Opinion
Economic redistribution: Who’s afraid of progressive taxes?
Summary
- They’re needed to fund essential public services and foster a society with equal opportunity for all. Inheritance and wealth taxes may be inefficient, but let’s properly ensure other direct levies raise more revenue from the rich than others.
India’s political debate on inheritance tax and wealth tax has led to fears of tax terrorism, with the incumbent National Democratic Alliance (NDA) using the issue to attack the principal opposition party, Congress. Although the latter has clarified that neither a wealth nor inheritance tax is part of its poll manifesto, questions have arisen on the feasibility and desirability of such a proposal. The use of taxation as a tool to redistribute income and wealth may be an important issue, but a far bigger one is inequality, which is high in India and has risen over the last three decades.
We don’t have nationally representative income data, except from the India Human Development Surveys (IHDS) of 2005 and 2012. IHDS data shows that the Gini coefficient of income inequality in 2012 was 0.54, having worsened from its 2005 level. This places India among major countries with the worst inequality. But even if we look at official metrics, inequality of consumption expenditure has increased secularly since 1993, reaching a peak in 2011-12. There are no comparable income/consumption surveys after that. On the other hand, tax data from the World Inequality Database (WID) suggests that both income and wealth inequality in India are at their highest levels ever since records began.
In 2022-23, 22.6% of all income accrued to the top 1% of the population. On wealth, India’s top 1% accounted for 40.1% of all wealth in the economy. One may quibble about the methodology of WID estimates, but still, multiple trackers indicate that inequality in India remains high and has trended up in the last three decades. It is undisputed that the real wages of casual wage workers in rural areas have either remained stagnant or declined for almost a decade. It is also undisputed that the largest corporations have seen the fastest profit growth in recent years, with a rising number of billionaires. It is equally clear that even better protected regular workers have seen their real incomes decline.
Taxation as a means to redistribute income and wealth is probably as old as governance itself. However, its form and content vary across countries. Even income tax and capital gains tax are redistributive, as these are levied on high-bracket earners and asset owners to fund programmes aimed at uplifting the poor and offering basic necessities such as health, education, nutrition and livelihood support, apart from the usual governance needs like law-and-order. All governments have done it and India’s present administration is no exception. Inheritance and wealth taxes have also been in wide use across the world. While some countries abolished these, including India, which axed its inheritance tax in the mid-1980s and wealth tax in the last decade, the reason was their inefficiency as resource-mobilization tools more than anything else.
Given our own experience, inheritance and wealth taxation may not be the most efficient way to get resources for government spending. But even for other impositions such as income tax, capital gains tax and corporate tax, what matters is the nature, efficiency and progressivity of such taxation. Unlike indirect taxes, taxes on income or capital gains are typically progressive, with the rich expected to pay a higher share than the less well-off. The reality in India, though, is a taxation policy which is too weakly progressive.
The effective tax rate in 2020-21 for large corporations with profits above ₹500 crore was 19%, while those with profits of less than ₹1 crore paid an effective tax rate of 25%. The corporate tax break awarded in 2019 helped companies increase profits even though consumption and private investment hardly witnessed any acceleration.
For a country with significant deprivations of nutrition, education and health, and with stagnant incomes for most people, generating resources to subsidize the poor is not a choice, but a necessary instrument of governance. However, despite significant deficits, government spending on essential public services such as education and health remains low, with a real decline over the years. The inability of successive governments to spend adequately on these essential public services is attributable not just to a lack of political will, but also of resources. Our tax-to-GDP ratio is among the lowest among middle- income countries, with almost no increase in the last three decades. This happened despite average economic growth of above 6% annually. An effective tax policy that’s truly progressive in application is necessary to fund essential public services. It is also an effective instrument to create an egalitarian society with equal opportunity for all.
