Can a 30% flat deduction bring taxpayers back to long-term investments, insurance?

Gone was the hassle of tracking investments, loans, or charitable contributions. Instead, taxpayers pooled their income, calculated tax liabilities, and filed returns with ease, embracing a system designed to simplify taxation.

Five years on, emerging trends raise concerns about its impact on essential financial habits.

Declining life insurance

One of the most concerning observations is the decline in life insurance penetration. The Insurance Regulatory and Development Authority of India (IRDAI) annual report released last month, indicated that insurance penetration declined for second consecutive fiscal year. 

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Traditionally, tax benefits associated with insurance premiums have been a reason why people purchased life insurance policies. Without these incentives, many are no longer prioritising life insurance and are lacking that important protection.

Falling long-term investments

The trend isn’t confined to life insurance; even equity-linked savings schemes (ELSS) are witnessing a decline, despite equity markets delivering stellar returns in recent years. 

Although overall inflows into equity funds have risen, last year also saw record-high SIP outflows. This suggests that investors are steering away from long-term commitments, bypassing the discipline ELSS offers through its mandatory lock-in period.

Not just equity, in the absence of tax deductions, interest in other essential  long-term savings also seems to be declining. Further compounding the issue is the declining interest in small savings schemes and the National Pension System (NPS). A recent survey by BankBazaar revealed that fewer salaried respondents are showing interest in these long-term savings vehicles.

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The seriousness of these trends is amplified by the broader economic environment. In the past year, India has experienced an economic slowdown, declining household savings, and stagnant incomes. Simultaneously, there’s increasing reliance on credit for consumption and delinquencies are on the rise. These are circumstances where low savings and protections can be particularly damaging for households.

Deductions as an incentive

Given these facts, it is essential to revisit the role of tax deductions in incentivising financial discipline. Traditionally, deductions have been linked to critical areas such as insurance, savings, and retirement planning. 

With this motivation gone, the future of retirement planning and financial security is now coming into question. Deductions tied with the right incentives could provide the impetus necessary for fixing this problem. 

One potential solution is to introduce a flat deduction of 30% of gross income including long-term savings, essential insurance, healthcare and education costs, and loan payments without confusing caps and sub-limits.

To ensure equity among income levels, the flat deduction could be capped at ₹15 lakh. This would allow middle- and upper-middle-income households to benefit from the provision while preventing disproportionately large deductions for high-income individuals.

A flat income-based deduction keeps taxation progressive while retaining the simplicity of reporting. Moreover, such a measure would also align with the government’s goal of promoting financial inclusion and ensuring that essential protections are accessible to a broad segment of the population.

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In conclusion, while the new tax regime’s simplified structure has its merits, the absence of deductions linked to essential financial activities is proving detrimental in the long run. By reintroducing targeted deductions in a simplified and equitable manner, the government can address declining savings and insurance penetration, encourage financial discipline, and strengthen the financial resilience of Indian households.

Adhil Shetty is CEO Bankbazaar