Why IT slabs should be used to fix small savings scheme interest rates

Published: April 1, 2021 at 11:02 am

In this article, I discuss why the govt can use income tax (IT) slab rates as a primary guide for fixing small savings scheme interest rates to (1) reduce hardships to lower-income groups and senior citizens and (2) avoid cringy embarrassment such as this PPF rate cut reversed but do not reverse your decision to reconsider it!

The government bond yield based formula can be used as a secondary guide to decide interest rates for each quarter. Every citizen in India whether can invest Rs. 100 a month or Rs 100,00,000 a month is given the same rate.  When the rates are cut, the former citizen is affected the most, but we do not listen to their lament because they are not on social media.

The govt. has already taken a step in the right direction by making employee contributions up to R. 2.5 lakh in PF tax-free and beyond that taxable as per slab. The same kind of logic can also be implemented to small savings interest rate in some convenient format.

The rates can be variable as per annual income (IT slab the person falls in), or it can be variable depending on the annual contribution. For example, the Sukanya Samriddhi Account is primarily meant for girl children born in lower-income households. The govt. could either make contributions by those in 30% tax slab taxable (thereby changing effective interest rate for them), or they could offer different interest rates for different contributions (which is a proxy for tax slabs).

  • For eg. 8% for annual contributions up to  Rs. 50,000
  • 7.5% for annual contributions between Rs. 50,0001 to Rs. 1,00,000
  • 7% for higher contributions etc.

The same can be done with PPF. Senior citizens in the 0% tax slab can get the highest interest rates, progressively reducing but still higher than other schemes.

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    Interest rates have to depend on inflation and long-term reduction in govt. borrowing. There is no escape from this. Rate may move up and down in the short-term but must reduce in the long-term.

    However, by using a contribution-based or IT slab-based categorisation, the increment the govt. provides to different sections of the society can be different, and rates of reduction can be different.

    For example, The govt provides 0.25% more returns in PPF“prevailing 10Y bond market rates”. This is the formula, but actual implementation depends on “several factors”, to put it mildly. See Worried about 7.1% PPF interest rate? It is higher than what it should be!

    The govt could provide 0.75% extra returns in PPF for those in 0%, 5% slabs, 0.5% for those in 20% and 0.25% for those in 30% or some such segmentation. This will help those who need the help the most and reduce the debt burden for the govt gradually.

    Whoever is in power can claim that they are taking care of lower-income groups (this by definition refers to those who do not trend hashtags on Twitter). This will take care of anti-incumbency fears.

    Even the loudmouths on social media will have relatively lesser to complain about. The “rich” get taxed more – their rates gets slashed more; the middle-class take a smaller hit, and the poor even lesser or not at all.

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      Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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