The Economic Survey has made a case for levying tax on the interest earned on small savings schemes such as public provident fund (PPF) at the time of withdrawal.

As of now, investments in the popular scheme are exempt from tax at all three stages -contribution, accumulation and withdrawal. A scheme such as this is called Exempt Exempt Exempt(EEE). In fact, investing Rs 1.5 lakh fetches you an exemption from the overall income calculation at the time of paying taxes.

Because of EEE, the effective interest rate on PPF works out to 16 per cent, against its 8.7 per cent rack rate with the assumed average tax rate of 15 per cent.

Tax incentives help increase household savings but come at a cost to the exchequer and distort the interest rate scenario in the market. In case of PPFs, a larger share of the benefit is cornered by the relatively better-off sections.

Tax incentives help increase household savings but come at a cost to the exchequer and distort the interest rate scenario in the market. In case of PPFs, a larger share of the benefit is cornered by the relatively better-off sections.

Other popular schemes such as the National Savings Certificate and the Post Office 5-year Time Deposit too aren't taxed at the deposit and withdrawal stages.But, the interest that accumulates during the investment period is taxed. Such a scheme is called Exempt-Tax-Exempt (ETE).

In case of tax-free bonds, savings are taxed both at deposit and withdrawal stages.Taxes aren't levied only at the interest accrual period.Hence, a five-year bond with 7.6 per cent rate gives an effective return of 13.7 per cent. Chief Economic Advisor Arvind Subramanian is against increasing the tax exemption limit, for such a move would affect financial sector reforms.

His survey argues that tax exemption on small savings schemes inflates effective returns which, in turn, affects the efficacy of RBI's monetary policy .

The survey suggests that due to inflated returns on small savings, banks can't cut lending rates.

"Because small savings schemes offer high and fixed deposit rates and compete with banks, it's difficult for banks to reduce their deposit rates and pass on policy rate cuts to consumers in the form of lower rending rates," the survey says.