The proposal to give tax sops for putting savings in infrastructure funds runs contrary to the principle of fiscal neutrality to kinds of savings
Expectations are being built up on a possible widening of the window for tax-saving instruments or products with budget 2008-08 closing in.
When the United Progressive Alliance government took over in 2004, the government took a decision to club all tax-saving products under one section of the Income Tax Act. The investment limit was then fixed at Rs 1 lakh in 2005-06. Within that basket, investors had the option to put money in any product up to the limit of Rs 1 lakh, except for the public provident fund where the rules governing that scheme restricts investment to Rs 70,000. In effect, the government leaves the choice to savers, reducing the bias towards any particular investment while attempting to avoid creating a serious distortion in allocation of savings.
Recently, the government widened the choice to include the Senior Citizens Savings scheme and also Postal deposits. Expectations are centered now around an increase in this limit marked by a possibly higher investment leeway for savers if they park funds in infrastructure funds. Indias securities market watchdog, Sebi has pitched with the government for a new section to be carved out in the tax law exclusively for investment in dedicated infrastructure mutual funds. The regulator, officials say, wants investment up to Rs 2 lakh in such mutual funds to be treated as a deduction from tax. The rationale for this apparently is that since returns from infrastructure projects tend to kick in later during the lifecycle of the projects, investment in this asset ought to be accorded a preferential treatment. A policy switch undertaken, if at all, could mean a throwback to a regime of directed savings.
Successive expert groups which had studied fiscal policy and tax reforms and also on small schemes led by Raja Chelliah, to Partho Shome, Y V Reddy and Vijay Kelkar had dwelt on how tax exemptions for savings rarely enhance national savings. The Task force led by Kelkar had in fact argued strongly against such incentives or sops.
The task forces report made the point that biases in favour of investment tend to provide arbitrage opportunities resulting in misallocation of financial resources. Rather, elimination of savings incentives would in turn lead to elimination of forced savings and enable savings to flow into the most productive channel in a competitive manner, it said.
Over the last couple of years, the flows into small savings schemes have been tapering off without the incentives being changed as higher returns from the stock market and bank deposits prompted investors to switch. Banks also offer a tax savings deposit scheme with a maturity of five years and above but the fiscal sops havent quite attracted many. That goes to prove what many fiscal experts have been saying that such incentives do not in the final analysis sway investment decisions or promote savings.
The argument they have advanced is that such incentives encourage a diversion of funds from one form of investment to another for just locking up of these funds for a specified period. At the end of it dissavings remain untaxed. As The task force said the demands of fiscal neutrality is that imposition of tax does should not distort the choice between different forms of savings and between consumption and savings. There should not be any discriminating tax treatment between of savings irrespective of the maturity period, it went on to say.
Any proposal to direct savings towards a particular investment product could lead to such discrimination and may not lead to the desired results. So far the government has resisted pressures. Giving in now could turn the clock back.