All India needs is better compliance with existing tax laws.
Ace stock investor Rakesh Jhunjhunwala recently warned against the possibility of reintroduction of wealth tax. There is considerable pressure on governments across the world to address rising income and wealth inequality. The idea of giving income support to the poor in India can be seen in this context. If elected to power, the Congress, for instance, has promised to give Rs 72,000 per year to poor families. The Bharatiya Janata Party has promised to extend the PM-Kisan programme to all farmers. Clearly, all of this will have fiscal implications. So, is wealth tax an option to raise resources? It can be argued that it will not only help raise resources but also reduce inequality.
Here is what it means and why it will not help.
Taxing the stock wealth
As the name suggests, wealth tax is a tax on the stock of wealth. This is different from income tax, which is collected from the income of an individual or a firm in a given year. In the US, Elizabeth Warren, who intends to run against President Donald Trump in 2020, has proposed a wealth tax of 0.1 percent for people with assets over $50 million. The idea behind such a tax is that wealth tends to create more income which increases inequality. As the celebrated economist Thomas Piketty has argued: “…past wealth tends to dominate new wealth, rentiers tend to dominate labor income earners, and inheritance flows are large relative to national income.” Many believe that wealth tax can be used to bridge the income gap in society.
Wealth tax in India
The government of India imposed wealth tax in the late 1950s and abolished it in 2016. Before the abolition, a tax was imposed at a rate of 1 percent on net wealth in excess of Rs 30,00,000. However, it didn’t help the government in any significant manner. While announcing its abolition, Finance Minister Arun Jaitley in his budget speech in 2015 noted that the total collection was only Rs 1,008 crore in 2013-14. Wealth tax was replaced by an additional surcharge on taxable income in excess of Rs 1 crore.
Is India an exception in abolishing the wealth tax?
India is not an exception. A number of other countries have also abolished it. A 2018 report by Organisation for Economic Co-operation and Development (OECD) showed that among its members, the number of countries that levied wealth tax came down from 12 in 1990 to 4 in 2017. Only France, Norway, Spain, and Switzerland had a wealth tax in 2017.
Similar to the Indian experience, revenue generated by wealth tax is fairly low. In 2016, revenue collection in Spain, for example, was 0.2 percent of gross domestic product (GDP) and wealth tax was worth 1 percent of GDP in Switzerland. However, in Switzerland wealth tax is used as a substitute for property tax. It perhaps makes sense to have a wealth tax in countries that are not able to tax returns on capital.
Why a wealth tax is not very popular?
It has multiple problems. For instance, it is difficult to administer and yields very little revenue. Besides, as the above-mentioned OECD report concluded: “While there are important similarities between personal capital income taxes and net wealth taxes, the report shows that net wealth taxes tend to be more distortive and less equitable.” This is primarily because the tax will have to be paid, irrespective of the income from assets. For example, if an individual owns shares worth Rs 1 crore, she will need to pay the tax on the holding even if there is no income from it during the year. In fact, shares might have to be sold just to pay the wealth tax.
Further, as the OCED notes, it could encourage borrowing. Since wealth is taxed at the net level (assets minus loans), people would be encouraged to borrow to reduce tax liability. Excessive borrowing may not always benefit the society. Also, it could encourage speculative and risky investments as wealth is taxed at a flat rate, irrespective of returns. For example, conservative debt investors would be paying disproportionately higher tax as a percentage of returns compared to equity investors.
In this context, the International Monetary Fund in its Fiscal Monitor (October 2017) noted: “They [taxes on the stock of wealth] are therefore particularly burdensome for investors holding safe assets, while benefiting better-off investors who can afford the risk of higher-yielding portfolios” Therefore, a tax on income from capital is said to be better than a tax on the capital itself.
Should India reconsider its position?Wealth tax was abolished in India as it did not yield a significant amount of revenue. There is no strong reason to believe that it will work now. Wealth tax is a big administrative hassle. It is likely that taxpayers would report a lower value of assets, which can lead to distortions. What India needs is better compliance of existing tax laws. It is correct that India needs more resources, but raising rates or imposing new taxes will not help. These options have been tried before and it only encouraged tax evasion. What is needed is a simple tax structure, backed by strong enforcement capabilities. Imposing wealth tax or raising the rate of income tax will not help.