It’s hard to remember a Union Budget whose approach is marked with quite as much negativity as Budget 2012. Whether it be the just concluded elections, the state of the economy or the steady stream of crises that are created by the West Bengal Chief Minister, the government seems incapable of doing anything but lurch from one disaster to the next.
However, while we may worry about these things as politically-aware citizens, as individuals who save money, pay taxes and make investments, there are another set of things to watch out for in the budget. The biggest issue is that of personal taxation. All of us would like to pay less tax and would like to have a simpler tax regime. The main hope for this to come about was the new Direct Tax Code (DTC) to come into force from April 1. The DTC is a replacement for the Income Tax Act of 1961, which currently governs taxation in the country. The 1961 Act is marked by a complex web of regulations and exemptions and has a poor match for the modern economy that India has become in the half century since then.
The new Direct Tax Code is a fix for all this and is genuinely a better taxation system. However, like many other good things that this government could have done, it’s proving a long time coming. The new law was originally supposed to become law from April 1, 2011 but is now unlikely to catch this year also. However, we do hear now that a few elements of the DTC could be brought in as part of the budget, whatever that means.
Taking a broader view of what the government could do on these issues, the perfect reform would be an overhaul (and extension) of the retirement savings systems that are available to Indians. This could be done very effectively by allowing mutual funds to launch a new class of pension plans. The SEBI Chairman U.K. Sinha, himself the ex-CEO of UTI Mutual Fund, has mentioned a greater role for pension products from mutual fund more than once. Therefore it’s possible that such a change could be in the pipeline.
What would such a pension product be like? Basically, these would be mutual funds into which investors would invest with a retirement time-frame. They would be tax-exempt as under Section 80CCD now.
There would be a certain upper limit to the annual contribution and the money would be locked in till the investor attains retirement age. Importantly, such a scheme could either work with separate special funds that are launched for the purpose, or they could be separate plans of existing fund schemes. The latter would mean that investors would have the option of choosing whatever type of fund that would be best suited to each individual investor. Such a system could also mean the flow of genuinely long-term money into equity, something that is missing from the Indian stock markets.
Because such investments could be locked in for very long period of time, they would need special provisions. One, their expenses, i.e., the charges that the fund companies deduct, should be pegged at a lower level then the 1-2% per annum of normal mutual funds. And two, investors should have portability between funds. It’s possible, during the long years that the pension investment would last, that there might be legitimate reason for changing the actual fund where the money is invested. In such cases, investors should be permitted to transfer directly between different pension funds without it being a withdrawal.
The important concept underlying this is a retirement account. Our legacy system sees each investment as an isolated compartment and savers can’t move from one to another. In a retirement account system, the entire retirement corpus would be a compartment and the actual investments within that would be portable. Such a pension product would revolutionise pension savings in India. Many countries have a similar retirement account system, including the well-known 401(k) system in the United States. Interestingly, the approach paper to the initial draft of the DTC actually mentioned this concept but concluded that the technology infrastructure required may be difficult to implement immediately.
Another forward-looking change that is possible is something that the parliamentary standing committee has said in its recommendations on the DTC. The committee wants tax slabs and limits to be automatically adjusted to inflation every year. I’m not sure whether the finance ministry would want something that could be tax negative every year, but this would certainly be fair.
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