"Sinha said no change in tax rate and then imposed a 5% surcharge. Who is he fooling?" C.V. Kamesh, manager in an MNC, invested in mutual funds and tax saving schemes. He will now risk investing in stocks.

February 28 was a day of collective mourning for the Indian middle classes. That day Finance Minister Yashwant Sinha delivered a triple whammy on them. Budget 2002 proposed the reduction and elimination of certain tax rebates, a 0.5 percentage point cut in interest rate on small savings and imposition of dividend tax on individuals. "It's a three-way squeeze-declining returns, higher tax outgo and fewer tax-free incomes," says Gurinder Singh, CEO of portfolio management company Parasmoney. As if that was not enough, the surcharge on income tax was raised from 2 per cent to 5 per cent.

The angst is unabated. "The middle class has become the sole milch cow for the government," laments Padmini Sharma, a textile consultant and a mother of two. "The rules of the game have been changed midway and we do not have an exit option," complains Digvijay Singh, a bank manager who invested in life insurance policies to earn tax rebates. Others can't fathom what Sinha is up to. "On the one hand he is discouraging investments in government instruments. On the other by taxing mutual fund dividend he is discouraging stock market investment. I am confused as to what he is trying to do," says C.V. Kamesh, deputy general manager with Hitachi.

"It's not only about collecting tax. It's also about how it is spent. Look at the amenities around us." Digvijay Singh, a public-sector bank manager, used to invest a big chunk in PPF. He now plans to scale down investments in PPF and take a home loan to reduce his tax.

Compounding the woes is the economic slowdown that has taken its biggest toll on the salaried class in terms of job loss and lower or no salary increments. For instance, a client of Delhi-based tax consultant Subhash Lakhotia has just taken voluntary retirement from her job with Rs 8 lakh as final compensation. The best investment option for her would have been Reserve Bank of India Relief Bonds. But not only has the interest rate on these bonds fallen from 8.5 per cent to 8 per cent, there is also now an annual investment ceiling of Rs 2 lakh. Lakhotia now has to suggest less lucrative or less safe options to her. "The Government has not thought much about the older lot who do not have any social security in India," he says.

Sure, like in most developed countries, tax exemptions have to be phased out and to that extent some of the complaints are merely a protest against the loss of long available incentives, even if many didn't deserve them any more. A more substantive complaint is against the manner in which rebates have been withdrawn-all of a sudden with no pre-plan or road map. That has left people like Rama Vaidyanathan, a professional classical dancer, in a lurch. Only last year she had taken a 15-year insurance policy with a Rs 70,000 annual premium, primarily to avail of the 20 per cent tax rebate on the investment. She had no idea that the rebate would be halved to just 10 per cent this year and may completely be withdrawn in the next year's budget. "I feel trapped. If I had known the rebates were going, I would have invested elsewhere," she laments.

"For an honest taxpayer who has paid tax every year, I feel cheated." Padmini Sharma, consultant, invested for regular income through dividends. She will now have to lock in for longer periods.

Worse, investors are not sure if the remaining tax incentives will be withdrawn or diluted in future. Singh now plans to take a housing loan to lower his tax liability, but he wonders if the tax exemptions on housing loans too will be withdrawn suddenly in the years to come.

Historically, tax compliance has come down every time income-tax rates have been raised. According to a study by Oxus Research, when tax rates were streamlined with maximum rate being reduced to 30 per cent in 1997-98, the revenues instead of dipping by 25 per cent as forecast remained constant at Rs 18,000 crore, indicating an increase in compliance. In contrast, when Sinha imposed a surcharge of 10 per cent in 1999-2000, the revenues collected was Rs 236 crore lower than the budgeted figure of Rs 26,910 crore. The lesson: remove exemptions, but combine that with a reduction in tax rates. One of the key assumptions of tax reforms in the 1990s was that low tax rates are good for both: people and the government. Sinha has altered that assumption. Tax administration, of course, isn't yet efficient. There are cases of people not having been allotted Permanent Account Number (pan) by the Income-Tax Department three to four years after application.

THE ECONOMY

OUTWITTING MR SINHA >Switch from dividend option of mutual fund to growth plan and stay invested for over a year. >If you have suffered capital losses, offset them against gains made in next eight years. >Take a housing loan and reduce your income tax outgo. >Do not terminate insurance policies-they give decent tax-free returns in the long run.

Another sore point with Budget 2002 is its proposal that dividend income from mutual funds should now be taxed in the hands of individuals. Instead of the flat 10 per cent dividend distribution tax being levied on a mutual fund, tax will now be paid by individuals depending on their income slab. Also, there will now be tax deduction at source. Sinha has, however, taken steps in drawing more non-taxpayers into the tax net and thus increase the tax base by making it mandatory to quote the pan for all bank transactions exceeding Rs 50,000.

There is another good news that only a few want to hear right now. "We will move away from our mental block of investing just to save tax," admits Kamesh. "The Government has brought about long-term thinking by law," says Dhirendra Kumar, director, Value Research. He says the tax on dividend income will make investors opt for growth options of mutual funds and remain invested for at least a year to take the benefit of long-term capital gains and pay a flat 10 per cent tax.

Irrespective of the merits or intentions, Sinha's tax proposals have offended a critical and traditional support base of the BJP, the middle class, at a time when the party's political fortunes are dipping.