In just about six weeks, the Union Budget for 2018-19 will be presented. It will be an interesting exercise, being the first budget after GST as well as the last official budget before the 2019 Lok Sabha elections take place. However, whatever be the budget's impact on the political economy of the country, the time is ripe for a number of simple, basic reforms in the way people make their savings, save on taxes, and make basic choices like insurance.
It is a fact that most salaried Indian--except for the small number in the top bracket--make financial savings and investments only to the extent of getting tax breaks. The tax breaks too can be hard to exploit when you are in the 10 to 20 per cent bracket. While demonetisation has turned the focus on those who are cash-rich but not rich on paper, there are a lot of relatively less well-off taxpayers in India.
These people need more active help from the tax-break rules in order to save more. The bulk of tax-break inspired savings come from section 80C of the income tax act. These investments, totalling up to Rs 1.5 lakh a year, can come from any combination of a wide variety of asset types. These include ELSS equity mutual funds, ULIPs, bank FDs, EPF, NPS, Sukanya Samriddhi, and many others.
Unfortunately, there are also some expenses that are allowed to be part of section 80C. The biggest among these--which a lot of taxpayers appear to use--is children's education fees. Now, I'm not arguing against the fact that school and college fees should be deductible from taxable income, but by lumping them with savings and investments, the government is shortchanging savers. 80C was supposed to be entirely about financial savings, that is, money that you can get back later. By adding an expenditure to it, investments made for the future are reduced in quantum. Education fees should be made separately deductible, and not a part of 80C.
The case of term insurance is similar. The root cause if for our law and policy's inability to distinguish between the savings function of insurance and the life cover function of insurance. One of the (many) unfortunate by-products of this is that savers just do not buy enough term insurance. While IRDA and the insurance industry cry about growth in premium collected, no one talks about what is the actual growth in the life cover (term insurance) that Indians are buying.
One culprit, which is easily fixable, is the way tax-breaks are offered. Term insurance is a highly desirable expense, not a saving. Instead of being lumped with actual savings and other types of insurance products in 80C, term insurance ought to have its own distinct allowance, which is undiluted by anything else. If an insurance product has any element except pure life cover, then it should not be allowed in this allowance. There is perhaps no other way that India's insurance rate--the actual amount of life cover people have-can be boosted. Actually, there's another way, even simpler, in which it can be done.
What we need is a simple rule that prohibits the sale of non-term insurance products unless the customer already has life cover equivalent to ten years' income, as per the last tax return. For those who do not pay income tax, the rule should be a basic amount of term insurance. Nothing else will be required. The entire sales machine of the insurance industry will be focussed on selling real insurance to people. Is this possible? No harm hoping.
Can one hope for such fundamental changes in the tax break rules? It depends on whether the government stops taking a tactical view of tax breaks and thinks of them as the shapers of how people save and invest for their old age. Certainly, lumping of expenses like school fees into 80C is short-sighted and counter-productive. These flaws need to be fixed.