Don't punish high earners

Written By Unknown on Rabu, 13 Februari 2013 | 21.16

Lubna Kably
12 February 2013, 09:50 PM IST

Raising taxes on these major contributors to the economy would be democratic theft

Finance minister P Chidambaram has hinted at the possibility of a higher tax burden on high net-worth individuals (HNIs). Understandably, given the inefficient utilisation of taxpayer's money, this suggestion has met with wide-scale disapproval.

Imposing a higher tax burden on HNIs is a populist measure. Typically, HNIs contribute a major chunk towards total tax collections, yet constitute just a small fraction of taxpayers — or for that matter, of the vote bank.

In the USA and Canada, the top 1% of taxpayers accounts for nearly 40% and 22% respectively of the personal income tax collections. In India, this percentage is higher. According to the standing committee's report on the Direct Tax Code, a little over four lakh individuals (earning a taxable income of more than Rs 20 lakh) comprise the top 1% of taxpayers. Yet, this minuscule segment of taxpayers contributed Rs 93,229 crore, comprising nearly 63% of the total personal tax collections during the last financial year.

HNIs in India also play a pivotal role in creation of economic growth. According to a Confederation of Indian Industry publication, family enterprise is the fulcrum of Indian business. Nearly 95% of business enterpri-ses are family owned. This includes large enterprises — with more than half of the BSE 30 companies being family-controlled — to medium, small and micro units.

The private sector in India is fast catching up as an employment generator and we are not witness to the chronic unemployment faced by a few EU countries that recently hiked their tax rates on HNIs.

The Economic Survey (2011-12) reflects that in the organised segment, the public sector employed 1.78 crore persons and the private sector employed 1.07 crore persons. For the year ended March 31, 2010 as compared to the previous year's figures, employment in the public sector increased by a minuscule margin of 0.38% whereas that in the private sector increased by 4.06%.

Several industry leaders, in their pre-budget interactions with the finance minister, have thus rightly voiced their fear that a higher tax burden on HNIs would dent entrepreneurship. In turn, this would have an adverse impact on employment creation and growth.

Interestingly, last year, HM Revenue and Customs (UK's tax administration authority) examined the behavioural patterns of HNI taxpayers arising out of the higher tax rate. This study supports the views expressed by the industry leaders.

UK's 2009 budget introduced a 50% tax rate for those earning taxable income of more than £1,50,000 (equivalent to Rs 1.27 crore approximately). On exami-ning the behavioural pattern of the HNIs, it was concluded that the negative fallout of this higher tax was far-reaching and the underlying yield from the higher tax was much lower than forecast. Based on this study, from April, the tax rate for HNIs will be reduced to 45%.

Higher tax rates can result in two kinds of responses. Owing to less take-home pay, people value their money more and put in more efforts (this is known as the income effect). Or it could result in people working less and reduce the incentive to start, finance and grow a business (this is known as the substitution effect). The evidence collected by HM Revenue and Customs showed that the substitution effect outweighed the income effect, and the overall impact of introduction of a higher tax on HNIs was negative.

This study also showcased other negative behavioural patterns that emerged. High tax rates encourage migration by HNIs — which includes migration of highly skilled workers — to more tax favourable countries and also increase legitimate tax planning. Even ins-tances of tax avoidance rise. A wider impact is that reduced disposable income translates into lower consumption thus reducing indirect tax receipts. Overall, a country's competitiveness in the global market decreases. The study concluded that the additional rate on HNIs was highly distortionary.

India's perceived low tax-GDP ratio of around 10% during 2011-12 is often relied upon to justify imposition of higher taxes on the rich. However, with less than 3% of India's population paying taxes, this argument is not tenable.

Our growth rate at present is around 5% or slightly higher and the Indian government can ill afford to impose a higher tax burden on HNIs which would prompt negative behavioural patterns and dent entrepreneurship. Further, a slowdown in job creation, will directly impact personal tax collections even from the lower and middle salaried class.

On the expenditure side, recent months have witnessed a few corrective steps including slashing of public expenditure or reducing the subsidy burden. Direct cash credit mechanisms may in the coming years stem the rot of corruption.

Even a casual glance at the Comptroller and Auditor General of India's reports for any year, pertaining to any ministry or department, shows wasteful expenditure, be it through procurement of goods that lie unused or payment of higher prices by disregarding a transparent procurement process.

The government not only needs to slash its expenditure but monitor its actual use. Imposition of a higher tax burden on HNIs will not solve the problem plaguing India. It is inefficiency in utilisation of taxpayer's money that needs to be curbed and not growth.


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