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Taxing the rich: Reality cheque
Some countries are hiking taxes on HNIs to get out of their fiscal holes. Yet others, such as the UK, are beginning to realise its pitfalls. With India considering a similar move, TOI-Crest looks at both sides of the debate.
In recent times, high net-worth individuals (HNIs) are under the harsh glare of the taxman the world over. At home, finance minister P Chidambaram appears to be testing the waters for the possible imposition of higher taxes on HNIs. Reintroduction of estate duties (also known as inheritance tax or death tax) also appears to be on his radar. These topics were discussed by him during a pre-budget meeting with a select group of economists. Former RBI governor and current advisor to the government, C Rangarajan, has also backed a higher tax rate for HNIs, as mere expenditure cuts may not help bridge the fiscal deficit.
An Ernst & Young report points out that governments continue to search for ways to boost revenues in a difficult economic environment and one source they are increasingly looking at are HNIs. "From higher tax rates to broader tax bases (read lesser deductions ) and from more scrutiny of returns to more information exchange, globally tax authorities have put wealth under the tax spotlight, " the report states.
While in terms of numbers, the size of the HNI population in any society is minuscule, they already contribute the maximum towards tax revenue. In the US, the top 1% of taxpayers account for nearly 40% of income tax collections. In India, the estimated tax collection figures for 2011-12, provided for in the Standing Committee's report on the Direct Tax Code (DTC) Bill show that those in the top tax slab (earning an annual taxable income of more than Rs 10 lakh) contributed an estimated Rs. 1, 11, 087 crore or 75% of the total income tax collections (see box).
"Clamping down on HNIs is often a politically expedient way of boosting tax collections - the government's argument being that it is a fair way of dealing with wealth inequality, " adds the Ernst & Young report.
The Fiscal Cliff Bill, passed recently in the US, has increased the tax rate to 39. 6% for individuals earning more than $ 400, 000 (Rs 2. 18 crore) annually. In the run up to these discussions President Obama found support from the personalities such as Bill Gates and Warren Buffett. Warren Buffett pointed out that, despite being a billionaire, he pays a lower average tax rate than his secretary.
On the other hand, a more desperate measure in France - of implementing a 75% tax rate, from January 2013, on those earning more than one million euros annually (Rs 72 lakh) - met with strong opposition, with some of its rich and famous threatening to migrate overseas. In late December, France's apex court shot down this tax proposal deeming it to be discriminatory and unconstitutional and it is currently under revision.
In the United Kingdom, individuals with a taxable annual income of pounds 150, 000 (Rs 1. 31 crore) per year pay tax at 50%. After having examined the adverse fallout of such a high rate, come April, this rate will be reduced by 5%.
Many other countries have increased their top tax rates (see table on left). Comparison of these rates is only a rough indicator as various allowances and amenities (many of which are not available in India - such as health care, unemployment benefits), social contributions and local taxes all impact the effective tax rate for an individual.
HNIs IN INDIA
The tax rates in India today are commensurate with those proposed in the DTC Bill. Those earning more than Rs 10 lakh and above pay the maximum marginal tax rate of 30%. Incidentally, a surcharge at 10% on those falling in this bracket was withdrawn from the financial year 2009-10.
It is a well-known principle that lower tax rates result in greater compliance. The Standing Committee, to which the DTC Bill was referred to, had called for greater leeway by modifying the slabs, whereby only those earning more than Rs 20 lakh would fall in the highest tax bracket. With the tax rate being constant at 30%, this suggestion meant a tax saving of Rs 1. 60 lakh for someone earning an annual taxable income of Rs. 25 lakh.
But as the economic climate changed a word of caution came from the Kelkar-led committee on fiscal consolidation, which called for deferring the implementation of DTC as loss of tax revenue was not conducive at this stage.
Understandably, the government has taken remedial steps such as tinkering with LPG subsidies and petrol prices to take care of the fiscal deficit. Its sights now seem to be trained on raising revenues through higher taxes on HNIs.
If HNIs (irrespective of how they would be classified - whether those earning more than several lakhs or crore) are subjected to a higher rate of tax, it is expected that the move will be counter productive.
LESS INCENTIVE FOR WORK
A paper issued by UK's HM Revenue and Customs examined the impact of the 50% rate of tax on taxpayer's behaviour. It points out that a higher tax rate reduces the reward for working (people take more leisure time - also known as the substitution effect). High tax rates also negatively impact entrepreneurship by reducing the incentive to start, finance and grow a business. Migration decisions - such as migrating to countries with more favourable tax regimes or early retirement are also prompted by higher tax rates. The immediate fallout is of course a reduction in spending power with a corresponding hit in indirect tax revenue). Instances of both legitimate tax planning and tax evasion also rise.
Organisation for Economic Cooperation and Development's research also shows that a 10 percentage point increase in the marginal tax rate could reduce annual growth by around a quarter percentage point, which over a medium to long term can be quite significant.
Pulin Nayak, economist and professor at the Delhi school of Economics, agrees: "The current tax rates of 10, 20 and 30% for individuals have been in existence since 97'-98 ' and should continue as they signal stability in the tax regime. Increasing the rate of tax, even if only for HNIs will be counter productive. It will kill the incentive to work, will result in lower investments and thus be detrimental to the economy as a whole. "
Decisions must not be made in a hurry. As Sudhir Kapadia, partner and India tax head, Ernst & Young states: "We saw that some provisions were hastily introduced during last budget resulting in unintended consequences. This should not happen again. Without a proper and independent economic impact analysis to assess the long term economic consequences on GDP, investments and consumption, provisions such as high taxes on HNIs should not be hastily introduced. "
Kapadia feels that if as a last recourse, short-term revenue considerations compel the government to levy, let's say a 10% surcharge on the maximum marginal rate on the 'super rich' there should be a defined time frame for its removal to give certainty to tax payers. "For instance, Portugal has enacted an increase in the top rate of personal income tax only for two years, viz: 2012 and 2013, " he points out.
Higher taxes will also not sent the right signals, globally. London based, Srinivasa Rao, Global Chief Operating Officer (Tax) Ernst & Young sums up: "However well-intentioned, well-conceived and wellaimed, higher taxes on the rich will dampen entrepreneurial sentiment in the short term and diminish economic performance in the medium to long term. At a time when many countries are forced to implement toxic tax proposals to deal with life-threatening fiscal peril, India's minimalism on any fresh taxgathering proposals will only add more strength and shine and eventually higher tax revenues both directly and indirectly. This will bolster the country's strong economic standing."
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