Forbes India – A Case for Inheritance Tax, by Nikhil Kamath

A major cause of high social inequality is the top percentile of the wealthy, who acquire their wealth primarily through inheritance
Image: Shutterstock

On the cold morning of February 1985, then Finance Minister Vishwanath Pratap Singh said in his budget speech: “Inheritance law failed to achieve the dual purpose of reducing the unequal distribution of wealth and to help States fund their development programs. While the inheritance tax yield is only about ₹20 crore, the cost of administration is relatively high. In the third week of March, the inheritance tax was abolished. For more than 30 years before that, inheritance tax was in vogue in India. If you made a lot of money because an old uncle kicked the bucket and left you his wealth, you had to pay inheritance tax on it. This is no longer the case. So what is this tax and what does it involve?

Inheritance tax or inheritance tax is a form of taxation levied on property acquired as part of an inheritance. When a person’s property and assets are transferred to their legal heirs, the latter must pay inheritance tax to inherit the property or assets. Although this is the norm in many countries, India repealed the law in 1985 due to implementation issues. It was riddled with loopholes that allowed unscrupulous people to play with the system and slip through the cracks.

There was a brief attempt to revive taxation, just four years after it was abolished. The Property Rights (Inheritance) Bill 1989 sought to tax property passed on after death. It was widely believed that this act was more practical and achievable than his previous avatar. Even the tax rate, a maximum of 10%, was considered moderate; but Parliament was dissolved and the Bill slipped into obscurity, never to be heard again.

make the case

At first glance, inheritance rights rest on a solid foundation of case law, morality and cold, hard logic. It levels the rules of the game for the ultra-rich heirs and the less fortunate. It is also based on the principles of utilitarian economics, which postulates that an optimal social state can be achieved by redistributing initial endowments. The disparity caused by inherited wealth has been the root of much of the economic inequality we are so used to seeing around us. Inheritance taxation promises to weaken it, if not completely destroy it. Countries like England, France, Germany, the United States and Greece have taxed inherited wealth up to 40%.

The world is realizing the benefits of this type of taxation due to the growing awareness of the extreme disparity that exists. Such high levels of inequality have contributed to a plethora of global crises, not excluding the subprime mortgage crisis of 2008. Andrew G Berg and Jonathan D Ostry, both IMF economists, have demonstrated through their research that if a economy exhibits high levels of inequality, it is unlikely to maintain a high growth trajectory in the future. One of the main causes of this inequality is the top percentile of the wealthy, who acquire their wealth primarily through inheritance. In rapidly developing economies like India, this chasm is even more pronounced.

Need of the Hour: A Resurrection

This level of selective prosperity can be attributed to flawed tax policies conducted over several decades, where the taxation of wealth does not contribute a fair share to the public treasury. There are a few very compelling reasons why inheritance tax should make a comeback in India.

First, it will allow for a more efficient dispersion of wealth. In India, wealthy families from different backgrounds have one thing in common: inherited wealth. This is not only unhealthy from an economic point of view, but also limits social mobility. Proper implementation of inheritance rights can remedy this malaise to a large extent.

Second, this approach to public finance also aligns with the egalitarian ideals enshrined in the Constitution of India. The right to equality is one of the main guarantees of the Constitution, and a fair taxation of wealth is an important step in this direction.

Third, most of India’s tax revenue comes from indirect taxes, which have further intensified on the economically weaker sections. More direct taxes are the need of the hour, and inheritance tax is an important part of that. This can generate a significant amount of revenue for the treasury.

Fourth, through this additional tax revenue, the Indian government would have the freedom to reduce the basic income tax of the economically weaker sections of the country. This could help combat the high barrier to entry to start more businesses.

Up and in front

It has often been asked whether the taxation of the richest could take off differently by reducing investments, capital expenditures and savings which could have a direct impact on the economy. It all depends on the effectiveness of the implementation. In a thriving, forward-looking economy like the United States, the 1975 Taxation Review Committee stated that estate taxation can “support the progressivity of the tax structure through the indirect means of a progressive levy on the wealth once per generation”, which will remove the “undesirable social consequences” of inherited wealth. As India’s wealthy grow at a dizzying rate, this kind of progressive tax structure can go a long way toward ensuring the redistribution of wealth, moving closer to a fairer economic balance, and encouraging more business.

The writer is co-founder, True Beacon and Zerodha

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(This story appears in the January 14, 2022 issue of Forbes India. To visit our archive, click here.)

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