NEW DELHI (Reuters) - Prime Minister Narendra Modi's government on Tuesday dropped a controversial proposal to tax pension withdrawals, caving in after an outcry by salaried workers threatened to undermine his party's prospects in upcoming state elections.
Finance Minister Arun Jaitley had proposed in his Feb. 29 budget taxing lump-sum withdrawals exceeding 40 percent of an individual's retirement pot in the Employees' Provident Fund (EPF), unless the sum is reinvested in an annuity.
At present, withdrawals from the EPF are tax-free.
The tax proposal sparked a backlash from small but vocal professional class, with some calling it a raid on the retirement savings of honest taxpayers. Only around 36 million of the country's 1.3 billion people contribute to the EPF.
The move also drew flak from opposition parties, forcing the government to change tack ahead of elections in five states in April and May in which Modi's Bharatiya Janata Party (BJP) eyes gains.
"The policy objective is not to get more revenue but to encourage the people to join the pension scheme," Jaitley said in a statement to lawmakers.
The climbdown underscores the challenges for vital but politically-sensitive economic reforms in Asia's third-largest economy. Protests by farmers last year forced Modi to abandon a bill to simplify rules for industrial land sales in India.
Critics of the surprise budget announcement say Modi should instead be looking to widen its revenue base and charge lower income tax rates to put the public finances on a steadier footing, rather than milk existing taxpayers for more revenue.
One aide said that Modi had intervened directly in the matter. "He felt that this will discourage people from using traditional means of saving," the official said.
Country's urban middle class, which mostly supported Modi in the 2014 general election, has shown resentment over a rise in its tax burden.
Apart from imposing a levy to fund Modi's clean India initiative, the government has taxed away half the windfall of a slump in oil prices. This year's budget hiked taxes on cars and aviation fuel, and introduced a new tax surcharge to pay for measures to aid the rural poor.
Additional reporting by Rupam Jain,; Editing by Douglas Busvine & Shri Navaratnam