The Hindu : Business : Alternatives to new measures

Online edition of India's National Newspaper
Monday, Jul 12, 2004

Business

Business

Alternatives to new measures

The proposed turnover tax may succeed only in inhibiting the entry of individual investors and this may not be good for the healthy growth of the market.

EVERY BUDGET has its excitements and controversies. Budget-2004 is no exception. It will long be remembered for its introduction of transaction tax. As per Government estimates, the proposed tax may generate a revenue of Rs. 3,000 crores. Is there no simpler, less controversial alternative?

Transaction tax

Entities involved in stock market operations can be broadly divided into three groups. Value-wise, banks, mutual funds and other financial institutions and some big corporates that come in the first group, will account for a major portion of the transactions. The amount involved in the transactions of the second group, namely. normal, individual investors, may not be high. But, higher the number of this class of investors and larger the volume of the transactions, better will be the health of the market. Speculators belong to the third category.

A much simpler, alternative tax system can be devised in respect of the first category. The proposed turnover tax may succeed only in inhibiting the entry of the second group of investors and this may not be good for the healthy growth of the market. The revenue from this group may not also be significant. As for the third group the proposed tax may not, as some fondly hope, curb speculation. It may only drive it underground. It is easier to enforce prohibition than to control speculation and gambling.

What can be the alternative system? It is easy to determine the amount of additional investments made each year by constituents of the first group. In the case of a life insurance company, for example, the additional investments during a year will be equal to the total premium income, net of operational expenses and claim payments, plus the investment income. The total additional investments in a year by these institutions will be a few lakh crores. A small percentage of this may yield the desired revenue. The other two categories may be left untouched. This means that only new investments, and that too only bulk investments, will be taxed.

Service tax

As expected, service tax has been extended to life insurance and it is proposed to tax only the risk portion of the premium. The proposal is not only cumbersome but also inequitable. The tax, as a percentage of premium, will increase as the term of the policy increases. This goes against the basic principle of life insurance, namely, to provide cover for as long a period as possible on guaranteed terms. Under individual and group term assurance plans, the impact of this tax will be quite significant. Under unit linked plans which generally offer only a token life cover, the impact will be negligible. It would be more logical, simpler and equitable to charge a flat half-a-per cent on the total premium collected in a year. This may yield better revenue.

Unit linked plans are simply mutual fund products, dressed up as life insurance. At any point of time, the surrender value is equal to the NAV, just as in the case of mutual funds. But this surrender value is not subject even to short term capital gains tax since the proceeds from a life insurance policy are not taxable. It is a good instrument for tax avoidance.

Disinvestment

Seven years ago, P. Chidambaram had the privilege of moving the first Bill for liberalisation of the insurance sector. The Bill could not be passed because of opposition from the Congress party. Now, as Finance Minister of the Congress-led Government, he has proposed the enhancement of FDI caps in life insurance and a few other key sectors. This is certainly an irony. But there is a greater irony. Any one familiar with the basics of life insurance will tell that it is one major industry that needs no capital. Where then is the need for raising the cap on FDI? It will not matter even if 100 per cent foreign owned life insurance companies are permitted as long as there is no deliberate discrimination against LIC of India and, the private sector, whether Indian or foreign, is not allowed a foothold within LIC.

A real boost to the life insurance industry could have been given in the budget by notionally dividing the country into five regions and reducing the minimum capital requirement to Rs. 25 crores in the case of companies operating within one region. This would have brought in fully Indian owned companies into existence and enabled rapid spread of insurance into rural sectors. This in turn would have led to more job generation and development in rural areas.

Foreign capital may be required only in capital intensive industries such as oil exploration and exploiting the oil and gas fields already discovered by Reliance and Cairns Energy and not for raising the Sensex and Nifty to illogical levels. There appears to be no mention of this important issue in the budget.

Tax exemption limit

The move to exempt from tax all those with taxable income less than Rs.1 lakh may be popular. It has however to be remembered that it is tiny trickles that ultimately make a mighty river. Eliminate these trickles. The river will one day dry up. In the mid-1960s, the tax exemption limit was Rs. 3,000. Four decades later, a limit of Rs. 60,000 would have been reasonable.

New scheme for

senior citizens

The proposed savings scheme for senior citizens replaces the Varishta Bima Yojana. It appears that the revenue department does not appreciate the difference between a deposit scheme and long term pension scheme. It is again an irony that the same finance minister, who was earlier instrumental for the introduction of the popular pension plan, Jeevan Suraksha, has now axed a very good pension plan, for no apparent reason.

Employment generation

No concrete measures have been proposed for employment generation. Over the century, while the mortality rates have decreased by more than 75 per cent, the reduction in birth rate is not significant. This has led to galloping growth in population. It appears that this year's budget has been presented only because a budget had to be presented. Let us hope that a better study of the long term needs of the nation will go into the presentation of the next budget, due within eight months.

R. Ramakrishnan

(Retired Chief Actuary of Life Insurance Corporation of India)

R. Ramakrishnan (Retired Chief Actuary of Life Insurance Corporation of India)

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