Taxing the Rich

The Indian rich class isn't paying its fair share of taxes. The time has now come to surprise them. 

Rich in India are  so wealthy that the moniker  'filthy rich' would happily apply here. They are also in the news for all the wrong reasons. The Mallya's floundering Kingfisher Airlines will most probably fly for some time longer thanks to bailouts funded from tax payers' money. A Liquor mafia Ponti Chadha's enormous wealth comes from cornering the liquor distribution in Uttar Pradesh. A recent 'surprise' I-T raid on him yielded a piffling Rs 10 crore or so (Chadha reportedly has mock 'raids' regularly conducted on his residences to see how fast evidence can be removed).
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. 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. 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.
It's clear that a very small number of people have really enjoyed the fruits of economic reforms. The poor, meanwhile, climb over the poverty line at a snail's pace of one per cent a year. Prof Arun Kumar, an expert on India's 'black' or tax-free market, says “India's wealthy have grown both in size and prosperity. They can afford higher rates and do without exemptions”.
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. 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. 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. 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 is the only way to wind up with a surplus down the line. 
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.
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 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.