Bequest tax worries

An estate duty at this stage may not be a good idea

Discussing the “moderation” of India’s tax regime recently, Finance Minister P Chidambaram indulged in a bit of soul-searching. He insisted that 15 years of moderation have “by and large” promoted growth and equity – remember, the finance minister who reformed taxes 15 years ago was a certain Mr Chidambaram – but said the question must be asked as to whether the unequal accumulation of wealth has been ignored in the process. Even with that in mind, he said he was nevertheless “still hesitant” even to talk about inter-generational equity or an inheritance tax – which was abolished in 1985 – but that these questions need to be debated.

Mr Chidambaram is correct that, over the past 15 years, the concentration of wealth at the top of the income bracket has become worrying. Further, countries at the stage of development at which India is have to focus very carefully on the implications of such concentration of economic power; it leads to the development of oligarchies, for example, that can blackmail and control entire governments; it increases cronyism and the subversion of institutions; and it can cause widespread anger and discontent if it is seen as unearned or demonstrating closed-off opportunities for those less fortunate. According to Credit Suisse, the top one per cent of India’s population owns 16 per cent of its assets; the top 10 per cent owns more than half. Economists have identified many advantages of inheritance taxes, in theory at least. Their fiscal impact may be small. But their impact on social mobility could be large. Most advanced economies across the world, especially those with pretensions to social democracy and which value equality, have some form of estate tax.

Yet it is difficult to see how, given India’s current institutional environment, inheritance taxes will work in the manner they are theoretically supposed to. Wherever the taxes have been enforced, even though they usually exempt single homes from wealth calculations, they have been particular targets for evasion. In India, there is the question of whether an inheritance tax should cover wealth held as shares, since there is no wealth tax on shares. Not including shares for such taxation would be meaningless. Also, the tax authorities are not likely to have the competence or resources to go after the really big offenders, capable of setting up complex trusts and such arrangements in order to avoid paying taxes; some in the tax department may settle for harassing the middle class, instead. It would perhaps be far simpler to introduce the exempt-exempt-tax (EET) scheme, which does not have to wait for a direct taxes code, and this would tax not the contribution made to society through wealth creation, but expenditure, which reduces society’s stock of wealth.

Nor is India’s family structure necessarily conducive to the law’s operation. Within families, the elderly might be coerced into handing over property to those children who live with them well before they die. Naturally, gifts to blood relatives will have to be taxed at the same level as inheritance tax, unless such gifts are made more than two years before the donor’s death, as was the case before the estate duty’s abolition in 1985. Meanwhile, tricky questions of valuation will be asked; should houses, for example, be valued at cost price? At circle rate? Or according to whatever method is used locally for calculating property tax? One option, though likely to be contentious, would be to value such assets at current rates and not at historical costs.

Mr Chidambaram has correctly identified a problem, and a partial solution that might fit when India has greater institutional strength. At the moment, perhaps the government should focus on cutting down the sources of the disease of wealth inequality, not attacking the symptoms.