What Is Thy True Worth?

So shouldn’t these two gentlemen pay higher taxes than, say, the senior executives in their vast business empires? At a broader level, isn’t it time that India’s super-rich contribute a fair share to tax revenues (just last week finance minister Pranab Mukherjee admitted they needed to grow faster)? Two decades after liberalisation, this question is being asked with increasing frequency, within government, by economists, tax experts and social commentators. Many are convinced wealthy people and corporations need to be taxed more, plus several say they should also lose the big tax breaks.

Last year, former FM P. Chidambaram suggested that the wealthy be asked to shell out more. Some of our leading tax economists have made a case for reintroducing an estate tax (on the value of all assets a person held at the time of his/her death). There’s increasing talk of stepping up surveillance on goods and services consumed by the wealthy. These demands are backed by strong arguments, political, economic and moral ones. It’s no coincidence that this sentiment comes after a wave of public anger at corruption driven by some large companies and, obviously, very wealthy people.

“Yes, there is a need for governments to tax the rich more than they do,” says Deepak Nayyar, economist and former chief economic advisor to the government. “Typically, tax rates on the super-rich are low. It’s just as true in India as in the US. As Warren Buffett rightly put it, tax as a proportion of income is much lower for him than for his secretary!”

The growing wealth and power of India’s richest is more than apparent. The top one per cent—a mere 12 million people or so—accounted for 5 per cent of the national income in 1980. In ’05, this share went up to 12.5 per cent; and was pegged at about 15 per cent in 2010.

India’s situation mirrors a similar rise in inequalities in many countries, from the US, UK, Germany, France, Mexico, China and so on. Many major economies—notably the US, France, and Spain—are looking at ways to tax the super-rich. Americans, for instance, are growing increasingly frustrated with their tax system. A Pew Research Center ‘People & the Press’ survey in December found that the frustration is driven not by their own tax dues, but the perception that the rich aren’t paying their fair share.

Alan Viard, resident scholar at the American Enterprise Institute, says, “The increase in inequality the US and other countries have experienced during the last few decades spurs concern about fairness in taxation.” US President Barack Obama wants to raise taxes on those making more than $2,50,000 a year by letting the tax cuts instituted for them by George W. Bush expire. He opposes eliminating the estate tax, but would like to increase the exemption level to $5 million and lower the top rate to 35 per cent. And he wants to put in place the ‘Buffett tax’ to ensure that those who make more than $1 million pay their fair share.

But by what yardstick should India’s elite class be taxed? Should it be a higher slab of income tax (say 40 per cent) for the super-rich? Or is there a case for an estate tax, which was discontinued in pre-liberalisation 1985 due to poor collections and loopholes? Some experts have also pointed at increasing the scope of the wealth tax (today’s one per cent earned a measly Rs 635 crore in 2010) and the obvious issue of fewer tax exemptions to the wealthy and corporations.

It’s not like there’s a consensus on the prescriptions. In fact, taxes on the wealthy are so highly contested that debating points are added up even to identify just who the rich are. Besides, there’s an implicit threat: what if you tax too much and entrepreneurs shut shop? Or what if a loophole—like charitable trusts, for instance—are employed to evade taxation? And then, of course, there’s the fear of increasing black money in an economy that already has so much of it. Any change in the taxation policy would have to take all these concerns to mind.

Nita Ambani, left, Anuradha Mahindra and Parmeshwar Godrej at a polo match. (Photograph by Fotocorp, From Outlook, March 05, 2011)

Increasing the rates would also run contrary to the core tenet of Manmohanomics: increase ‘base’ or number of taxpayers, reduce tax rates. This is what India has been doing since the ’90s. Is it now time to relook this taxation tenet?

“So far, there’s no evidence to show this (approach) hasn’t worked,” says Dr Arvind Virmani, executive director, India, IMF, and ex-chief economic advisor in the finance ministry. “Often, there are demands for higher taxes on a section of people or industry, when really what you need is a policy intervention to sort out a more fundamental problem.” The argument here is that as the economy grows, the value of many things may increase, but if the value of some things (like land) spiral out of control, something must be wrong. But is tax the answer? “A tax in such situations will penalise people who did nothing to elevate the value of, say, the only home they own. That’s not the way to go. The answer is to supply more land so that prices come down—a policy response, not a tax one,” Virmani says.

