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Of tax sops, inflation and home loans

BS Reporter in Mumbai | July 14, 2008 10:45 IST

The finance minister's tax giveaways are what have saved tax-payers from the impact of inflation and higher home loan rates.

When Finance Minister Palaniappan Chidambaram completed his Budget speech on February 29, most tax payers were a happier lot because of the raising of income tax slabs, and the resulting reduction of the overall tax burden for everyone.

But in the four months since then, inflation has climbed into the double digits, reflecting an increase in the cost of both food items and fuel. Most banks have raised interest rates on loans by up to 0.75 percentage points.

"Though the FM had expected a rise in the inflation rate, even he would not have imagined the real numbers," says Madan Sabnavis, chief economist at NCDEX, the commodity exchange.

The tax benefits were quite significant. For a male taxpayer with an annual gross income of Rs 500,000 a year, after the eligible deductions of Section 80C (Rs 100,000) and 80 D (Rs 15,000), and after taking advantage of the higher tax exemption floor as well as the adjustment of tax slabs, the annual income tax liability would have fallen from Rs 74,160 to Rs 32,960, or by 55 per cent, yielding an extra cash in pocket of Rs 3,500 per month.



Gross income500,000
Savings in 80C100,000
Pre-tax disposable income400,000
New tax liability32,960
Net income a year367,040
Income per month30,500
 EMI on Rs 12 lakh loan12,500
Disposable income for
household expenditure
Impact of 5% higher inflation900
Tax benefit (per month)3,500
Additional outgo on EMI plus
Household expenditure (per month):
Net benefit (per month)2,100

On the other hand, the inflation rate has risen by 5 percentage points in the last three months.

On top of which, home loan rates have risen by up to 0.75 percentage points. Someone with a home loan of Rs 12 lakh therefore finds that the equated monthly installment has risen by about Rs 500 per month.

The balance of these different elements still leaves our Rs 500,000 earner with a  net benefit of perhaps Rs 2,000 per month or a little more (see table), though it would also be true that the value of his assets (house, mutual fund units, etc) would have fallen and left him poorer.

However, for people lower down the income ladder, the benefit-cost matrix works out quite differently - chiefly because the tax benefit they would have got would be less than Rs 3,500 per month, while the living cost increases would be broadly comparable.

If the home loan is for a smaller amount, it would mean a smaller increase in the EMI. For people with lower income levels, therefore, the net impact of the Budget and subsequent events may be broadly neutral, or in some cases even marginally negative.

The real losers therefore are those who have got no tax benefit (because they are below the tax-paying threshold) and who at the same time have had to cope with all the cost increases.

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