What if all Income Tax Exemptions are Removed?

The Budget 2023 has further revised new income tax slabs (which the Budget 2020 had introduced). And the new system has been made the default one and is perfectly clear that even though the Old & New tax regimes will co-exist for some more time, eventually, we may move to one regime only – the new tax regime that probably does away with all the exemptions (or some version of it).

To be honest and for the last 2-3 years, this dual taxation regime has complicated matters a bit. And the choice between New Tax Slabs Vs Old Tax Slabs has now become very taxpayer-specific. Each taxpayer would have to study his or her unique situation and then decide whether to opt for the new or the old tax regime.

As of now, the new tax slab is provided as an option. Taxpayers can voluntarily opt for it and its not mandatory. If they want, they can remain with the old tax slabs thereby keeping their exemptions.

However, we don’t know if this option would be available in the coming years.

In fact, it has been made very clear that the aim is to eventually move to a simpler tax structure and remove all exemptions.

There aren’t any fixed timelines for this but very soon, and in just a few years, the new no-exemption tax system will be the only one left. The broad idea seems to be to “have an income tax framework for India, which will be simple, rates come down to the minimum and easy to comply with.”

Personally, I like the idea of simpler and lower tax slabs with no exemptions. It is forward-looking and the intent is right. And I am all for it. Life will be so much so simple. And you will agree that due to years of tinkering with, our tax and exemption structures did need a cleanup and simplification.

But we need to look at it from another perspective as well.

The Finance Minister conveyed that the government believed that the taxpayers should decide where they’d like to invest their money. The old fashioned way of nudging people to save and invest and insure was a limiting one. It was also conveyed that the older tax system of exemptions underestimated the taxpayer’s ability to decide.

I have my reservations about this.

In India, the tax exemptions have been an important incentive for people to save, insure and invest. I have said this countless times that tax saving should not be the primary motive (here’s why?). But right or wrong, most people still purchase financial products to save taxes. The enlightenment that there is more to money than just tax saving and why investing for real goals properly is the way to go, comes much later.

I won’t mince words here.

We are a country which has been mis-sold crappy financial products like endowment insurance plans and what not for decades! So in all fairness, most of us don’t know what is right for us financially. And the agents have been doing their bit to make matters worse.

So if we as a country are financially illiterate, have no social security or proper government-backed healthcare system and where children are still considered as a retirement plan, I think the tax exemptions were the right-intended nudges that helped people to do something right. Save something, buy insurance and invest a bit. All in the name of tax saving but still helping push the right agenda.

Now if these nudges go away, will these people still save and invest and insure properly?

Many would. But many won’t. And that is troubling.

I know that many taxpayers are smart enough to decide. But many aren’t. And if these people stop investing money because there are no tax sops, imagine what will be their situation when they eventually realize that they are very late in saving for their goals? Not a pretty picture. Many would run the risk running out of money before years!

Some may argue that over the last few years, an increasing number of people are demonstrating financial maturity and making the right choices. That’s correct. But if you look further down the financial literacy pyramid, there are a vast number of those who are still clueless about what’s right for them and what isn’t. If everyone were smart, there wouldn’t have been any buyers of crappy financial products. Right? But they are still sold. So not everyone is mature.

And for a vast majority, saving income tax was all that meant about making investments and expenses according to the list of deductions and exemptions. That is, people still are driven by incentives. But the removal of exemptions can potentially lower household savings as many (who aren’t financially savvy) will refrain from investing because there are no incentives now.

I personally feel a no exemption lower-tax system will work best for me. But I am not the only one. And I am worried about those who would have no incentive left to save or insure. So I don’t know what the right solution is here. Maybe, everyone will just rise to the occasion and learn to look out for them. Fingers crossed for that!

Update – This post was originally written in 2020 and has been updated slightly in 2023 to account for new changes in the Budget 2023.

1 comment

  1. I second your concerns. Its wishful thinking that everyone will rise to the occasion . In my opinion the less financial savy folks ( most people!) will spend rather than save and feel good about it too. While it will sadly compromise their financial future, on the flip side, the spending would move and hopefully distribute money in the system and that will help the economy fire again. Maybe the govt is looking at this to kickstart the spending cycle apart from other measures it continues to take. Just my 2 cents.

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