But experts find plenty on this front to fault with in India’s taxation policies. Like many Indians pay a much higher average rate of tax on earned income than on unearned income (which is taxed at lower rates as there are too many exemptions and deductions). Several experts Outlook spoke to—including Thermax’s Anu Aga, Biocon’s Kiran Mazumdar and journalist P. Sainath—acknowledge that this must change. “For instance, why should capital gains on investments in equity, or dividend income, get a tax break at all? This is the government’s way of encouraging speculation among the wealthy,” says Sainath.

The finance ministry’s statement of ‘revenue foregone’, published with the budget since 2007, details all tax concessions. Last budget, it said corporate income-tax breaks were roughly Rs 88,000 crore. These should be tackled. Personal income-tax breaks were huge too—33 per cent of the said proceeds. Despite these exemptions, all the experts agree that a higher percentage of tax within the economy (what economists call ‘tax-GDP ratio’) is the only way to wind up with a surplus down the line. (At 17 per cent, India’s tax-GDP ratio compares poorly with UK’s 34, US’s 24 and Germany’s 37 per cent.)

The problem is those who don’t pay (income) tax are everywhere. Only 3 per cent actually do, and that includes the self-employed, professionals and businessmen. Income from agriculture is constitutionally tax-free. Worse, there’s no denying the system is unfair. Those who earn more than Rs 8 lakh a year are taxed at the highest rate—roughly 30 per cent—same as an ultra-rich Ambani. There are numerous opportunities to evade paying taxes. Businessmen can conceal income as ‘cost’ of doing business, cutting their personal tax liability. The salaried have no such luck. Their tax is deducted before the paycheck arrives.

One way, perhaps, to effectively tax the rich is to consider an estate tax, a topic that has been coming up among India’s taxation experts in recent months. This tax—on the value of a person’s estate, subject to a threshold limit—is present in many major economies the world over. In an interview to Outlook last year, leading tax economist Vijay Kelkar had advocated Rs 50 crore as a threshold limit—others feel even Rs 20 crore would be a good staring point. Dr Ajit Ranade, chief economist and head of research, Birla Group, agrees that estate tax is the “big one” India doesn’t have.

An earlier experiment with estate tax had failed—it was complex, had a low base, the tax burden was too high. But in post-liberalisation India, experts agree the pickings could be enormous. “It can be huge. High-value properties worth hundreds of crores are scattered across the country, constantly changing hands,” says Nitin Baijal, director, bmr Advisors.

But the worry, of course, is that any new tax means a new tax administration to track each transaction. And there are the potential ‘loopholes’. “Now you’re entering the zone where we ride into the cloak-and-dagger 1970s era,” cautions Surjit Singh Bhalla, managing director, Oxus Research and Investments. He says there is scope to raise tax revenue, but largely through indirect, professional and service taxes. On another front, factor in the massive exemptions—Rs 5.3 lakh crore ($10 billion) last year—and the effective tax rate on wealthy companies distills to something like 22.2 per cent. Corporate watchers admit that concessions, though time-bound when introduced, tend to stick around forever.

So, finally, if very few pay taxes, evasion is relatively easy and exemptions linger on, how can India tax the wealthy more? Well, whether the super-rich like it or not, the search for answers has begun.

Pro-view
Reduce Corporate Tax Exemptions
Pranab Bardhan | Prof of Economics, Berkeley

When you talk about the burden of taxes in India being borne by only 3 per cent of the population, you are mainly talking of direct taxes. In fact, the entire general population bears the burden of indirect taxes which are levied in the form of sales taxes, different kinds of value-added tax as well as other taxes. I think that there is a lot of scope for increasing taxes on the wealthy in India. Most economists would accept that such taxes can be a major instrument of reducing inequality, but they are often worried about high marginal tax rates inducing large tax evasion. Yet, I think the government could first somewhat raise the rates of capital gains tax in India. Second, the government could impose gift and inheritance taxes and third, it can impose taxes on the large gains coming from the increasing value of land, particularly in urban and semi-urban areas. And, fourth, the government could reduce the large tax exemptions the corporate sector currently enjoys in various forms. It should be kept in mind that the tax-GDP ratio in India is lower than in many other developing countries.

