Estate duty is a tax on assets left behind by a person upon his death, while inheritance tax is a tax on assets inherited by a person. Many countries have or have had either estate duty or inheritance tax. In India, too, we have had estate duty from 1953 till it was done away with in March 1985. Recent statements of the finance minister seem to indicate that the government is looking at reinstating such tax to raise further tax resources.
From the late 1950s to the early 1980s, estate duty was a part of the overall integrated direct tax system which comprised income tax, wealth tax and gift tax, besides estate duty. The whole objective was to ensure that the social objective of redistribution of income and wealth was achieved through these taxes, so that while income and wealth of a person was taxed, transfer of assets resulting in transfer of income or wealth by gift or legacies was also taxed to prevent such transfers to reduce the tax liability.
Since then, estate duty ceased to be applicable from 1985, gift tax from 1987, wealth tax was reduced to a truncated form (being levied on only 6 types of assets) from 1993, and wealth tax rates were reduced from a maximum rate of 5% to a flat rate of 1%. Income tax rates at the highest slab, which were over 90% in the early 1970s, and at over 50% in the mid-1980s, are now at levels of 30.90%. The whole tax scenario has therefore undergone a sea change in the last 25 to 30 years. Of course, gift tax has made an indirect but limited comeback from 2004, with gifts of money or certain specified assets received from persons other than close relatives being taxed as income.
The whole objective of such tax rationalization was to remove the then tax disincentive to earning income and accumulating wealth to encourage productive endeavours and discourage black money, which would automatically lead to an increase in tax collections. This purpose has been achieved as tax collections have multiplied manifold, in spite of such drastic reduction in tax rates. Is the time therefore now right to undo some of the changes made earlier, by reintroducing estate duty?
Clearly, considerations of boosting tax collections have a big role to play in the rethinking on the part of the government. However, it needs to be kept in mind that one of the reasons for abolition of estate duty was that the cost of collection and administration of estate duty was too high, compared with the actual estate duty collection. This reason would be valid even today. As the experience with fringe benefit tax and currently with wealth tax shows, the amount of time, effort and costs involved in collection of such other taxes is certainly not commensurate with the collection.
Besides, enforcing a very high rate of estate duty would result in driving away much-needed capital from the country. Given the economic slowdown in India as well as worldwide, we need to encourage more economic endeavours, rather than deter businesses from locating in India through an unduly high tax structure. The experience over the past couple of decades clearly indicates that a lower level of taxes does act as a significant incentive to economic activity.
One of the reasons given for levy of estate duty or inheritance tax is that it ensures that the second generation does not enjoy the same level of wealth as the first generation entrepreneur did, since the estate gets reduced by the amount of estate duty. This seems logical, since the first generation entrepreneur builds up his wealth through his efforts, while the second generation obtains the advantage of the efforts of the first generation without any efforts of his own. Here also, however, one needs to keep in mind the Indian context of most businesses being family run businesses, and the impact that a break-up of such businesses, necessitated by high levels of estate duty, may have on the growth of the economy.
In recent times, many countries have abolished estate duty or inheritance tax. These include Singapore in 2008, Russia in 2006, Hong Kong in 2006 and Sweden in 2005. To reintroduce estate duty, when other countries are abolishing it, does not seem to send out the right message to businessmen, who today have the option of various countries in which to locate their businesses.
Given the need for increasing tax collections, it may perhaps be a far better idea to marginally increase the income tax rates, particularly at the highest levels of income, say for income levels above Rs.1 crore. This is what the US has done, raising the tax rates only for those having income in excess of $400,000. This is what France also sought to do. The chairman of the Prime Minister’s Economic Advisory Council, C. Rangarajan, also endorsed this view a couple of days ago. Such a change would affect only a few people and probably fetch the same amount of tax with far less complications and cost. However, it must be kept in mind that pegging the rate too high or making the highest rate applicable at low levels of income could backfire resulting in destroying the culture of voluntary tax compliance, which has been gathering force over the past two decades.
Gautam Nayak is a chartered accountant.