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Death and taxes

Why smart capitalists should demand an inheritance tax.

Written by Pratap Bhanu Mehta |
January 22, 2015 12:53:58 am
There are no strong property rights-based arguments that stand in the way of inheritance taxes; in fact, most arguments point towards having one. There are no strong property rights-based arguments that stand in the way of inheritance taxes; in fact, most arguments point towards having one.

The claim that some form of inheritance tax is a good idea has had a subterranean existence for a while. But it never gets fully debated. Indeed, for some, its mere mention evokes a return to the Dark Ages. This is surprising. The economists who have advocated such a tax in print include Raghuram Rajan, Vijay Kelkar, Ajay Shah and, most recently, Minister of State for Finance Jayant Sinha — hardly a cast of characters that marches under a red flag carrying a hammer and a sickle. Regulating inheritance was thought to be the central feature of a democracy: it would prevent the congealing of new undeserving aristocracies. As Franklin D. Roosevelt put it, “inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our government”. Or as Kelkar and Shah put it, “there is a case for an estate duty, through which the intensification of wealth concentration across generations can be counteracted”. Most democracies have had such taxes, without any evidence that it has impaired their growth, though it is an interesting fact that civil law countries seem to regulate inheritance even more than common law countries.

There were grounds to be sceptical of many forms of estate tax: their administrative costs were high, there was fear that they could cause disruption to family businesses and the yields were often not that large. These considerations gained ground in the intellectual arguments in the United States and, combined with a fear-mongering that led the middle classes to side with the super rich, created a climate of suspicion against these taxes. In India, the V.P. Singh government abolished estate taxes, which were absurdly pegged at the rate of 85 per cent.

But the issue was more complicated than critics have suggested. For one, the classic estate duty is just one form an inheritance tax can take. Even Gary Becker, who was virulently opposed to estate taxes, suggested that some form of inheritance tax was more workable than the classic estate tax. Countries like Ireland have designed inheritance taxes that smartly combine well-judged thresholds at which taxes kick in with sensible rates. To take another example of a possibly interesting design proposal: Lily Batchelder has argued, in the context of the US, for an inheritance tax where those receiving inheritances over a certain amount would include it in their income and pay a 15 per cent surcharge on the excess. The advantage of this proposal is that it does not tax solely on the basis of the size of the inheritance; it takes into account the income of the heirs. Inheritance will incur lower taxes if it goes to poorer recipients and is distributed widely. And the rates can be fixed in ways that are sustainable for the heirs. Designing a workable proposal will require a great deal of empirical data and smartness. But there are many more possibilities now of designing good inheritance taxes that are worth considering.

The justness of taxation always involves balancing different principles of justice. Let us be clear: there are no strong property rights-based arguments that stand in the way of inheritance taxes; in fact, most arguments point towards having one. There is no natural right to property; it is a monopoly granted through a social contract. In many instances, this monopoly is functionally good for all kinds of reasons, so we grant it. But there is little to support the claim that reasonable taxes on inheritance cannot be justified. There are competing considerations. Should those who leave an inheritance be taxed more than those who consume? On the other hand, should not unearned income, as it were, be taxed at a slightly higher rate than earned income?

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The fears of inheritance taxes are exaggerated. India is now in a different place than in the 1980s in terms of people who can bequeath more than Rs 25 crore, a threshold Sinha has suggested. So the possibility of revenue gains is higher. The second argument is that India does not have the administrative capacity to implement such a tax; it will require the ability to do proper valuations, for one. But surely this is a capacity India can now possess? How can a democratic state say that all considerations of justice and fairness will be set aside simply because the state does not want to build capacity? The third argument is the fear of avoision. Tax avoision is different from avoidance. In the latter you cheat; in the former you use all available legal means to minimise tax liability. The fear is that smart avoision will nullify the effects of the tax. But this fear is also exaggerated. In part, it depends on how the inheritance tax is designed. But in fact the possibility of avoision is also a strong argument in favour of an inheritance tax. If, for instance, it leads to behaviour where people don’t hoard as much landed property as they do now, this might be a good outcome you want institutionally. If it gets people to transform family businesses into professional enterprises or structure more trusts, you might still get good outcomes. If these taxes produce good institutional outcomes, so be it.

The other fear is that inheritance taxes send the wrong signal to investors. Again, this fear is overblown. A modest, well-designed inheritance tax is not going to deter investors; what will attract them is all the other reforms you can carry out in an economy. In fact, just making this argument deepens the crisis of legitimacy for Indian capitalism: it gives the impression that any sensible tax discussion will be held ransom to the ability of a few individuals to make noises and threaten the social contract. We are in a context where there is no attempt whatsoever to regulate the single most powerful mechanism for transferring intergenerational inequality: real estate. Taken together, the subverting of real estate regulation, the reluctance to introduce Aadhaar for real estate transactions and the reluctance to even discuss inheritance taxes can produce a crisis of legitimacy for Indian capital.

We are in a context where the land acquisition ordinance has practically negated all social impact assessment. The land acquisition bill needed administrative simplification, but the ordinance sends a strong signal that taking away livelihoods for development requires no scrutiny. Yet the slightest talk of inheritance taxes will yield paranoia. Inheritance taxes are not what dumb socialists demand; they are what smart capitalists should demand.

The writer is president, Centre for Policy Research, Delhi, and contributing editor for ‘The Indian Express

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