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Con view
Why More, When Tax Money Is Wasted
Anu Aga | ex-chairman, Thermax India

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Our view
We Need Egalitarian Capitalism
Sunit Arora | Business Editor, Outlook

Een if you don’t think you’re that rich, nothing can stop a tax whose time has come. For a society that has witnessed tremendous prosperity over the past two decades, now is an excellent time to debate how to redistribute wealth. Not by force and fear, but in a clear-headed and fair manner. This is not Leftist claptrap or a way to take us back to the bad old days of 97 per cent tax rates. Major economies over the world are making capitalism more effective—and egalitarian. So should we. It’s also not a passing fad; in the UK, the idea behind estate tax is at least a couple of centuries old. In India, the sense of entitlement—be it money, land, privileges, tax exemptions—is deep-rooted. People hold on to their wealth. This is often driven by insecurity and helped by governments. That’s why we need to tackle this in a focused—and transparent—manner. Go after the really big fish (and don’t target taxpayers who have become ‘wealthy’ in the normal course). The question to be asked is, do we want India to be an emerging economy that debates pressing issues and amends course when needed. Or do we want to be like Russia?

And In The Donor Column We Have...
A lowdown on our Richie Rich sweepstakes and how they can be made to cough up a bit more for the greater good

Who are India’s super-rich?

• Billionaires 55 people worth over Rs 4,500 crore ($1 bn) each.
• Ultra-Rich 70,000 households worth over Rs 25 crore ($5 million) each.
• Globally Rich 1,70,000 people worth over Rs 4.5 crore ($1mn) each.
• Well-off Rich 4.5 million households with $100,000 (Rs. 45 lakh) annual income.
• Black Economy Those circulating a chunk of the Rs 35 lakh cr black money in India.
• Total number of rich Anywhere from 10-20 million people—they are the top 1.9% of the population.

Why should they be taxed more?

• Economics India is poor and the tax/GDP ratio is low. There’s scope for taxes to be increased on those who can afford to pay.
• Society Fast-growing India has seen the rise of fantastic inequality; taxes can bridge the gap between haves, have-nots.
• Global Like millionaires and billionaires abroad, Indian business can volunteer to contribute a higher share as tax.
• Politics A host of exemptions and tax breaks for the wealthy distort the markets, jeopardise government credibility.

Are you rich? You are if you...

• Buy watches, pens over Rs 1 lakh, jewellery over Rs 5 lakh, gizmos over Rs 5 lakh, cars over Rs 23 lakh, bikes over Rs 12 lakh.
• Go for holiday packages over Rs 10 lakh, or for a destination wedding; yachts and choppers (even on lease).
• Give over Rs 5 crore to charity, a temple, educational foundation. Have expensive hobbies like sailing, polo, flying, car-racing.
• Have more than a couple of properties in your name, and have bought land/property/
  plantations abroad.
• Spend more than Rs 20 lakh ($20,000) a year on educating your children and have large investments in art and equity.

How can the rich be taxed more?

• Income tax Have a higher tax rate for the super-rich, say 40% instead of the current 30%, the maximum personal tax rate.
• Estate tax Tax on the value of assets of a rich person (above a threshold limit) when he/she dies. Exists in many countries.
• Unearned Income Dividend income is tax-free, as is long-term capital gains on equity sale, huge benefits for the wealthy.
• Wealth tax Currently 1% on income above Rs 30 lakh, generated just Rs 635 crore in 2010-11. Is being redefined.
• Exemptions Removing them for the rich/corporations would generate huge amounts of
  revenues.

How the world taxes super-rich

• Estate tax exists in many countries like Japan (70%), South Korea (50%), US (46%), France and UK (40%).
• Austerity budgets in France and Italy recently imposed 3% surcharges on incomes of the super-rich.
• The US plans to introduce a Buffet rule to ensure rich households pay more tax than middle-class families.

What the extra tax will do

• Current income-tax proceeds are a mammoth Rs 1.7 lakh crore*.
• Corporate exemptions led to Rs 88,263 crore of revenue foregone in 2010-11.
• A 5% ‘wealth’ tax on 1/5th of a person’s annual income of Rs 5 crore ($1 mn) will generate approx Rs 50,000 crore a year** (the annual expense on nrega).

*Including surcharge and cess

** Assumption = no exemptions

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By Pragya Singh with Ashish Sen in Washington