes are various kinds of expenditure tax. And income tax and expenditure tax should not exist concurrently. The government is widening its revenue base by limiting the tax payer's avenues. The government currently doesn't seem to be in a mood to neutralize the backbreaking effects of abolishing tax exemption by reducing income tax rates.
We have been witness to a general decrease in excise rate, which has been accompanied with a widening of service tax net to include almost all services. but a similar step has not been taken on the income tax front. ETT base should be implemented only after income tax rates have been reduced.
(This letter published in the Economic Times on 1st February 2006)