Impact of tax incentives on household financial saving Radhika Pandey Ila Patnaik Renuka Sane National Institute of Public Finance and Policy 10 July 2018 Presented at the India Policy Forum, 2018
Context • Easy access to adequate capital is one of the key drivers of economic growth • In India, there is concern over low financial savings of households. • Tax incentives through Section 80C of the Income Tax Code used to influence savings into financial markets • Tax breaks can have two effects: increase overall savings, or lead to substitution between products. • Policy reports in India have claimed that there is only a “substitution effect” in India. • Empirical work largely remains absent. 1
This paper: Questions • Has the tax policy led to an overall increase in financial savings? • Has the tax policy channelled household savings into specific products? • What might we be able to say about tax policy? • Bring together both micro and macro data sets to answer the questions. 2
Why does this matter? • Individual households are the major contributors of direct tax in India. • Distribution of tax-payer status in India as of 31st March, 2018 shows that, 97.46% of the tax-payers are individuals. • In the assessment year 2014-15, 93% of the returns were filed by individuals. • Distortions by the tax breaks • “Incentives that erode the tax base the most relate to savings” (Shome, 2002) • “Tax incentives for household savings lead to fiscal loss, distort the interest structure and merely help in mobilising funds to specified savings instruments” (Economic Survey 2015-16) 3
Describing India’s tax incentives on savings
Tax thresholds Annual income Tax rate < Rs.2,50,000 NIL Between Rs.2,50,000 - Rs.5,00,000 5% Between Rs.5,00,000 - Rs.10,00,000 20% > Rs.10,00,000 30% • A deduction of Rs.150,000 can be claimed from total taxable income through Section 80C. 4
Tax incentives: Section 80c • Payment of life insurance premium to effect or to keep in force (Premium restricted to 10% of the actual capital sum assured) • Payment made to effect or to keep in force a contract for a deferred annuity (including payment made by Government as an employer) • Contribution to a provident fund (or superannuation fund) • Subscription to any notified security of the Central Government, or saving certificates • Subscription to units of any units of any mutual Fund of section 10(23D), referred to as equity linked mutual funds. • Contribution to a pension fund set up by a mutual fund under section 10(23D) • Investment in notified fixed deposits of not less than five years in banks, or time deposit at the Post Office. 5
Tax incentives: Section 80C (contd.) • Subscription to equity shares or debentures forming part of any eligible issue of capital • Subscription to such bonds issued by the National Bank for Agriculture and Rural Development • Any subscription made to any such deposit scheme or, pension fund set up by the National Housing Bank • Any investment in an account under the Senior Citizens Savings Scheme Rules, 2004. 6
Snapshot of changes on 80C Increase in tax break Overall Insurance Pensions Other 2015-16 Yes NA Yes Yes (post off) 2014-15 Yes* Yes Yes NA 2013-14 NA Yes NA Yes (shares) 2012-13 NA No NA Yes (bank) 2011-12 NA NA Yes Yes (bonds) 2010-11 NA NA NA Yes (bonds) 2009-10 NA NA Yes NA 2008-09 NA NA NA Yes (bank) 2007-08 NA NA Yes NA 2006-07 Yes NA NA Yes (bank) 2005-06 Can’t say NA NA NA 2004-05 NA NA Yes NA 2003-04 NA NA** NA NA 2001-02 NA NA NA Yes (annuity) *Overall limit increased to Rs.1.5L **Change under 88, not under 80C 7
Changes to fixed deposits taxation Year Section Tax changes 2006-07 80C Investment in a term deposit, for a fixed period of not less than 5 years, with any scheduled bank shall be eli- gible for deduction. 2012-13 80TTA Deduction of Rs. 10,000 can be claimed against interest income from a bank savings account 8
Changes to insurance taxation 2003-04 10D/88 Any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy is exempt. Restricted to 20% of the actual capital sum assured. 2012-13 80c Deduction for life insurance premium, issued on or after 1st April, 2012 shall be allowed for only so much of the premium payable as does not exceed 10% of the actual capital sum assured. This is a change from the 20% of capital sum assured, earlier. 2013-14 80C A higher limit of 15% of actual capital sum assured has been provided for persons with disability and people with diseases or ailments. 9
