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Government refuses to link tax exemptions and slabs to inflation, to charge higher taxes
April, 09th 2014

By refusing to link tax exemptions and slabs to inflation, the government is getting to charge you ever higher taxes in real terms. Last week, the finance ministry released yet another draft of the proposed Direct Taxes Code. Although it's difficult to see the point of doing so when a new government is likely to come in within weeks, some of the changes are interesting. What is even more interesting — the proposed changes that have been rejected . Of the various suggestions made by Parliament's Standing Committee on Finance, some have been accepted and some rejected.

One suggestion that has been rejected was the one on linking the exemption limit to the consumer price index. The committee's logic is quite clear. In times when the consumer inflation is running at close to 10%, leaving the exemption limit even unchanged is tantamount to lowering it in terms of real purchasing power. What . 2 lakh used to buy last year clearly can't be bought with it this year. So why does the exemption limit stay the same? With its rejection, the finance ministry has given a rather curious response. Here it is: "It is not practicable to link exemption limit to the consumer price index for a number of reasons. First, it is not clear why the Consumer Price Index should be the base and not the Wholesale Price Index. Further, complications may arise if the base of the index or the commodity basket changes. Second, it would lead to changes which are not multiples of whole numbers. Third, indexing the slabs to inflation index is not a comprehensive approach as the slab structure is dependent on a number of factors, including other reliefs given to a taxpayer, potential revenue loss to the government, number of taxpayers who would go out of the tax net etc."

Clearly, these reasons are rooted not in principle, but in implementation . They seem to suggest that the demand is being admitted to being fair. It's just that it isn't been conceded because Indians are so dumb that they can only deal with round numbers, and that it's impossible to decide between the WPI and the CPI, and that the indices might change and so on and so forth. These answers are not really justifiable. In fact, whole number and index choice reasons are easily refuted by choosing the costinflation index that the income tax department publishes every year for adjusting capital gains. That's an index that already exists for precisely these sort of calculations . I think the real reason is that finance ministers like to do a bit of grandstanding by announcing raised slabs in their budget speeches. While the slabs broadly keep pace with inflation, they are adjusted in dribs and drabs and delivered as favours bestowed upon the electorate, rather than as a rightful and routine adjustment. However, there is one limit that hasn't been adjusted for almost a decade, and that's the Rs 1 lakh that is allowed as tax-saving investments . From 2005, when this limit was set at this level, its real value has been degraded by inflation to just Rs 47,000. By the next budget, it will be worth even less.

This decline in the real level of tax-saving investment has had an extremely negative effect on people's saving habits. In these hard times, many middle-class salary earners' savings are driven entirely by this limit. By not adjusting it for such an extended period, finance ministers have effectively increased taxation and reduced savings in real terms. In principle, there is absolutely no reason why all numbers related to taxation should not automatically be adjusted every year in line with the tax department's cost-inflation index. After all, since tax rates are set in percentage (and not in actual rupee amounts), what the government gets is automatically adjusted for inflation.

So, it's absolutely fair that not just all tax slabs, but all sorts of tax deductions like taxsaving investments, infra bonds, Rajiv Gandhi Equity Savings Scheme (RGESS), medical expenses , HRA and many others should be adjusted with inflation. After all, the high inflation is a product of the government's policies . So, why should it (thegovernment ) benefit from it by getting to charge higher taxes. And if there's really no index suitable for such an adjustment, then surely one can be created.

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