Budget 2013: Why Inheritance tax means more money down the drain

Now that P Chidambaram has reopened the debate on the reimposition of estate duty – the so-called death tax on wealth inherited by the progeny of the rich – it is worth looking at the issue at length.

That an inheritance tax will raise hackles among the wealthy is a given. This is probably why the finance minister sought to couch the issue as one of “inter-generational equity”, a bogus term empty of meaning. If he is so concerned about “inter-generational equity”, he should first clean up the budget deficit, since loading future generations of taxpayers with high government debts is hardly conducive to inter-generational equity.

Let’s be clear: this is not about inter-generational equity, but double-taxation of income and wealth. The rich presumably pay both taxes annually. If they are not doing so, they should be caught and put in jail.

When Chidambaram talks of inter-generational equity he is actually confusing the taxman’s greed for revenues with a moral issue. PTI

What an inheritance tax does is knock a big slice off inherited wealth after the death of the wealth creator. And when Chidambaram talks of inter-generational equity he is actually confusing the taxman’s greed for revenues with a moral issue: should inheritors be allowed to get Papa’s wealth without having worked for it? Shouldn’t a large chunk of the wealth instead be available for redistribution?

The truth is this: more than just profits, the ability to pass on wealth after one’s death is a huge motivator for wealth creator. I don’t want the taxman to stand between my wealth and my children. Take away a person’s ability to decide where his or her money should go, and you would have weakened capitalist motivation substantially. Leaving a legacy – whether as cash or institutions or good deeds – is one of the biggest drivers of human effort,   and the less governments meddle with this idea, the better.

In any case, there is much rethinking going on in this subject among the super-rich themselves. From Warren Buffett to Bill Gates to David Rockefeller to Vinod Khosla, billionaires the world over are balking at the idea of leaving billions of unearned dollars in the hands of callow inheritors. At last count, billionaires who had pledged a substantial chunk of their billions to charity through the Buffett-inspired Giving Pledge were nearing the 100-mark. A hundred billionaires gifting their billions is truly awesome.

But this idea isn’t new even to India, with the Tatas have pledged as early as in the last century the bulk of their riches to their trusts. And many of India’s relatively new tech billionaires – from Azim Premji to NR Narayana Murthy – are pledging their money for the betterment of other people’s lives.

The question of inheritance tax thus needs to be turned around: would simply taxing the super-rich make any difference to the poor in whose name the tax is sought to be levied?

This writer believes that in India, given the sheer inefficacy of government spending, an inheritance tax would be a grave moral hazard: more money in the hands of the government will mean more waste, more corruption. Not only would businessmen rush to hide their wealth in layers of holding companies and trusts, many would also move it clandestinely to tax havens abroad. The Economic Times reports that the mere mention of the possibility of such a tax has sent the rich scurrying to their CAs for cover.

In fact, this was the exact experience in the mid-1980s, when the government sought to rationalise both wealth tax and estate duty in one go. The man to do it was Vishwanath Pratap Singh, India’s original economic reformer, more than half decade ahead of Manmohan Singh.

This is what he said in his 1985 budget:

“As both wealth tax and estate duty laws apply to the property of a person,  the former applying to his property before death and the latter after his death, the  existence of two separate laws with reference to the same property amounts to procedural harassment to the taxpayers and the heirs of the deceased who have to  comply with the provisions of two different laws. Having considered the relative merits of the two taxes, I am of the view that estate duty has not achieved the twin  objectives with which it was introduced, namely, to reduce unequal distribution of  wealth and assist the states in financing their development schemes. While the yield from estate duty is only about Rs 20 crore, its cost of administration is relatively high. I, therefore, propose to abolish the levy of estate duty in respect of estates passing on deaths occurring on or after 16th March 1985.” (Italics ours)

Note what he said: Estate duty was leading to “procedural harassment” of taxpayers. Is it any different now? Are taxmen less corrupt now? Moreover, collecting the tax was a bigger headache than what actually got collected in the mid-1980s – a mere Rs 20 crore. Even assuming the government collects 100 times that amount now by reintroducing the duty – Rs 2,000 crore – it’s a drop in the bucket of actual government spending. The government has spent 100 times that potential amount over the last five years on NREGA alone. And the loss on 2G spectrum, even if it was not Rs 1,76,000 crore, was at least Rs 50,000 crore in lost revenues.

Wasting time on collecting estate duty and encouraging more corruption is hardly worth so much heartburn.

This should lead us to better questions: what should we do instead of levying inheritance tax? Can the rich redistribute their incomes themselves, provided they are given an enabling environment?

A sensible government must ask itself: will Rs 1 crore spent by the Tatas on, say, insuring the health of the poor, yield better results than collecting Rs 1 crore as taxes from the Tatas and letting bureaucrats spend that amount? Ratan Tata, post-retirement, plans to be even more active in the charity arena. Maybe he is on to something here that Chidambaram isn't.

Few people will say the government will do better with Rs 1 crore.

The debate should not be about inheritance tax, but how the rich can be roped into the development debate as social entrepreneurs. This is what Warren Buffett is trying to do. This is what Gandhi would have wanted them to do – build trusteeship capitalism.

Let’s also remember that the new Companies Bill mandates profit-earning companies to spend 2 percent of their net profits on corporate social responsibility (CSR).

Now, if this is supposed to work with companies, why not individuals?