The trade-off those who choose the new tax regime will have to be prepared for

It’s very comforting and easy to write about savings and investing problems with unambiguous good-vs-bad choices. Diversified funds vs thematic ones, term insurance vs Ulip, and stocks vs derivatives are no-brainers. In sharp contrast, Budget 2023 has thrown up a question that will vex savers for many years. It will probably never have an unambiguous answer, at least one generally applicable to many people.

I’m talking, of course, about the shift to the new income tax regime, which is based on the principle of fewer exemptions and lower rates. The logic of the scheme is that it’s better to give people financial freedom than put them in a straitjacket of rules that guide their behaviour precisely. That’s an admirable approach and correct. Different people have different financial needs, and for the government to specify where they should save is pointless.

In this view, it’s better to put a larger sum of money into the hands of a taxpayer and let everyone save what they need to. Fundamentally, there’s nothing wrong with this. What the old ‘Direct Tax Code’ attempted and failed in more than a decade ago, the new tax regime has given operational shape. A simple system, with lower rates and drastically few exemptions, is better in theory and practice. Exemptions are inherently biased towards the well-off being able to game the system and pay less than what they should be doing. Moreover, the parallel system, under which the two systems will run side-by-side for some years, is the best way to do this. It’s also clear that the government is moving towards eventually switching to the new system. Just the fact that it has been made default indicates this intention.

However, the problem with this is obvious to anyone reading this newspaper. Across the country, a ritual is played out every year in December and January, that of employees informing the employer of their tax-saving investments. A friendly accounts person typically tells those who have made none that if they make X investments, Y amount of tax will be saved. I’m sure many, if not most, of my salary-earning readers, have gone through this experience. For almost every salary earner, this ‘X for Y’ tradeoff is the gateway to becoming a saver and an investor. In the beginning, it just looks like a bit of taxsaving, but eventually, the transition from being a spender to a saver is the bigger factor.

The shift to the new tax regime will finish this off, and to my mind, this is a huge negative. This shift won’t come at some point in the future but from this year itself. Contrary to the calculations being carried out in the media, in terms of comparing the old and the new systems, the new system is already more advantageous to people in the lower tax brackets. In the media, the calculations assume that everyone who saves can make at least Rs.2 lakh of tax-saving investments. This is laughably unrealistic. How many people earning Rs.7-9 lakh can save Rs.2 lakh in a year? Most people at these earning levels can save about Rs.50,000 to 75,000 a year. For these people, the trade-off will be to either save tax by investing a bit or save tax by switching to the new regime! And that will be a disaster.

Anyhow, this can be prevented only at the policy level. For us savers, the question now becomes, what will we do about this? The answer is to take personal responsibility for our savings and investments. Gradually, the new scheme will take over, and the tax incentives will be gone. After that, only those with an investment and savings mindset will start saving, and the rest will have a hard time.

(The author is CEO, VALUE RESEARCH.)

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