Originally Published 2013-01-16 00:00:00 Published on Jan 16, 2013
Taxing someone who is earning in crores at a much higher rate than 30 per cent is quite justifiable in terms of equity and it is in accordance with the principle of progressive taxation.
Taxing the rich more
In 2013, it is fashionable to tax the rich because the US and France are contemplating doing so in order to solve their own budgetary problems. While US Senate has approved the idea of taxing the rich at a higher rate in order to overcome the 'fiscal cliff', France's path has not been cleared yet because the 'Conseil Constitutional' has rejected President Francois Hollande's idea of increasing income tax on France's wealthiest to 75 per cent from the current top rate of 46.7 per cent. But Hollande has not given up yet. The high unemployment rate in France calls for higher expenditure on social security and the government is under great pressure to find more financial resources.

In the US, on the other hand, there was a time especially under President Ronald Reagan, when it was believed that lower taxes would bring in higher revenues ( as per the Laffer Curve which states that there is an optimum tax in every country above which people would not pay more and indulge in tax evasion). But even though lower taxes may have worked for some years in the US leading to a period of prosperity, resulting in high savings and investment, it is certainly not the right time now to continue with the same policy. The nascent economic recovery in the US has to be nurtured and it requires more government spending which can only be possible with higher revenue collection. According to many American economists, the rich have benefited from the US economy more than the 'not so rich' and it is argued that they should contribute more. Yet the counter argument is that it is the rich who save and invest and taxing them at a higher rate will lead to less incentive for them to save and invest.

In India, recently the Chairman of Prime Minister's Economic Advisory Council Dr. C. Rangarajan, has proposed that the rich should be made to pay higher taxes. How much is this higher rate albeit surcharge going to be? We do not know right now but in the US it used to be as high as 91 per cent. In India too income tax rates were much higher in the 1970s and 1980s than now. The highest rate in 1974-74 was 97.75 per cent and in the 1980s it was at 66 per cent. After the economic reforms of 1991 there was a gradual scaling down of income tax to around 40 per cent. In subsequent years, taxes have been lowered and the highest tax payers today are paying something like 33 per cent. People earning up to Rs 30 lakhs a year are liable to 30 per cent taxation rate but what about those who are earning much more?

Taxing someone who is earning in crores at a much higher rate than 30 per cent is quite justifiable in terms of equity and it is in accordance with the principle of progressive taxation. Everyone knows that India has many super rich people. Taxing them will definitely give a fillip to revenue collection. As Finance Minister P. Chidambaram said recently there is a need to boost tax collection because though direct tax collection has been satisfactory, indirect tax collections including excise duties are falling and are short of expectation.

Clearly the inspiration for taxing the rich more is not new in today's global environment in which countries are trying to come out of recession through an increase in government spending. In India too there is need for such a boost to the flagging GDP growth. But unfortunately the fiscal position of the government is precarious and the government expenditure has exceeded 80 percent of the budgeted amount already.

To control the fiscal deficit and bring it down to 5.2 per cent, the emphasis has so far been on expenditure control. All kinds of ideas have been floated specially regarding cutting down of subsidies and imposing a strict austerity programme. The government ought to be controlling its own expenditure drastically first especially the travel of ministers/high officials abroad and the lavish treatment given to them by embassies. Also it has to control other conspicuous expenditures on grand events like the CWG and colossal corruption/scams in various government departments. It may however want to defer cutting down subsidies. While there are definitely big leakages in the delivery of these subsidies, corrective steps should be taken to improve the supply of food, fertilizer and fuel to the very poor because even if we do not like these subsidies they do reach the poor and help in poverty alleviation.

Politically, the government's 'unconventional' idea of taxing the rich more will please every one especially if the super rich are taxed and their wealth a bit diminished. The government can go further and reintroduce inheritance tax which will further shrink inherited wealth which may not be such a bad thing as the scions of industrial houses will have to work harder to build back their wealth. Otherwise they would tend to become lazy and do nothing much to improve the family's business. The government may thus take the populist step of rounding up the rich for more taxes but it is unlikely that it will gather a huge amount of resources by taxing the top layer of the super rich at higher rates. This is because there are only around 1.8 million Indian households which have an annual income of Rs 45 lakhs. There are around 200 to 300 million people in the middle class (but according to NCAER there will be 267 million in the middle class in five years' time). The rich farmers are not taxed and many self employed rich entrepreneurs avoid paying taxes. Thus there are people earning a lot more than the current income tax exemption limit Rs 2 lakhs a year and are not paying income tax. Actually only about 3 per cent of the population pays income tax.

Thus while the 'big fish' can be caught in the tax net easily and made to pay higher taxes, the smaller ones that are slipping through it, have yet to be caught. For raising the direct tax revenues, the tax base has to be broader. Otherwise the Black economy of India will not be dented. One of the fallouts of the pervasive Black money in circulation is that the RBI's monetary policy of stemming liquidity in the economy (through hikes in interest rates) has not had much impact and inflation continues to rise unabated.

The government is thus confronted with an impasse of controlling fiscal deficit and inflation when the general elections are less than a year and half away. It knows that if the fiscal deficit is not reduced and there is an increase in public borrowing, inflation will go up. Thus reducing the fiscal deficit by collecting more revenue is a mission that has to be accomplished. The UPA government is also committed to continue with its MNREGA programme, fulfilling the promise of universal education and has to increase the share of GDP allocated to health. It must also increase investment in infrastructure. All such expenditures will be seen favourably by the 'aam admi' and to finance the expenditure, taxing the rich seems to offer the easiest and the shortest cut. But if it is serious about increasing its resources, the government should also bring back Indian money stashed away in Swiss banks.

(The writer is a Senior Fellow at Observer Research Foundation, Delhi)

Courtesy : The Pioneer
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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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