There is, in principle, nothing wrong with richer people paying a bit more in income tax. But when, in her budget speech, Finance Minister Nirmala Sitharaman raised the surcharges on the super-rich, those taxpayers with an annual income of more than Rs 2 crore, it was - like much else with this government - badly thought through. For one, income taxes should be kept simple. P Chidambaram's "dream budget" for the third front government of 1997 simplified India's tax code, reducing the number of different slabs to three. Now, in effect, we have many more slabs - with a top marginal rate of 43 per cent for those with an income of over Rs 5 crore. Simple tax rules and a smaller number of slabs mean that overall tax revenue tends to go up; raising surcharges, creating more and more different categories of taxpayers, is the wrong way to get richer Indians to pay more tax. The government should have had the political courage to raise the tax rate on all the richest taxpayers to, say, 40 per cent, or it should have left well enough alone.
What are the consequences of this poorly designed policy? First, increased evasion. The higher the incentive to evade taxes, the tougher it is to grow the tax base - the number of people who pay taxes. The difference now between the rate of taxation on small companies and that on rich individuals is 18 percentage points. More and more rich individuals could just incorporate small companies, and have their income go instead to these new companies, taxed at the lower rate of 25 per cent.
Second, migration. Richer Indians, spooked by "tax terrorism" and tired of the shortage of investment opportunities in India, are already migrating in droves to cities like Singapore and Dubai or even further afield. These departures will increase. And while I'm sure some of us would like to say "good riddance", it isn't that simple. These are the people that we rely on to push investment and growth, and we need them to have stakes in the domestic economy as residents.
Third, the stock market tanked. The markets are not pleased with the new "rich tax". Which is not because stockbrokers all earn over Rs 5 crore, but because the Finance Ministry either did not examine the actual consequences of the new tax, or did not care. You see, the new tax isn't just on individuals - it will apply, it appears, also to entities like trusts or an arcane formation called an "Association of Persons". These are the ways in which foreign portfolio investors and overseas funds invest in the Indian markets. The tax bureaucrats shrug their shoulders and ask - why not just operate as a company with the 25 per cent tax rate? Well, it is reportedly tougher for overseas funds to do that than it is to set up a random company. I don't know if that's true - but the belief is enough to send many foreign funds scrambling for the door.
Fourth, India looks less attractive as an investment destination. Countries that seek to arbitrarily squeeze foreign investors whenever a bit more government spending is wanted are places investors would prefer to avoid. Yes, India looks attractive in a world that is not growing too fast. But that never lasts forever - at some point, somewhere else will be the story of the day. India should build a reputation for reliability as well as growth.
I want to stress that not all tax changes in this budget were negative for India. For example, the Finance Minister also promised pre-filled income tax forms for low-end taxpayers - with less than Rs 50 lakh in annual income - that summarises their already recorded income from interest and salaries. That's an excellent move.
But it's a shame that not only did the Finance Ministry not properly consider the implications of their new "rich tax", but that even after the negative response, they are refusing to budge. A budget speech is merely a set of proposals to parliament. Proposals can be amended or withdrawn. At the very least, the government should set out to reassure investors, particularly foreign investors, that their path to fairer and lower taxes will be easier than they think. Very little effort has been made in that direction. Indeed, the response of the minister and ministry to criticism of the budget, however mild, has not been encouraging. The job of budget-making is not easy and it requires patience with those who are upset with your proposal. Sometimes, they may have a good point. And, in fact, even if they don't have a good point to make, you might have to listen to them anyway and withdraw your proposal. If Pranab Mukherjee had listened to the outcry about his retrospective tax changes in UPA-II, the country would have been on firmer ground to weather the "taper tantrum" of 2013, and that government's reputation would not have suffered as much as it did.
The oddest part about the "rich tax" is that given its negatives, it is not likely to mobilise much revenue at all. At best, a little over Rs 10,000 crore will be raised - dwarfed by the government's actual needs and by other potential sources of revenue such as privatisation. Was the real desire of the government simply to attack the sources of growing inequality in the country? Surely not, or there would have been a wealth tax or an inheritance tax in the budget instead, as many feared. A wealth tax is a more efficient way of dealing with inequality, after all, if properly structured. I'm left with the conclusion that the government put it in there for political reasons. A budget that otherwise tried to stoke growth and investment had to have some headline "anti-rich" measure to pre-empt criticism. It seems that Modi Sarkar is still sensitive to Rahul Gandhi's "suit-boot" accusation, first made almost five years ago. Rahul has moved on - shouldn't the government as well?
(Mihir Swarup Sharma is a fellow at the Observer Research Foundation.)
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