Is raising taxes for the rich justified?

P Chidambaram has proposed to raise taxes for the rich

Finance Minister P Chidambaram is almost certainly expected to raise taxes for the rich in the upcoming annual budget but can it really help India’s financial position? Is it the right way to manage a ballooning fiscal deficit? Or are we misty eyed with the hermits of morality attached to the idea that taxing the rich in effect is helping the poor?

At the outset, how do we define the ‘very rich’ in India? Are people earning more than Rs 20 lakhs a year considered rich? Or are we talking of taxing the poster boys of India’s family-owned conglomerates?

Some questions ought to be raised:

One, can taxing India’s rich cut our large fiscal deficit? Can the top 100 of the highest paid chief executives bridge the gap?

If it’s about salaries, remember many CEOs and owners are already reducing that form of compensation to one mixed with variable pay, profit-led returns and shareholding. Escaping tax on items outside of salary is a matter of financial jugglery.

Should it then be an inheritance tax? For example, should the son of an Indian billionaire be taxed because of the wealth he inherits from his father? Aren’t there ways around this if it is implemented? Mukesh Butani of BMR Legal Services says taxing non-productive assets (like a chunk of shares inherited) is one time and can never be material enough for the government collection whereas taxing productive assets (such as corporate jets, yachts etc) comes over lapping with the wealth tax. India already has a wealth tax of 2 percent.

“To just pluck a western idea and expect it to work in a country like India is wishful thinking,” suggests Mukesh Butani. Some CEOs have already gone on record to say there is no point comparing tax rates in India with other parts of Europe where there is no growth.

Two, Indian entrepreneurs are already crying hoarse about a tough environment for doing business. Any such move to tax the rich will surely invite a backlash. Adi Godrej has gone on record to say, “We have all seen how low India’s growth rates were when tax rates were high.” Expect more under-invoicing, evasion, round tripping of funds or what’s commonly called hawala in India.

Three, if we tax the rich at home are we not forcing them to park their money outside India in tax havens? Nothing’s new about India’s top business promoters using other countries such as Mauritius, Dubai or Switzerland to park their wealth. Often executives and owners travel enough to cover up the minimum days of staying overseas and then avail benefits of being a non-resident Indian.

Four, India’s tax to GDP ratio has been lopsided for a long time. There is a need to bring more people into the tax net and thereon improve the amount of tax collected. Shouldn’t that be a priority? Mukesh Butani makes the point that “without qualitative changes in tax widening, any tax on the rich can’t be effective beyond a point.”

Five, what does this move do to the perception? The Finance Minister has been on road shows recently talking of the stability of tax structures in India. Isn’t a tax like this going to interfere with the stability? Sources tell Tehelka that Inheritance Tax was part of the original Direct Tax Code as envisaged under the former Finance Minister Pranab Mukherjee but at the last minute the chapter was removed fearing criticism. On the other hand, it’s a proposal lying ready, so it’s just as easy for Chidambaram to place that chapter back should he want to crack the whip.

On the flipside, the argument is that a rich tax makes us ‘look like’ a society committed to equity and inclusive growth. My hunch is that, logic isn’t going to work in a country where the per capita is a distant $1700 (as per Credit Suisse report) from the rich. Until we become a nation that has a reasonably fat layer of the middle income rich kind, we will not be able to avail serious tax collections off this proposed tax.

Critics of this argument would call Chidambaram’s suggestion populism put on a plate. Given the outrage in the country around corruption, the global spotlight on the Anna Hazare movement and most important of them all, the elections where the recent Congress ‘Chintan Shivir’ proposed to move away from ‘elitism’, all point towards where the ‘tax rich’ theme may have its origins.

Many would agree that the display of wealth must be abridged. Harsh Mariwala who runs consumer giant Marico didn’t specifically comment on a potential tax but maintains that India Inc has a long way to go in terms of portraying personal austerity. Azim Premji too recently justified the idea to tax the rich but wasn’t sure of how the government could go about it.

No doubt, India needs to sort out the fiscal mess and have a more equitable distribution of wealth. But a tax on the rich may not solve any of these problems in perpetuity.