One man’s fiscal problem is another man’s lifeline. Economists may love shooting down subsidies because they bloat the fiscal deficit and burden the government but the fact is that a one-billion-strong nation, in which nearly one in three lives below the poverty line, needs an efficient social security method. The government’s proposal to partially tax provident fund (PF) withdrawals from the next financial year needs to be seen through this prism.
The big change in the Budget announcement was that the National Pension System (NPS), which was taxable on maturity, has now been made partially tax-exempt, and the employees provident fund (EPF) and superannuation funds, which were tax-free on maturity, are now partially taxable.
The EPF corpus consists of employer’s contribution, employee’s contribution and interest on both. Until now, the EPF has enjoyed an EEE (exempt-exempt-exempt) status of tax treatment, which meant that the maturity proceeds after five years were tax-free. But this is not the case any more.
Some analysts have the hailed the measure as a smart move to nudge people into switching to the mark-to-market-based NPS system. In the accounting world mark-to-market represents the price or value of a security, portfolio or account to reflect its current market value rather than its book value.
The argument is that over the longer term, subscribers will reap substantial gains by switching to a market-based pension system. The other argument in favour of a long-term annuity scheme such as NPS is that pension products are long-term schemes. India needs resources to fund its infrastructure needs to build highways, ports, airports and railways. Creating a well-developed and regulated pensions market can ensure that thrifty Indians help bridge the cash deficit for India’s infrastructure sector. Frugal households could well turn out to be the primary financiers of these mammoth projects.
Indeed, the same arguments can be applied to EPF as well, begging the question as to what prompted the government to make India’s largest workers’ welfare scheme that bit more taxing rather than marking it to the market.
Most mature economies have highly developed and efficient social security systems. That’s not quite the case with India where an organised pension market is, at best, fledgling. Pensions do need a leg up. But should it come at the cost of provident funds? Both should co-exist and flourish together. Only then can India’s savings rate reach 40% of GDP in the next few years and potentially be sustained at high levels for well over a decade primarily by armies of young people entering the workforce.