In a recent interview with CNBC on the current economic outlook, Raghuram Rajan, the former governor of the Reserve Bank of India, opined that “inflation will be higher for a longer period…it appears less transitory….in the medium term which is what central banks are concerned about… India’s headline CPI inflation has reportedly averaged 6 percent since the start of the pandemic, while core inflation has averaged 5.3 percent.

In practice this has led bank depositors to come close to having no real or even negative returns, after considering the tax on interest. Older people who depend largely on income from fixed deposits (FDs) are particularly affected. This generation of depositors were not taught, during their lifetime, how to diversify their sources of income and savings. Low interest income and ever-rising prices are a double whammy for this class of savers.

In this context, the tax on interest income from bank deposits should be reviewed and possibly abolished, either directly or progressively, since this tax does not justify the classical canons of taxation.

tax laws

Adam Smith, in his classic book wealth of nations, Subtract the four “canons” of taxes. and this is:

(i) Equality, in the sense that tax payments must be proportional to income.

(ii) Certainty, in the sense that tax obligations must be clear and certain.

(iii) Ease of payment, which means that taxes should be collected at a time and manner convenient for the taxpayer.

(4) The economy of collection, which means that taxes should not be too costly and should not discourage business. Under current IT rules, interest earned on bank deposits is treated as income and if it exceeds €10,000 during the fiscal year (FY) is taxable under Section 80TTA of the Information Technology Act 1961. Interest earned on term deposits, i.e. FDs and Recurring Deposits (RDs) fully taxable; They are added to the taxpayer’s income and are taxed according to the tax slab in which they fall.

Equality Law

India’s savings have always been driven by the household sector in the form of bank deposits—savings and term deposits. The household sector consists mostly of “fixed income earners” ranging from factory workers to government employees to retirees. Thus, the “fixed-income earners” constitute a broad spectrum of the “middle class”, which represents a huge “demand” and keeps the economy going.

With a higher life expectancy thanks to an improved standard of living, several factors have made aging a painful experience for the middle class. These include (a) the high cost of living (particularly, medical expenses), (b) inadequate social security systems (not all receive a pension from their employers, and the national pension system is rather modern), and (c) due to high Unemployment Rates Many are required to provide for their children even after retirement. Therefore, taxes on interest income do not fully satisfy the principle of equality.

law of certainty

There is no doubt that over time IT rules have become less opaque and more transparent, and procedures have become simpler. However, regarding the taxation of interest income, two ambiguities remain. First, the interest earned in the fiscal year, regardless of taxes in that year, is added to the account holder’s deposits under the compound interest rate system and again becomes subject to taxes in subsequent years.

Secondly, the interest earned for taxes is calculated on an accrual basis, and not on the basis of investigation, that is, depositors do not withdraw interest accrued for current consumption except in the case of monthly income schemes or early closure of the account.

Moreover, despite significant improvements over time, it still takes a long time to get the money back from the IT department if the bank deducts more taxes at the source.

Convenience to pay

The epidemic has brought great difficulties. There is debate as to whether this tax should be collected in these difficult times; With that said, the tax remained even during the 2008-2009 economic slowdown. Also, during Covid-19, TDS has only been reduced to 7.5 percent from 10 percent, and that’s also temporarily. The lack of “accommodation” may lead to incitement to tax evasion.

It is noteworthy that under the current declining interest rate regime, deposit rates have fallen at a faster rate than lending rates, and this hurts more than those who have a “dual” relationship with banks, that is, as depositors and borrowers with EMI. Payments related to interest income from deposits.

Moreover, it is curious that as long as a person works, her contributions to a provident fund, along with interest on them (mostly), are tax-deductible, while the interest on the day after her retirement when she puts her retirement benefits in a bank is taxed on him! In fact, in the post-retirement period, she needed this money more than ever. Moreover, with interest on provident fund contributions exceeding a certain threshold being taxed from fiscal year 21, there is a stronger case for fixed deposit interest not being taxed.

Collection Economics Law

Mechanization in the banks as well as the IT department has reduced, although not eliminated, the workforce involved in related activities, and hence related cost. However, buying the machines, and maintaining and updating them regularly, requires a cost. And machines require guarding. Against this background, whether it is economical for an IT department to collect this tax needs careful examination.

In view of the above, taxes on interest income should be eliminated. There is no publicly available data regarding the amount of tax collected on this head, the cost incurred on it and the net inflows. If canceled, there will be many positive effects.

First, it will boost savings in the banking channel. Perhaps, at the present stage, banks do not need funds because credit withdrawal is slow, but for banks, individual depositors are the cheapest and most stable source of funds, which they should not abandon.

Second, the savings that would accrue to individuals would help them service their monthly installments if they had a “dual” relationship with the bank. This is likely to have direct positive effects on the economy compared to those collected through budgets. Third, a high level will reduce income inequality in the country.

Dass is a former Senior Economist, SBI, who is the former Director General of the RBI. Opinions are personal

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