The Indian stock market suffered its worst July in 17 years, prompting the government to roll back the surcharge levied on the super-rich in the federal budget announced on July 5. The grandstanding rhetoric of taking from the rich and giving to the poor saw the finance minister decree an increase in the marginal tax on earnings of more than 20 million rupees (US$276,800) per annum. This was the fourth increase in the surcharge on the super-rich since it was temporarily introduced in 2013. This coercive redistribution of income through a higher tax on the wealthy would have made India's super-rich one of the most taxed in the world, with 42.7% taxation if their annual income went beyond 50 million rupees.
The misguided announcement turned out to be the last blow to an already sluggish economy evident from the unprecedented investment exodus of more than 205 billion rupees since the budget speech in the Lok Sabha, the lower house of the Indian Parliament. The indices saw the market value of Bombay Stock Exchange-listed companies erode about 13,000 billion rupees' worth of capital, a figure more than four times the entire defense budget.
India is hardly the first or only country to adopt high taxation on the super-rich. Flush elites in many countries including the US and Canada are also onerously taxed in the name of welfare. The collected taxes are then repurposed for subsidies to health care, education, and social security such as unemployment allowances among others. The irony is that India does neither fair taxation nor reliable social services.
All taxes have a distorting effect on economic activity. While a tax on capital gains causes people to invest less, a higher tax on income disincentives people from working harder than they would have if they simply followed the standard market forces of supply and demand. In short, any time you tax something people do, or anything that is produced by things that people do, then people are going to do less of that thing.
Historically, every time the government has increased taxes, people have come up with inspired ways to evade them. The surcharge, if continued, would have encouraged "round-tripping," where substantial sums of money leave the country only to return while dodging taxes along the way. Such funds may exit through payments and deals with shell companies, hawala, etc, only to re-enter India swiftly, making this a very expensive parlor trick for the economy. This encourages thievery and wastes the resources of the businessmen who figure out ways to evade the restrictions, and of bureaucrats who endlessly try to plug loopholes.
All taxes have a distorting effect on economic activity. While a tax on capital gains causes people to invest less, a higher tax on income disincentives people from working harder than they would have if they simply followed the standard market forces of supply and demand
Apropos to the announcement in the July 2019 budget, individuals and trusts earning between 20 million and 50 million rupees would have paid a 25% surcharge, and for income above 50 million rupees, the surcharge would have been 37%, pushing the new maximum marginal rate of taxation to 39% and 42.7% respectively. The higher taxation also affected nearly 40% of foreign portfolio investors (FPIs) operating in India under a non-corporate structure and as trusts.
The government according to its own estimates would have earned about 27.24 billion rupees from this additional surcharge, a mere 0.48% of the total 5.69 trillion rupees expected in the fiscal year 2019-20, in personal income tax. Given this low projection, was a tax shakedown that puts investors at flight risk worth it? Is a rollback on the surcharge after 205 billion rupees have exited the country too little too late? Such uncertainty in taxation makes India a volatile place to invest. This breach of trust with foreign investors is likely to accrue more incremental losses over time.
Such policies are not expected from the government that abolished the wealth tax in the 2015 budget, in the name of ease of doing business and simplification of tax procedures. "Should a tax which leads to the high cost of collection and a low yield be continued or should it be replaced with a low-cost and higher-yield tax?" remarked the finance minister at the time, Arun Jaitley. Backpedaling on such measures, the current government's proposed increase in the surcharge was a poor response to an already slow economy.
Milton Friedman, Nobel laureate economist and seminal author, once stated: "There's a sense in which all taxes are antagonistic to free enterprise, and yet we need taxes. So the question is which are the least bad taxes?" Is it time for the Indian government to take cognizance of other equitable forms of taxation?
If the aim is to increase the tax base while reducing the taxes levied, the government needs to embrace the not so popular but much-needed taxation on agriculture and education. Taxing just 4% of the super-rich farmers with the largest farm holdings in the country, at 30% of their income, the government would amass an additional 250 billion rupees in taxes. Education is another sector that needs to be treated at par with other industries, with edupreneurs paying honest taxes for honest income. Is it time to free up these sectors and expand the tax base, or should a surcharge – a tax on tax – be allowed systemically to pillage only the rich?
Because of a communication mix-up, this article was published previously under an incorrect byline. Asia Times apologizes for the error.