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A file photo of supporters from ‘Occupy Wall Street’ in New York City. Photo: AFP (AFP)
A file photo of supporters from ‘Occupy Wall Street’ in New York City. Photo: AFP

Why India needs a tax on inherited wealth

There are both ethical and economic reasons for an inheritance tax, which has won support from many economists

Recent comments from two of India’s most influential voices on policy, finance minister P. Chidambaram and Prime Minister’s economic advisory council chairman C. Rangarajan, on taxing the super-rich have sparked a debate on the issue.

Such a tax is finding favour globally because of a growing awareness of the risks of extreme inequality. Inequality is an important incentive for innovation and growth but after a point, it can be economically inefficient and can exacerbate crises such as the one in 2008. Research by International Monetary Fund economists Andrew G. Berg and Jonathan D. Ostry shows that high levels of initial inequality makes an economy less likely to sustain a high growth path. A large part of the rising inequality in recent decades has been due to the phenomenal increase in the wealth of the top percentile—the infamous 1% that the Occupy Wall Street protesters railed against. Since the 1970s, top income shares have exploded in several major economies, including China and India, research by economists Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez shows.

Can a super-rich tax reduce the damaging impact of inequality? Or will it dampen savings and investments by the wealthy, and harm the economy, as business lobbies claim? Much depends on which kind of tax is imposed and how it is designed.

Of all the ways to raise taxes on the extremely wealthy, the inheritance tax appears to be the most efficient. There are both ethical and economic reasons for an inheritance tax, which has even won support from hard-headed economists such as Nobel winner James Buchanan. The moral argument for an inheritance tax is that it removes the extreme advantages of wealthy scions and levels the playing field at birth. Utilitarian economic theory, on which much of modern policymaking rests, says that the market mechanism leads to an “optimal" social state only after a redistribution of “initial endowments" (the conditional clause is usually neglected by the proponents of the so-called fundamental welfare theorem).

India is a particularly apt case for imposing an inheritance tax and there are two key reasons for this. First, with nearly two-thirds of its tax revenues accruing from indirect taxes (which are a heavier burden on the poor), India needs to raise more direct taxes. Inheritance or estate taxes can be one of the key options.

Second, there are very few large-sized economies where inheritance has such an overwhelming influence on national life as in India, and an inheritance tax can be part of a broader strategy to change the status quo. Across the top echelons of business, politics, and even Bollywood, inheritors tend to be in a majority. In various fields, one finds a few dynasties controlling large swathes of territory. The culture of inheritance seems to unite the nation: it finds as much acceptance in Kashmir as it does in Kanyakumari. This culture restrains social mobility and is economically damaging. More than half of those born in the families of agricultural labourers end up being agricultural labourers themselves, according to a 2012 Indira Gandhi Institute of Development Research (IGIDR) working paper by economists Sripad Motiram and Ashish Singh.

India had a failed experiment with estate taxes till the mid-1980s before it was scrapped. But India’s version of estate taxes had a number of exemptions which allowed people to game the system. Evidence from other countries seems to suggest that estate taxes can yield substantial revenues, if exemptions are minimized and other policies such as taxation on gifts are tweaked. The empirical evidence on the impact of estate taxes on savings rate is mixed. Economies which raise substantial revenue through estate taxes are among the richest in the world.

Some critics of estate tax have pointed out that India can raise much greater revenue through better tax administration. Others have suggested better utilization of existing public funds. Both are valid criticisms but steps such as better tax administration and improved public delivery systems can complement rather than substitute an estate tax, in reducing inequality and poverty. After all, it is not enough to take away a share from the inheritors of riches. It is imperative that such resources are efficiently used to help the inheritors of poverty climb up the income ladder. An effective public inheritance involving such public goods as quality education and healthcare must complement an inheritance tax if India is to become a land of equal opportunities one day.

In the short run, an inheritance tax is most unlikely. The current government, headed by a dynastic Congress party, has zero moral authority to counter the culture of inheritance. In any case, industry lobbies have been vociferous in their opposition to an inheritance tax (which is not surprising, given their role in perpetuating inheritance), and at a time when investment sentiment is bleak it is unlikely that the government will raise taxes on the very wealthy.

Over the long term though, an inheritance tax can help raise public funds and contribute to a more dynamic economy.

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