Over the past few years, around budget time, the wish list of the investors in the country contain the usual items - further rationalization of tax slabs, relaxation of 80-C limit, additional investment products that are tax deductible, and doing away with the pesky securities transaction taxes. This year is not likely to be much different on this count, and we are likely to see these familiar requests reaching the ears of the finance minister. However, thanks to the recent talk of potential long-term capital gains taxation on equity investing, investors might just breathe a sigh of relief if they just escape that announcement in the budgetary proposals, even if they don't get some of the concessions that they are wishing for.
Increasing the participation of retail investors in the capital markets is a laudable objective, and much of these wish list items would work in that direction. However, a more important goal for the finance minister should be to increase the size of the investor base in the country. As any financial service company in the country would tell you, increasing investments from your existing client base is important, but increasing the size of your overall client base is even more important for the future of the company. The finance minister's goal should be along similar lines.
A recent endeavor along these lines was the Rajiv Gandhi Equity savings scheme, which incentivized opening of new demat accounts using tax deductions. Unfortunately, it has been several years since the scheme was launched and it has not really taken off - probably due to the size of deduction and the limits on where and how one can invest the money.
A different approach to increasing the investor base would be to encourage purpose-driven investing. Rather than urge people to start investing to 'grow their wealth' or 'get more returns' or just to get tax breaks, they should be incentivized for investing with a clear purpose, such as retirement or saving for higher education.
The best way to do this would be to institute 'container' demat accounts such as retirement demat account or education demat account. Such accounts would come with certain privileges and certain restrictions. Contributions to these accounts would be tax-deductible up to an annual limit, but they can be used only in specific ways. The retirement demat account can be used for withdrawal only at the age of, say, 60 with penalties and tax consequences for early withdrawals. The education demat account can be used only for payouts to qualifying higher education institutions in the country.
Another important benefit to confer on such accounts would be to remove tax consequences for internal asset transfers within these accounts. That is, an annual rebalancing effort or a asset reallocation effort should not attract tax burden, as these assets are still purpose-driven and not withdrawn out.
When people see that they are investing for their child's education or for their own retirement (and, in future, say, to cover health costs), the goal or the purpose of their investments comes to the front, and the tax incentive becomes a sweetener to the process. This would have the effect of treating the people as aspirational individuals who take responsibility for their own future expenses, rather than treating them as just tax payers who are looking for sops to reduce their tax outgo.