Unpacking household finance in an election year
Wearenowayearorlessfroman election, aperiod in which, inevitably, short-runobjectives dominate longer-run initiatives. That said, there are some longer-run policy initiatives that are “double bottom line”, simultaneously eye-catching, and important for the Indian economy. Several policies in the area of household finance have the attractive property of meeting political goals, while simultaneously improving the quality of people’s lives.
Indian households require customised, relevant, and scalable financial products that account for their unique economic conditions andlongstanding traditions. These must be available and comprehensible to households regardless of their level of education, free from incentive problems, and available at a fair price.
Unfortunately, we are far from this ideal world. Indian households face numerous impediments to using financial instruments to efficiently achieve their objectives while minimizing risks. This is true for households at all levels of wealth and income. The first part of the report of the RBI (Reserve Bank of India) Household Finance Committee, released last year, documents many of these issues in detail.
To solve these issues, a combination of old-fashioned and technologically advanced remedies will be necessary. This column focuses on a few old-fashioned policy remedies in the three important areas of gold, real estate, and insurance
For years, we’ve known that Indian households hold substantial (and suboptimal) quantities of gold and real estate. As demonstrated in the RBI report, this has negative consequences for households themselves, as well as for the government exchequer. There are many plausible reasons that households hold gold. One distasteful possibility is tax evasion.
All parties have an avowed interest in reducing black money and increasing tax compliance. This is top of mind for the electorate.
There are two policies that can help here. First, the requirement to provide a PAN card at the time of gold and jewellery purchases should be reinstated. Last year’s GST (goods and services tax) Council notification that the PAN card is no longer mandatory for purchases above ₹50,000 also exempts jewellers from reporting such purchases to the financial intelligence unit. This is a retrograde step and should be walked back.
A complementary policy is to require all gold and jewellery transactions to be registered electronically and monitored, with nonumerical thresholds set for transaction value—a step that only encourages misinvoicing. Being serious about reducing tax evasion requires better monitoring of gold—an easy soundbite in an election year. It will help households reduce unreasonably high allocations to this asset.
Here’s another policy: the statutes currently allow mortgage interest tax to be deducted for any income from residential real estate. This is true whether the real estate is the individual’s principal private residence, or if the property is let out to generate rental income.
The tax exemption for second and further homes should be removed. This will discourage the use of real estate as an investment vehicle without touching housepurchases for housing service consumption.
What about the political constraint? The overwhelming majority of Indians do not have second homes for rental purposes; only the wealthy do.
This is a progressive tax policy, which can play well with the electorate and will help reduce the unusually high allocation to real estate.
Back to tax evasion, it’s obvious that electronic land registration and certification is hugely important, and should be a continuing focus of dedicated effort. However, that is an issue for a different column—a more technocratic, and less visible, but nonetheless important policy.
The government’s recent announcement on health insurance has been eye-catching.
This is laudable, but there are questions about whether the policy is well-funded relative to the vast contingent liabilities.
Many issues need to be carefully solved for when designing such policy. One example: how does the provision of apparently free health insurance change the incentives of households to make claims?
Simpler things can be done in the insurance space. For one, distribution incentives for life and other insurance policies should be rationalized to harmonize commissions for initial sale and policy renewals. Renewals should be encouraged, rather than de facto encouraging households to lapse payments— with the consequence that they forego receiving benefits in the event of a subsequent claim.
Political parties could promise an alternative—a simply administered, transparent termlife insurance policy that doesn’t suffer from incentive problems. Clean up the distribution and increase trust in the product.
Trust also depends on households easily seeking redress when mis-sold products. It is not currently possible to delegate redress to representatives.
It is no surprise that financial product take-up is low when redress is complicated and forces rural households to sacrifice income to travel long distances for personal representations. A policy that’s on the side of the poor has a powerful emotive quality in an election year. And it’s the right thing to do.
These are a few steps on the road to better household finance in India. Thestakes are high, and not just in an election year. Whether now or later, these and other issues must be addressed.
The overwhelming majority of Indians do not have second homes for rental purposes