How to deal with rising inequality without appearing anti-wealthy

The solution for a country like India is to lower tax rates, widen the tax net and plug tax loopholes

With marginal propensity to consume of the rich and wealthy being lower than that of poorer households, growing income and wealth inequality caps the growth of private consumption and in turn the growth of private capex and GDP. If unaddressed it can lead to social unrest and political instability.

The top 1 percent of Indians receive nearly 23 percent of the country’s annual national income and hold a staggering 40 percent of the country's wealth, according to The World Inequality Lab. That’s worrying. Therefore, to address this issue, many propose significant increases in effective taxation for wealthy Indians, such as the imposition of inheritance taxes or raising taxes on capital gains and real estate investments.

Trying to tax the rich more is also good politics in a country where a significantly large number of citizens think that the rich have become so by using unfair means such as tax dodging and/or wilful defaults on loans extended by state-owned banks. The likes of Choksis, Mallyas and Modis only help strengthen this perception that the rich and wealthy are crooks. It’s no wonder, Congress Party leader Rahul Gandhi has said that if voted to power, his party would conduct a nationwide survey for redistribution of wealth.

Irrespective of the merits of these proposed solutions, taxing the rich more would disincentivise savings in a country like India where most people save for their children. Besides, many fail to understand that India’s top income tax rate including cess and surcharge is already too high at 40 percent. Thus, raising it further will end up penalising those who pay taxes honestly, and induce others, the non-salaried wealthy, in particular, to hide income and dodge taxes. The solution for a country like India is to lower tax rates, widen the tax net and plug tax loopholes.

Alternative Solutions to Rising Tax

Given the intense global competition to attract the wealthy, high taxes may drive the super-rich to migrate to tax havens. As many as 6500 dollar millionaires are expected to have left India in 2023. This exodus  will lower India’s savings rate and in turn cap investment and GDP growth, at a time net domestic savings are at a five-decade low and FDIs inflows are drying up. That doesn’t mean New Delhi should go easy on crooks and thugs. However, a distinction must be made between wealth earned through legitimate means and wealth acquired through illegitimate or unethical means, and only the latter should be discouraged.

Second, the Indian government has increasingly been relying on indirect taxes which tend to be regressive and aid income inequality. Thus, there is a need for increasing the share of direct taxes in the country’s tax revenue. But achieving that by raising top income tax rates is unadvisable. A better idea would be to cut direct tax rates and widen the tax net by including rich farmers, for instance, under the purview of income taxation. Income tax should apply to all incomes including those from agriculture without any distinction. Keeping it out from the purview from taxation has made it a major instrument of money laundering - conversion of unaccounted cash or bribe money into white money by declaring it as income originating from agriculture. No wonder, the top bureaucrats, film actors and politicians, all claim to be farmers.

Third, taxation of financial and non-financial incomes such as salaried income at different rates also aids inequality of income and wealth. However, India will have to tolerate it for the time being in order to encourage retail participation in financial markets by luring them away from less productive and speculative investments in land and gold.

Four, indexation benefits should be extended to all debt investments including bank deposits as small savers including small businesses and households account for a big chunk of bank deposits, and high and sticky inflation along with high effective tax erodes most of the gains.

Last but not the least, the best way to check inequality of income and wealth is genuinely to help small business entities and first-time entrepreneurs. That will increase market competition and check rent-seeking that aids income inequality. Despite the rhetoric on business facilitation, things on the ground are really difficult. New Delhi must look at the ease of doing business reforms from the perspective of small business operators.

Registering a business has become easy, but closing down a non-viable one is not so. Changing the registered address of an LLP or private limited company from one state to another is a nightmare, irrespective of size or sales turnover, which is difficult to understand. This must change.

It makes sense to extend the benefits of reduction in tax on business profit currently available to corporations only to all businesses, especially LLPs. That will also help in formalisation without being too cumbersome in terms of additional compliance burden. Besides, instead of monthly GST payment and filing, quarterly tax payment and annual tax filing similar to the income tax should be introduced to cut regulatory cholesterol.

Instead of mandatory GST registration, voluntary registration should be encouraged up to an annual sales turnover of Rs 1 crore. However, it may create complications for GST registered businesses when they try to claim input tax credit. This problem can be addressed with the help of "reverse charge mechanism" and hence its use should be encouraged instead of forcing smaller firms to embrace GST.