As the clock is ticking, the final pieces of the jigsaw puzzle of the Indian budget are being put in place. The finance minister promises that the red lines on fiscal prudence would not be crossed and a responsible budget would be presented.
Undoubtedly, the budget will set the stage for economic developments in the coming year. The finance minister candidly admits that for reviving growth, the ball is in the government’s court. What remains to be seen is how the government plans to achieve its objective of reviving growth. But, a question that continues to be more debated is: will the rich be taxed more?
Inheritance tax and higher rate of tax for the “super rich” are being hotly discussed in the corridors of the finance ministry. C Rangarajan, the chairman of the Prime Minister’s economic advisory council, tabled the idea. Rangarajan has found support in Azim Premji, the chairman of Wipro, who said that there was merit in the idea of having a higher marginal tax rate for the “very, very wealthy”. One hears that the government is seriously considering it.
Higher tax on the super rich looks like an idea borrowed from the developed world, which is trying to beat its rising fiscal deficit with increased taxes on the rich. Unlike US where rich have been taxed and France which is also planning to tax reach, we are a developing economy and need to do a meaningful evaluation of the proposal before changing the rate of tax in haste.
In the past, India has witnessed higher tax rates and that did not help strengthen our fiscal health. Empirical evidence suggests that the direct tax-to-GDP ratio goes up when tax rates are slashed. Higher taxes on the super rich may deteriorate investor sentiment and hamper capital formation. It may be all the more counterproductive in a country that is trying to achieve a high savings rate and higher investment levels. Instead, India needs to make policies that promote investment and economic activities.
When we talk about a higher rate of tax for the super rich, it is imperative that we compare the absolute tax rates to the effective tax rates (the tax payable as a percentage of income). India has a lower maximum marginal rate as compared with the US and the UK. But this maximum marginal rate of tax of 30.9% kicks off at a much lower threshold income (Rs.10 lakh) in India. Any increase in the rate of tax must be at a substantially high level of income such that it is truly the “super rich” who pay higher taxes.
A random change in tax rates without defining the type of super rich that are being considered may also be counterproductive. The definition of super rich is not clear. We are well aware that super rich in the agricultural sector still live off others and don’t pay taxes because agricultural income is exempt from tax. Taxing the agricultural super rich would be a welcome step towards making them pay their way.
Also, the number of declared wealthy taxpayers is too small to make a substantial difference to the country’s fiscal health. With nearly 35 million taxpayers, only 1.7 million declare income over Rs.10 lakh. Nearly 89% of tax paying population is below the Rs.5 lakh threshold. Additionally, taxpayers with income above Rs.20 lakhs already contribute 63% of the tax collections. Taxing this rich more may not be the optimal policy to substantially increase revenues.
To garner additional revenues, it is more important to widen the tax base and improve compliance. Last year, as per an estimate, less than 3% of the country’s population filed their tax returns. A large section of the Indian society is thriving on the parallel black economy. Tax administration and processes need to be overhauled to identify tax evaders and severely punish them. A well spread tax information network must be created to track tax evasion. The government should take steps to encourage better tax compliance. Implementing the goods and services tax will create a unified base for taxing purposes and improve compliance as well.
Indeed, one must look at both sides of the coin before making any decision on taxing the rich at a higher rate. The author advocates a better tax regulatory framework, increased tax compliance and more steps to promote investor confidence. Taxing those who anyway pay taxes will not make up for those who don’t pay taxes. Moreover, India needs to send out a positive signal with its policies to improve its growth trajectory. However, what the finance minister decides remains to be seen, but the promise of “fiscal prudence” keeps the hope of a ‘responsible budget alive.