Changes to pensions taxation 2004-05 80CCD Mandatory NPS for new entrants to civil services from 1 January 2004. 2007-08 80CCD Individual employed by “other employers”, and not just the Central Government are now included under the purview of this act 2009-10 80CCD NPS extended to “self-employed” also 2011-12 80CCE The contribution made by the Central Government or any other employer to a pension scheme shall be ex- cluded from the limit of one lakh rupees provided under section 80CCE. 2015-16 80CCD Additional deduction of Rs. 50,000 for amount de- posited by taxpayer to their NPS account 10
Data
Macro data • Instrument wise savings data at the macro level. • The data is sourced from the reports of the Central Statistical Office (CSO) and RBI publications. • Financial assets include • Currency (13%) • Bank deposits (44%) • Shares and debentures (3%) • Claims on government (4%) • Insurance (17%) • Pension and provident funds (18%) 11
Household data: IHDS • A pan-India household survey jointly organized by researchers from the University of Maryland and the National Council of Applied Economic Research (NCAER) • Total sample of approx. 41,000 households • Two waves: 2004-05 and 2011-12 • Households interviewed throughout the year • Asks questions on income, consumption, sources of credit, and choice of savings instruments • Savings question: Over the last five years has anyone in your household invested in • Fixed deposit; bank savings; • Credit society; Post office account; • Pension, LIC other; securities; • Gold; buying property. • For establishing tax liability, can focus only on households interviewed in March. 12
Household data: Consumer Pyramids • A pan-India household survey carried out by the Centre for Monitoring Indian Economy, three times a year. • Total sample approx 160,000 households. • Asks questions on income, consumption, sources of credit, and choice of savings instruments • Savings question: Do you (the household) have outstanding investments in • Bank fixed deposits; Post office savings • National Savings Certificate; Kisan Vikas Patra • Insurance; Provident Funds/Pensions • Mutual funds; Listed shares • Gold; Real estate 13
Classifying households • Households are asked “Do you have outstanding investments” in various financial products. That is, if there is anyone in the household who has invested in a specific financial product. • However, to classify a household as a tax paying household, we need to know member income. • CP provides us with income of each member of the household. • We calculate the total annual income of each member of a household for the months April 2016 to March 2017. • We then classify each household as “taxed”, or “not-taxed” if there is at least one member with annual income greater than Rs.2,50,000. • We use the responses of households on savings in Wave 1 of 2017 (January - April 2017). 14
Defining the occupations Used the occupation of the HOH, or the member paying tax whichever is applicable. Occupation Occupation in CP Own employment Businessman, Self employed entrepreneur self employed professional, small trader/hawker Labourer Agricultural labourer, wage labourer Salary Industrial worker, white collar employee, support staff manager, technical employee Farmer Organised farmer, small farmer Others Others 15
Overall financial saving
Household financial assets as percent to GDP 20 15 Per cent to GDP 10 5 Household financial assets as % GDP (Base series 2004−05) Household fianncial assets as % GDP (Base series 2011−12) 0 2001 2003 2005 2007 2009 2011 2013 2015 Source: RBI and CSO 16
Total financial assets of households 14000 10000 Rs.Billion 6000 2000 2001 2003 2005 2007 2009 2011 2013 2015 50 Per cent of Gross Savings 40 30 20 10 Financial assets as percent to gross household savings (Base series 2004−05) Financial assets as percent to gross household savings (Base series 2011−12) 0 2001 2003 2005 2007 2009 2011 2013 2015 Source: RBI and CSO 17
Composition of household financial saving
Composition of household financial savings 2011-12 2012-13 2013-14 2014-15 2015-16 Currency 11.39% 10.48% 8.36% 10.61% 13.19% Deposits 57.95% 56.97% 56.01% 50.94% 43.59% Shares and Debentures 1.77% 1.60% 1.59% 1.58% 2.72% Claims on Government -2.35% -0.67% 1.94% 0.08% 4.38% Insurance Fund 20.98% 16.91% 17.17% 23.81% 17.50% Provident and Pension Fund 10.26% 14.71% 14.93% 15.02% 18.21% Source: RBI and CSO 18
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