Withdrawing EPF tax will be a grave mistake

It's unfortunate the govt seems close to bowing to pressure from a limited section of the public.

It appears that one of the more forward-looking provisions in the Union Budget for 2016-17, the decision to make a proportion of employee provident fund (EPF) withdrawals taxable, may be put on hold.

At the time of withdrawal, 60 per cent of any money deposited in an EPF account after April 1 was to be made subject to tax, unless it was re-invested in a pension product like an annuity.

The uproar from the salaried class was loud and along predictable lines. This was in spite of the fact that the proposal would apply to those drawing wages over Rs 15,000 a month - a minuscule proportion of the total number of EPF account-holders, and an even smaller proportion of the general proportion.

The economic argument is clear: the EPF provides a comfortable, tax-free return that is guaranteed and subsidised by the government, and should thus not be encouraged with tax incentives any further.

In addition, the tax-exempt nature of the EPF meant that the government's alternative and better structured pension product, the National Pension System or NPS, was suffering in comparison and had not taken off to the degree that it should have.

Given the many arguments in favour of the change to the EPF's tax-exempt status, it is unfortunate that the government seems close to bowing to pressure from this limited section of the public.

It has been reported that Prime Minister Narendra Modi has suggested a "detailed examination" of the proposal and that the finance minister might put its implementation "on hold" while the examination is carried out.

This shows a puzzling weakness on the part of the government and its leadership.

On the one hand, the PM himself told an audience of industrialists recently that subsidy rationalisation should extend to those that are enjoyed by richer Indians - and which are typically, as with the EPF, not called "subsidies".

The Economic Survey provided a detailed accounting of such subsidies and showed that they accounted for Rs 1 lakh crore a year, or 0.7 per cent of gross domestic product. Clearly there was both an economic rationale for cutting down on such government support for the rich and also a political understanding of the need to do so.

The government is also a majority government that could be able to push a change like this through.

There is thus very little reason for this proposal to be put on hold. If it is in fact put on hold, then it must be seen as yet another example of an unwillingness to reform even when the government possesses both the understanding of the need to reform and the capability to do so.

This is not to say that adequate preparatory steps were taken to make the proposal's acceptance smooth.

For one, no attempt has been made so far to explain that the proposed tax would only apply to the relatively well-off sections of society and those who had many other tax-free options for savings.

Moreover, the idea that investing in annuities must be encouraged, by permitting the taxable proportion withdrawn to remain tax-exempt if invested in annuities, should have been preceded by necessary steps to create a large enough market for annuities to help savers enjoy a wider choice.

Without such steps, it could serve as little more than a boost for inefficient and expensive annuity plans run by only a few insurance companies.

Certainly, therefore, there are good reasons to reflect on the details of the EPF proposal.

But rolling it back in response to pressure from the better-off sections of the salaried class should not be an option.