India’s Conundrum: More Wealth Less Tax Burden

Every budget is preceded by calls for lower top income and corporate tax rates. Some are calling for the complete abolition of the income tax system. Representatives of the corporate sector have combined multiple taxes on income from capital and criticism of excessive tax rates and taxes at the top income level.

Despite the “groundbreaking features” of the income tax system, the tax-to-GDP ratio remains low compared to some developing countries. Besides, few of the richest Indians pay top income tax.

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According to media reports, the list of top taxpayers is dominated by celebrities such as Akshay Kumar, Amitabh Bachchan, Salman Khan and cricketers. This means that wealthy groups do not report the highest incomes, as tax payments are closely tied to income reported to tax authorities.

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wealth and reported income

A recent study explains the paradox that so-called overtaxed wealthy Indians do not pay their highest taxes. less than that. Similarly, wealthy individuals pay relatively less taxes.

For the poorest 5% of individuals and families, reported income is more than five times (500%) their wealth. In contrast, households in the top 1% report only 3-4% of their wealth in gross income. For the richest 0.1%, their reported income is less than 2% of their wealth. For the richest families listed on Forbes, their reported income is just over 0.5% of their wealth.

This means that the wealthy group’s reported income as a percentage of wealth is well below the national average. The total income wealth ratio reported by the top 20% of the wealth pyramid is less than one-third of the national average. The ratio reported by the wealthiest 0.1 centile stratum is slightly above the national average of one-sixth.

nominal taxable income

Things get even worse when reported income is considered “taxable”. People report some of their income as tax exempt. Her wealthiest 1% of her family’s taxable income is only 2% of her wealth. For the Forbes-listed group, taxable income is less than 0.5% of her wealth.

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The same is true for personal property to the value of income reported as taxable. Specifically, the richest Indians are not the same as those reporting the highest incomes. Of her 100 wealthiest individuals in the general election data, only 35% of her reported income levels that belonged to the top 100 income levels in the dataset.

Simply put, Indian billionaires pay very little tax on their wealth, much like Jeff Bezos, Elon Musk and Warren Buffett do in the United States.

In terms of national income accounts, the average rate of return on private capital in India is over 7.2%. You can easily get this kind of return even from a fixed deposit account. Mutual funds and stocks offer much higher returns. Return on average equity tends to be much higher, typically he’s over 15%.

equity factor

Since stocks have a dominant share of the wealthy group’s asset portfolio, capital income must be at least 10% of assets, even after taking corporate taxes into account. This reasoning is further evidenced by the fact that average GDP growth over the past two decades has exceeded his 6%. Historically, the return on capital has been several percentage points higher than the growth rate.

Simply put, ignoring the labor income earned by India’s richest group, their total income should be at least one-tenth of their wealth simply because of their capital income. But their reported income levels are surprisingly low, less than 1/100th of their wealth. A question arises here. What explains the smaller share of income reported by the top group of wealthy people?

The answer lies in the tax system that applies to capital income, where unrealized capital gains are not taxable and need not be reported on your tax return. This means that wealthy groups have strong incentives to avoid realizing capital gains in order to reduce their tax liability. doing. This is the main reason why realized capital gains each year represent only a small fraction of the return on capital held by the wealthy.

Dividend

Guided by similar considerations, wealthy groups minimize dividend payments — they minimize the distribution of profits among shareholders. Profits distributed as dividends are reported as personal income Because it is necessary to do so, the recipient becomes liable for tax.

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In contrast, reinvested earnings translate into greater returns for shareholders. One is to give shareholders huge tax-free capital gains by reducing their tax liability while boosting the value of their shares. Naturally, corporate tycoons want to keep their dividend payments as low as possible in order to reinvest most of their profits in their group companies. As CEOs, members of the Board of Directors, or promoters of group companies, they decide whether and how much profits will be distributed as dividends. In other words, the incentives to keep income in company accounts are underpinned by the powers they enjoy in the corporate governance hierarchy.

In fact, dividend payments by Indian companies are paltry compared to many other countries. The average dividend yield for the top 100 privately held publicly traded companies is just 0.85% of the value of their equity assets. Forbes-listed family-controlled companies have even lower dividend yields.

Deliberately subdued dividend yields are one of the main reasons why reported equity income is a small fraction of the wealthy group’s actual equity income. In addition to this, some of the dividend income may be received indirectly in accounts of financial intermediaries such as limited partnerships and kept away from personal accounts.

capital income

Due to such creative accounting treatments, only a small fraction of the wealthy group’s actual capital income is reported. In contrast, a significant proportion of the return from their capital income is lost from personal income reported to tax authorities.

Interestingly, unlike the average Indian, whose wages and salaries are determined by market conditions, the wealthy group can choose their labor income. Media reports abound of wealthy groups freezing the salaries, perks, benefits and commissions they receive from their group companies each year. Such decisions may seem charitable, but they are part of the wealthy’ tax-saving strategy.

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Business moguls pay themselves too little, in contrast to banking sector CEOs and their bankers who are notorious for demanding high salaries. If the wealthy can receive more salaries and dividends, the burden on the average taxpayer will be less and the tax-to-GDP ratio will improve.

tax strategy

The wealthy’s tax control strategy makes the direct tax system regressive. The study above shows that at the top wealth levels, the wealthier the taxpayer, the smaller the tax liability relative to the wealth. Even ignoring salaries and consultant fees received by the wealthy group, the average tax paid by the richest 5% is less than one-fifth of his capital income. The tax liability of the top 0.1 centile is less than one-tenth of their income. The tax liability of the ultra-rich Indians is smaller than the relative tax liability of the middle-rich/

Indeed, some of the wealthy group’s income is taxed multiple times. However, this is a small portion of their total income. Their remaining income is held in company accounts as undistributed earnings and is taxed at a much lower rate than the highest rate applicable to salaried workers. No matter how you look at this issue, wealthy Indians are not overburdened.

We must recognize that risky investments by wealthy groups are important to the growth and prosperity of the country and need to be rewarded for it.

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But lowering tax rates is not the way forward. A good-for-investment growth strategy should reduce the regulatory burden on companies, allocate a higher proportion of tax revenues to fund capital expenditures, and improve economic and legal infrastructure.

In addition, Budget 2023-24 will allow the Treasurer to streamline and standardize capital gains tax rules by streamlining holding periods and harmonizing tax rates across different asset classes. These measures are in line with the government’s agenda to make taxation more citizen-friendly and will lead to improved compliance.

(The author is Professor at the Faculty of Economics, Delhi and Director of the Faculty of Public Policy and Governance, Delhi.)

(The federal government strives to present views and opinions from all sides of the spectrum. The information, ideas, or opinions in the articles are those of the authors and do not necessarily reflect the views of the federal government. )