Battling for equality the right way

Highly progressive taxes on income, wealth, and inheritance have been tried for long. They failed in producing the desired result

On April 23, Sam Pitroda, chairman of Indian Overseas Congress until Wednesday, drew our attention to the problem of inequality. Large inequalities of income and wealth are repugnant in every society. The problem is in finding a solution and not fighting it the wrong way. 

Highly progressive taxes on income, wealth, and inheritance, and, in the extreme, even state-ownership of the means of production, have been tried for long. They failed in producing the desired result, and at worst, resulted in the withering away not of inequality but of the state itself, like the former Soviet Union.

India was no exception to this experimentation. For example, in the heyday of Indian socialism, after the Congress split, in 1970-71, Prime Minister Indira Gandhi took charge of the Ministry of Finance from Morarji Desai. In her Budget, she increased the highest marginal rate of basic income tax applicable above Rs 2 lakh from 75 per cent to 85 per cent. With the surcharge of 10 per cent, the highest marginal rate became 93.5 per cent.

Indira went to the polls during 1-10 March 1971 with the populist slogan, “Garibi Hatao” or abolish poverty. She trounced the opposition and won a two-thirds majority of 352 out of 518 seats in the Fifth Lok Sabha.  YB Chavan became finance minister after Indira in June 1970, and in his Budget for 1971-72, increased the surcharge for income above Rs 15,000 from 10 per cent to 15 per cent. Thus, at the pinnacle of Indira’s socialism, the highest marginal rate of tax became 97.75 per cent! This confiscatory level of taxation, however, solved neither the problem of inequality nor of poverty. It seriously eroded incentives for the highest income earners to venture into more economic activities, especially those involving risks. Furthermore, perilously, it reinforced the preexisting proclivity to evade taxes and accumulate ‘black money’.

The Direct Taxes Enquiry Committee, popularly known as Wanchoo Committee, pointed out how prevalence of high tax rates made evasion, despite attendant risks, profitable and attractive. High taxes were the first and foremost reason for tax evasion. It recommended that the maximum marginal rate of income tax, including surcharge, be brought down from 97.75 per cent to 75 per cent. Accordingly, in 1974-75, Chavan reduced the marginal rate for the highest income slab of Rs 70,001 and above to 70 per cent. With a unified surcharge of 10 per cent at all levels, the highest marginal rate came down from 97.75 per cent to 77 per cent. We all know how the rates were subsequently brought down by successive governments.

While most, or at least a large part, of your income may be by the dint of your labour and expertise, ascribing your inheritance from your parents to anything that you have done at least in this life is difficult. Thus, at least at first sight, inheritance tax looks less problematic than income tax. It has been mentioned widely, including by Pitroda, as a tool to address the problem of inequality.

In this advocacy of inheritance tax, we forget the lessons of the past wars fought and lost. For over three decades, from 1953, we had an inheritance tax. It was called estate duty. It was calculated after a person’s death when the property or estate of the deceased passed on to the inheritor, and was payable only if the total value of the inherited portion of the property exceeded Rs 1.5 lakh. The duty rate progressed from 7.5 per cent at its lowest to 85 per cent at its maximum.

Unfortunately, insignificant revenue mobilised from estate duty indicated its ineffectiveness in reducing inequality. In 1985, VP Singh, finance minister in Rajiv Gandhi’s government, pointed out how the yield from estate duty was only about Rs 20 crore, while its cost of administration was relatively high. He abolished it for estates passed on following deaths on or after March 16, 1985.

Under the Wealth Tax Act, 1957, India also had a wealth tax to fight inequality. It was imposed at the rate of 1 per cent on assets of Rs 30 lakh or more (excluding equities, bonds, and first house). In his Budget for 2015-16, Finance Minister Arun Jaitley repealed this tax and replaced it with a surcharge of 2 per cent on income of Rs 1 crore or more. While collection under wealth tax in 2013-14 was only Rs 1,008 crore, the new surcharge was expected to bring revenues of Rs 9,000 crore.

The frustrating experience with progressive income tax, inheritance tax or wealth tax is not limited to India. It pervades most countries of the world. Pitroda has drawn our attention to inheritance tax in the US. But it is a state-level tax and exists only in six of the fifty states.  Recently, the International Monetary Fund (IMF) has noted how tax rates on wealth have generally declined over the past decades.  Furthermore, of the dozen Organisation of Economic Co-operation and Development (OECD) countries that had wealth taxes in 1990, only three (Switzerland, Spain, Norway) now levy a broad-based wealth tax. 

Taxation is a highly technical matter. Some of the best legal and accounting brains are engaged by rich clients to find loopholes and avoid taxes, for example, by setting up shell companies. While tax evasion is against the law, tax avoidance is not. In plugging loopholes, we need to avoid rules that can lead to collusion among unscrupulous taxpayers and dishonest officials. Furthermore, we should not forget the tax havens in the world, where the rich can migrate to avoid high taxes.  

So, do we just give up on our effort to curb income inequality? Of course not. We only need to stop thinking of weapons such as high taxes that failed us in the past. We need to target and eliminate the inequality of opportunity that lies at the root of our poverty and much of our income inequality. Experience shows how, with access to quality education and healthcare, children from very poor families can effectively compete with children born with a silver spoon in their mouth. Do we not know enough first-generation billionaire businessmen, brilliant doctors, engineers, and professors from very humble backgrounds?

The author is a Bharatiya Janata Party member of the West Bengal Legislative Assembly and a former Chief Economic Adviser in the Union Finance Ministry