Budget promotes wealth creation but gives no tax incentives for savings

The budgetary strategy 2020 towards wealth creation is through disinvestment of public-sector undertakings like Life Insurance Corporation (LIC), Industrial Development Bank of India, Bharat Petroleum and Air India.

The budget plans to promote prosperity through a free market economy reminiscent of the 1991 New Economic Policy which ushered in a new economic era in the country. For instance, the budget acknowledges that start-ups are engines of economic growth and has recognised a long-standing demand from industry to tax employees only at the realisation of ESOPs (employee stock options).

Towards this objective, the budget has deferred the tax payment on ESOPs by five years, or till the employees who hold ESOPs exit the company or when they sell their shares, whichever is earlier. The move is significant as ESOPs are the trump card for start-ups to attract and retain human resources for a longer period and constitute a significant component of compensation for these employees.

Today ESOPs are taxable as perquisites at the time of exercise, which leads to cash-flow problems for employees who do not sell the shares immediately and continue to hold the same for the long term.

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However, listed start-ups will benefit because of the gains on the sale of the long term listed shares would be taxed at 10%, while the tax burden on unlisted shares would be at least 20% with a much longer holding period. The budget also abolished the Dividend Distribution Tax (DDT) for domestic companies which individual taxpayers now need to bear.

According to the Central Board Direct Taxes, taxpayers with an income up to Rs 5 lakhs will not have to pay tax on dividend income as against 20.56% that was earlier paid as DDT. The effective rate of tax under the regime levied on dividends is much lower than what was previously paid.

Surprisingly Budget 2020 does not aim to create wealth through savings with the move to remove tax deductions and exemptions for individual taxpayers. Considering 9-10 per cent of the GDP constitutes household savings this would adversely impact economic growth.

To that extent, the budget goes against the focus of the Economic Survey which highlights the need for creation of wealth wherein individual investments and savings are important.

The creation of wealth is possible only when both individuals and financial institutions are able to accumulate money through savings. According to the Survey, “For instance, wealth creation and economic development in several advanced economies has been guided by Adam Smith’s philosophy of the invisible hand… As wealth creation happens by design, the overarching theme of Economic survey2019-20 is wealth creation and the policy choices that enable the same… The exponential rise in India’s GDP and GDP per capita post-liberalisation coincides with wealth generation in the stock market”.

The importance of savings and investments towards wealth creation arises because it takes money to make money; just as it takes wheat to grow wheat. A healthy savings rate is the basis to create wealth. This could, of course, raise the question as to what a healthy savings rate actually is.

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Well, it simply is the rate that enables individuals to achieve their financial goals, given their investment temperament and preferences. Importantly it is savings and not gross income that makes individuals and nations wealthy.

According to the budget, a taxpayer with ₹15 lakh annual income who does not avail any deductions has to pay a tax of ₹1,95,000 under the new tax regime while it would be ₹2,73,000 under the old tax regime.

However, the old tax regime is more beneficial to individuals rather than the new regime – if tax deductions are availed. Besides, the taxpayer can create wealth through investment avenues like 80C and cut down medical expenditure and avail housing loan repayment as a deduction. Further, one must consider that long term wealth creation is more important than short-term tax benefits. Most taxpayers buy a life insurance policy to reduce their tax liability and also to obtain insurance benefits.

However, with no tax benefits for investment in insurance schemes, individuals may not find insurance products attractive. Thereby insurance companies would find it hard to sell their insurance policies which can also, in turn, affect GST collections.

The lack of tax incentives would no longer make the financial sector attract investment with ease. Instead, the budget promotes a culture of consumption without incentive towards investments and savings which is the building block of wealth creation in the country. Especially when the country faces an economic slowdown in its net savings and capital formation, domestic savings at the individual level assumes paramount importance for the economy to bounce back.

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The budget did not meet the expectations of stock market investors which was evident from the fact that the Sensex fell sharply by around 1000 points and the Nifty by around 300 points soon after budget announcements. The budget is an instrument of economic governance and is a political statement of the government in power.

It is an expression of what the elected government wants to do for the country. Through it, there can be repercussions of a social and economic nature. Today the world over there is a move to understand budgets and being pro-active so that the budget can act as an effective tool to make people prosperous.

(The writers are Assistant Professors with the Department of Commerce at Christ Deemed to be University, Bengaluru.)