It is a part of the folklore of pre-reform India that its tax rates were stratospheric. And it is true that the peak income tax rate of 97.75 per cent in the early 1970s was plain extortionate. But that was not out of line with rates elsewhere: Britain had a peak tax rate of 99.25 per cent during World War II; in the early 1970s it varied between 75 per cent and 90 per cent. In the US it was 90 per cent till the mid-1960s. Both countries slashed rates in the 1980s (part of the Thatcher and Reagan revolutions), and the Rajiv Gandhi government’s first Budget in 1985 did the same, slashing the peak rate to 50 per cent. India was part of an international trend when tax rates were high, and also when they were lowered. Now the pendulum is swinging again. In a world increasingly concerned about sharp growth in inequality, France has just raised the peak rate to 75 per cent. No one else is going quite that far, but President Obama wants to raise it in the US from 35 per cent to 39.6 per cent. In Britain, though, the Cameron government has gone the other way, dropping the peak rate from 50 per cent to 45 per cent this year.
India may follow trend again. The “new” finance minister argued last year (when he was the home minister) that higher taxes on the rich were in order. At a Planning Commission meeting more than a year ago, he is sitaid to have argued for higher taxation of luxury consumption and for an inheritance tax (which Rajiv Gandhi had abolished in 1985). Then, at a function last September, Mr Chidambaram said, “the rich must be prepared to pay higher tax”. Indeed, he referred to rich people in Europe saying “Please tax us more”, and to Mr Obama’s tax proposal. This is an about-turn, since it was Mr Chidambaram who slashed the peak tax rate to 30 per cent in 1997, and who abolished the long-term capital gains tax on exchange-traded shares. His argument is that India needs to raise its tax-GDP ratio. The minister has acknowledged that people will not like the idea, but he is nothing if not goal-oriented.
Still, expect a lively debate. The direct tax-GDP ratio went up when tax rates were slashed, so will it not go back down if rates are raised? Perhaps not, if the higher rates remain moderate (say a peak rate of 35 or 40 per cent, above a threshold income of Rs 20 lakh). But perhaps half a million out of 36 million taxpayers report income above this level, so it is hard to see macroeconomically significant revenue resulting in the short run. Taxing luxury items will fetch even less. As for the estate duty, it yielded virtually no revenue before it was abolished. There is, of course, more wealth today, but the revenue will not be significant if shares are not taxed — and, if that is an option, why not include money held in shares for wealth tax calculations, and re-introduce the long-term capital gains tax on shares? That might send shock waves through the stock market, and Mr Chidambaram likes share indices to be buoyant. Taxing second homes will depress construction activity, and drive even more black money into real estate. There will also be a return of the complicated tax avoidance stratagems that businessmen had worked out in the past; the clear risk is of more avoidance as well as evasion.
Hence, two questions: is quick introduction of the goods and services tax a better way to raise the tax-GDP ratio, and slashing subsidies to the “rich” a better way to tackle the deficit?