Will The New Tax Regime Leave A Deeper Hole In India's Shrinking Household Savings Habit?

Under the new regime, Srini does not have to put any money in tax savings instruments such as life insurance, or small savings schemes including national savings certificate or public provident funds to reduce his taxable salary. On the contrary, Srini would have had to pay 20 per cent tax under the old regime. Also he would be required to invest in several instruments to reduce the taxable income.

“I opted for the new tax regime as it is simpler and I am left with more money, which I can spend freely or decide what to do with it,” Srini said.

Like Srini, more and more people are now opting for the new regime -- not only India’s millennials but even older taxpayers -- to avoid the complicated tax filing exercise. Besides, this allows more financial flexibility to many who are still recovering from the Covid pandemic shock.

Dipping Savings Rate: Will The New Tax Regime Worsen It?

But this has led to a larger question - Will the new tax regime further bring down India’s already sagging household savings level and push up debt?

Finance Minister Nirmala Sitharaman’s announcement of increasing tax benefits under the new regime is expected to push more taxpayers to opt for this new structure, introduced in 2020-21, largely to address the Covid pandemic-induced economic crisis.

Sitharaman has repeatedly said that the new regime is in line with the government’s efforts to simplify the country’s tax structure. Undoubtedly, the new regime has significantly simplified the tax-filing exercise. An assessee filing her income returns under the new regime is not required to provide proofs of investments to reduce the overall tax burden as has been the case traditionally under the old regime.

Under the old regime, an assessee can claim deductions on the total taxable income in case of investments in tax-saving instruments. But with the government steadily making the new regime more attractive by offering elower tax rates, two-thirds of the country’s taxpayers have now willy-nilly opted for the new regime.

With more money being left in the hands of the people, unsurprisingly, India’s consumption is surging—something the government would not mind as it supports economic growth. Powered by a spike in consumption and demand, India registered a GDP growth rate of 8.2 per cent in 2023-24. Sitharaman projected a growth rate of 6.5-7 per cent during the current financial year.

Policymakers while welcoming the rising consumption graph, are worried about the declining savings rate. According to RBI's assessment net financial savings of households fell to 5.2 per cent of Gross National Disposable Income in 2022-23 compared to 7.9 per cent in 230125-16. 

At the same time, the gap between financial assets and liabilities also declined as household borrowing rose (See Graph below).

 

 

“This is something that is worrying and needs to be watched. The incentive to invest in various financial instruments for decades to claim tax benefits had in turn inculcated a structured habit of saving among the young taxpayers, making India a nation of savers,” a senior economist at a private sector bank told The Secretariat.

“While the increased consumption may prove to be beneficial for the economy for some time, in the long term, this could have a severe impact,” the economist said, adding that it is important to nurture a habit of forced savings from an early age.

The  Reserve Bank of India (RBI) data revealed that the share of net financial savings in the total household savings basket has been declining. In 2022-23, it stood at 28.5 per cent – a significant drop from an average of 39.8 per cent during the 2013-2022 period. India’s gross savings rate stood at 29.7 per cent of gross national disposable income (GNDI) in 2022-23, with households being the primary savers and forming 60.9 per cent of aggregate savings. However, the 10-year average for 2013-2022 stood at 63.7 per cent. For the household sector, savings in physical assets have been the dominant and rising component, the central bank noted.

With more and more taxpayers now opting for the new regime, the country's savings rate is not likely to go up anytime soon. 

Household debt has risen too along with consumption which has dented savings. The RBI in its financial stability report said that household debt at 40 per cent of the GDP warrants close monitoring from a financial stability perspective even as it is lower compared to other emerging economies.

Financial liabilities of households have risen in the post-pandemic period pushing demand for retail loans. The retail credit is being used for both consumption and investment.

A larger household debt is also the result Covid pandemic-induced pent-up demand along with easier access to credit. Personal loans have been a significant driver of personal loan portfolio. As the consumption is steadily growing, overall savings is declining.

Why The Declining Savings Rate Is Cause For Worry?

High rate of domestic savings helped India in limiting the economic impact of the 2008-09 global financial crisis. India was among the fastest economies to recover from the economic shocks of 2008-09. During the time of the crisis, India’s savings rate was 38 per cent of the GDP. China’s was 39 per cent in 2010. Along with the savings level, India’s economy was also cushioned by the investment rate, which was 25 per cent.

In China, the gross domestic saving surged from 2000, touching over 50 per cent of GDP starting in 2007, noted a Brookings report. Though the higher than required savings rate coupled with an overall reluctance of citizens to spend money has now started to affect China’s growth rate, it has helped Beijing steer through several economic challenges in the past. “The idea should be to balanced savings rate with consumption…to focus only on consumption may pose challenges in the long term,” another analyst said.

While the declining household savings rate may not be immediately felt, a healthy savings rate is key for any economy, as it feeds investment. It also helps in case of an economic crisis as was the case for India in tiding off the impact of the global financial crisis in 2009. Though an excessively high savings rate is detrimental to growth as it hinders consumption but an alarmingly declining savings rate is a cause for concern too.

Economic managers and researchers have continued to debate over whether a high savings rate is at all desirable as it can severely dent consumption, the solution lies in creating a healthy balance between savings rate and consumption.