On Inheritance Tax

Source-This post on Bad ideas in taxation has been created based on the article “What makes wealth and inheritance taxes bad for India’s economic progress” published in “Business Standards” on 29 April 2024.

UPSC Syllabus- GS Paper 3 – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context– The article warns against popular demands for advancing wealth redistribution in India, that is taking wealth from the rich and giving it to the poor. According to the author, it could lead to sustained poverty and economic failure.

The mechanism to ensure this redistribution is levying Wealth tax and inheritance tax. However, these have not been very helpful in reducing poverty. They’ve already been tested in India before and hence shouldn’t be brought back. On Inheritance Tax

What are the arguments against imposition of wealth and inheritance tax in India?

1) Complexity in tax collection-In India, there was an estate duty from 1953 to 1985, with rates as high as 85%, but it wasn’t collected much. Taxes on estates or inheritances are common in many advanced economies, but they contribute only 0.5% of tax revenues on average in OECD countries. However, collecting this small amount requires complex procedures, thus it is not economical.

2) Negligible tax revenue– Wealth tax was introduced in India in 1957.However, it has only brought in Rs 800 crore by 2012-13. Thus, it was scrapped in 2015. Wealth tax exists in four OECD countries but doesn’t bring in much tax revenue there either.

3) Diversion of focus– Imposing these taxes lead to a loss of focus on the core business of establishing a sensible tax system in India. Furthermore, tax administration in India lacks fairness, adherence to the rule of law, and suffers from the arbitrary power of tax officials.

4) Disincentive to work hard-The first response to more taxation is to work less. If wealth and inheritance are penalized, people will work less hard to create wealth. This is harmful for the country.

5) Incentivize tax avoidance strategies– People may rearrange their affairs to pay fewer taxes. Instead of leaving assets in a will, they may give them to chosen heirs while alive. This changes behavior and makes it harder for the government to collect taxes. Some parents may prefer to keep updating their wills instead of giving assets to their children early to avoid taxes.

6) Relocation of business activities-It leads to relocation of business activity to friendly jurisdictions such as Dubai, Sri Lanka, Cayman Islands, Singapore, or Ireland. This hampers tax revenues.

A detailed article on Inheritance Tax in India can be read here.

What should be the way forward?

There should be more emphasis on growth rather than wealth redistribution because sustained economic growth is crucial for poverty reduction. The author suggests focusing on raising the median income instead of redistributing wealth, as wealth redistribution might slow down economic growth.

Question for practice

What are the arguments against imposition of wealth and inheritance tax in India?