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November 9, 2002
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High risk proposals

Devangshu Datta

Most political commentators have categorised the Kelkar Committee tax proposals as "courageous". As anybody who has read the Jim Hacker diaries is aware, courage is used euphemistically to describe unpopular proposals.

The Kelkar proposals certainly fall into that category. Taken along with the recent RBI clearance on individuals holding forex accounts, the suggested tax reforms would radically transform the personal finance environment. Cynics on the Delhi cocktail party circuit are suggesting that the committee actually has a well-worked out "backup", which it will trot out after this set is rejected.

The individual Indian taxpayer now lives in an environment of absurdly low tax-slabs coupled with high exemptions. This results in enormous paperwork and low tax collections. Every taxpayer keeps taxable income low, and collects breaks by spending on stuff that they may not really want or need.

One could argue that this is the patriotic thing to do. The consumption boosts GDP, individual Indians improve their lifestyles and the government gets less money to squander. However, netas and babus don't see it that way.

It is difficult to get rich under the current regime, or even provide for comfortable retirement. Provident funds are high-risk and low deduction at tax-exempt maximums of Rs 60,000 per annum. Insurance is low-interest, well below long-term inflation.

There are no provisions like the US's 401K, which allows individuals to park a per cent of their incomes in equity and mutuals. Returns from real estate (where there are extant tax-breaks for loans on self-occupied property) are often moot, or localised. If land prices are rising in Dehra Dun, for instance, a Mumbai-based taxpayer cannot claim breaks by buying in Uttaranchal for retirement purposes.

The self-employed can structure their returns by changing expense patterns. The inducement to spend is high. No self-employed professional wants money in the bank at fiscal-end - it makes more sense to buy an unnecessary car or take out more insurance.

The new proposals would change optimal strategy. It may make sense to show higher taxable income, pay the (lower proposed) tax and park savings in higher-return instruments. In that sense, the Kelkar Committee proposals would help the self-employed who can massage their returns.

But the structure is skewed against the salaried person at the lower end. And this is the biggest voting bloc among taxpayers. The salaried get far fewer tax-breaks anyhow on expenses like vehicle costs, asset depreciation and communication expenses. The standard deduction supposed to cover such things is tiny. That SD would disappear along with housing loan breaks.

The RBI clearance to hold individual forex accounts is very positive. It hurts nobody except hawala operators who now lose some relevance. Individuals with legitimate income abroad can hedge against economic mismanagement by making calls on when and if to convert. Of course, most will make the wrong calls - but the gainer in that case is the RBI as the counter-party.

If Sebi would follow up by clearing derivative contracts in indices like the Defty and Dollex, everyone would get a chance to hedge. By offering rupee contracts, there wouldn't be any pressure on reserves and a new high-volume financial market could result.

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