Sec 80 C increase nil, a missed opportunity ?!

As much as the government’s expenditure is – looks like a simple answer. But the problem is that, the citizens (we) may not be ready to pay if the tax rate is very high. A major grey market (unaccounted money), may be created if the citizens do not want to pay taxes. The solution is to keep the tax rates at an optimum level so that the citizens do not see the tax as a burden and the government is able to collect taxes from as many people as possible.

All undertakings depend on finance. Hence foremost attention must be paid to the treasury.. Thus when the receipts and expenditures are properly earned for, the king will never find himself in financial and military difficulties.

– Kautilya in Arthasasthra

Tax is the income for the Government. The Government can get this income in order to perform its duties to its citizens – provide protection from external enemies, administer law, provide basic amenities (roti, kapada aur makaan), provide infrastructure, support the under privileged, provide education, provide social security, provide employment, etc…

How Much To Collect As Tax?

As much as the government’s expenditure is – looks like a simple answer. But the problem is that, the citizens (we) may not be ready to pay if the tax rate is very high. A major grey market (unaccounted money), may be created if the citizens do not want to pay taxes. The solution is to keep the tax rates at an optimum level so that the citizens do not see the tax as a burden and the government is able to collect taxes from as many people as possible.

The income tax administration in India is fairly simple. For corporate it is a flat 1/3^rd of their profits. For individuals there are slabs with less tax for lower income. The present slabs (Post Budget 2009) are:

The expectation from the Budget 09-10 was that the initial tax slabs or the subsequent tax slabs will be widened to reduce the individual tax burden. But this has not happened.

Tax Exempt Investments

Going with an objective to collect taxes to fulfil its mission, the government also gives us some ways to reduce our taxes. Now is that not counter-productive? Well, not exactly.

The Government specifies certain investment and expenses alone that will qualify for the tax exemption. The common thing with all these tax exempt investments and expenses are that in one way or the other they help the Government do its work.

When you pay the school fees for your daughter, you get tax exemption for the amount. This is because otherwise the Government has to provide education for her. When you pay your insurance premium, you get exemption. If you do not have insurance and pass away, the burden of protecting your family will then rest on the Government.

When you build a house (say 1000sq ft), you give direct employment to about 100 skilled, semi-skilled and unskilled people (architects, engineers, masons, carpenters, plumbers, electricians, helpers, etc.) for 5 to 6 months and indirect employment to over 1000 people (steel plant, brick manufacturers, cement plant, tiles, paint, kitchen fittings, bank, etc) for the same period. All these people could have stood at the Government Employment Exchange, if you had not built your house. So do you get a tax exemption? Of course you do.

If you retire without any money for post-retirement expenses, where do you think you will go? Ask the Government for support, of course. So invest in pension plans, PPF and EPF, get tax benefits.

Tax Exemption Slab

The Government of course cannot leave everything in the hands of its citizens (otherwise it will not have anything to do!). So it sets a slab on how much of money invested (expended) will get the tax exemption. We have the Section 80C of Income tax act which sets this limit at Rs.1 lakh.

We have already seen in an earlier article that the limit of Rs.1 lakh is too low for even a reasonably salaried young person. The expectation form the Budget 2009 was that the limit would be increased substantially.

Not Increasing Slab is Self-Defeating

The explanation given is that if the slab is increased then the income for the Government will be in the form of reduced taxes. The Government has a lot of plans related to infrastructure and social schemes and all these need money (1000s of crores).

Not increasing the exemption slab to build infrastructure and give social support can be self-defeating. It was our esteemed dynamic late Prime Minister Rajiv Gandhi who said “If I give Rs.100 to lay a road, because of the existing mechanism, only Rs.20 actually reaches the road”. Since his time, nothing much has changed in this ‘mechanism’.

Calculations behind higher slab

Lets us do some back of the napkin calculations. Let’s say your income is Rs.3.2 lakhs post my investments for Rs. 1 Lakh in Section 80 C instruments. The tax calculation will be:

First Rs.1.5 lakhs: nil

Next 1.5 lakhs @10% Rs.15, 000.

Balance 20,000 @ 20% Rs. 4,000.

So you pay a tax of Rs.19, 000. Plus you support the Government directly to the tune of Rs. 1 Lakh. The net benefit to the country is Rs. 1 Lakh Plus 20% of 19,000 =Rs 1, 03,800/-. Without considering the ‘Rajiv Discount Factor’ – Rs. 1, 19,000/-

Now suppose the limit was increased to Rs.2 lakhs. What happens to the tax that you pay? The taxable income will come down to Rs.2.2 lakhs, assuming you use the full slab. But in reality you will not be able to save Rs.2 lakhs out of your total income of Rs.4.2 lakhs. So instead you invest only Rs.1.5 lakhs. You pay tax for the rest. So the tax paid will be Rs.12, 000/- (Taxable income is 2.7 lakhs – first 1.5 lakhs nil. 10% of 1.2 lakhs)

The benefit to the country now is Rs. 1.5 lakhs plus 20% of 12,000 =Rs.1, 52,400/-. Without considering the ‘Rajiv Discount Factor’ – Rs.1, 62,000/-

Missed opportunity

Whichever way we look at it, with the discount factor or not, the above calculations show that it would have been beneficial for the Government to increase the slab and work with a reduced income than to retain the slab at the present level itself. This year has been a missed opportunity to increase the slab. Hope the next year will work out to be better to the Citizens and the Government of India. By then hope the FM would have completely read the Arthasasthra!