Budget 2020: Income tax on interest income from bank deposits merits abolition
Budget 2020-21: In today’s falling interest rate regime, deposit rates have been declining at a faster clip than lending rates.
Budget 2020-21: With the Budget around the corner, relief in personal income tax has emerged as a significant expectation. But income tax on interest income from bank deposits contradicts the four “canons” of taxation propounded by Adam Smith. Economists like Pigou and Dalton further expanded these canons; but the basics remain the same.
Equality: India’s savings story is driven by the ‘middle class’ household sector. While savings bank accounts are mainly used for transaction purposes, a significant chunk of the middle class put their savings in term deposit for meeting future (bulk) transaction needs and precautionary requirements. Post offices and insurance companies do not offer attractive return, and contributions to PPF are capped. As there are many problems associated with old age, taxation of interest income doesn’t quite satisfy the canon of equality.
The principle of equality gains added significance by factoring inflation. Notably, for the middle class, the propensity to consume is high, and today, rates of interest offered on deposits are meagre to yield an ‘adequate’ positive ‘real’ return. Thus, the tax promotes current consumption, rather than savings.
Certainty: No doubt, the IT rules have become less ambiguous and more transparent and have simple procedures. However, as far as taxing interest income is concerned, two ambiguities remain. First, interest earned in a FY, besides being taxed in that year, is added to the account holder’s deposits under compound interest rate regime and becomes again liable for taxation in subsequent years. Second, interest earned is taken for taxation on accrual basis, not on realization basis—depositors don’t withdraw the accrued interest for current consumption except in the case of MISs or premature closure.
Moreover, despite significant improvements over time, it still takes a fairly long time to get refunds.
Convenience of Payment: Even though the government finds it difficult to abolish the tax on interest income, it should not be collected during economically hard times. For instance, many individuals, who had switched from bank deposits to debt/liquid funds for higher returns, suffered significant loss, post-NBFC imbroglios. Such situations merit reprieve, albeit briefly, and its absence can instigate tax evasion.
In today’s falling interest rate regime, deposit rates have been declining at a faster clip than lending rates. Further, it is strange that, so long as one is in employment, her PF contributions, along with interest thereon (mostly), are tax-free, whereas the day after her retirement when she puts her retirement benefits in a bank, interest gets taxed!
Economy of Collection: Mechanisation at banks and IT department has reduced, though not eliminated, the workforce engaged in the related activities. However, procurement of machines, and their manning, regular maintenance and upgradation do entail cost. Hence, whether it is economical for the IT department to collect this tax is debatable, especially when there is paucity of data. These resources can be freed for more productive uses.
In sum, taxation of interest income defies the classical canons of taxation. Hence, it merits abolition.