Inheritance Taxation And The Lottery Of Birth

Emotions are high in India. The rich, the meritorious, the grifters and the suave, all believe the political opposition is proposing to intervene in dynastic matters where it has no apparent business. Earlier this week, the United States-based representative of the Congress party, Sam Pitroda floated the idea of reintroducing a tax on inheritance as part of the party agenda if elected to power.

It is one of several ideas that may or may not see the light of day, given the probability of Congress winning the 2024 election. But there is a history of the present government incorporating redistributive proposals from competing manifestos.

If introduced in some form, a taxation on inheritance essentially appropriates a fraction of net wealth transmitted at death to the next generation. Very large dynastic fortunes in India were subjected to an inheritance tax (called Estate Duty at the time) starting in the 1950s. But in the build up to liberalisation, Rajiv Gandhi’s government abolished it in 1985.

To many, mostly on social media or TV panels, the revival of the so-called “death tax” marks a return to the terrible times of the 1970s when economic growth was low, expropriation by the state was aggressive and

attitudes towards money-making were hostile. Others are a little confused between merit and inheritance, pondering as to why lifetime wealth accumulation is being discouraged by adding a penalty as the funeral pyres are on the verge of being lit.

Also Read: What Is Inheritance Tax And Why Sam Pitroda's Statement Has Sparked A Row

Times have changed; the rich are not subjected to the same expropriation today, and history often shows that ideas that were a bad fit once, become appropriate at another time. For example, the Indian government has been subsidising a manufacturing push in a similar spirit to state-led industrialisation in the early years of Independence.

The concept of inheritance taxation is an old idea which was as relevant as any other institutional reform in the 20th Century. The concept of inheritance itself, however, is an even older phenomenon that served as the principal driver of hereditary class status through much of human history. Princes inherited the thrones of their fathers, landed estates remained under the same dynasty and industrial capital became a multigenerational family business.

From a practical standpoint, today it is a question of assets with varying degrees of liquidity. While income accrues as wages to the worker who sells their labour, or as profits to the enterprising capitalist, inheritance does not accrue to either (although it plays a role in one’s future income). Instead, it represents the residual wealth (real estate, cash, stocks, family heirlooms etc.) that is transmitted to the next generation at death.

It is in effect ‘unearned’ in the absolute because the new owner of this wealth is entitled to it purely by the randomness of birth (children do not choose their parents). Of course, in a world of private property and property rights there is nothing unusual about transferring one’s

property. Most people leave nothing to their kids, but those who are fortunate enough to accumulate more than they can consume over their lifetimes are able to leave something behind.

Modern history is marked by disputes in the inheritance process—from the famous case of the Ambani brothers to smaller squabbles over ancestral real estate among siblings in urban and rural India. At its heart, claimants of inheritance want their ‘rightful’ shares in the country’s wealth. And while one can argue that this is the foundation of family life, it makes inheritance perhaps the most appropriate form of taxation for both revenue and redistributive purposes.

Wealth is highly concentrated in India. In recently published research with my co-author Ishan Anand, we found that in 2018, India’s top 1 per cent exercised claims on more than 40 per cent of private wealth. This inequality is difficult to reverse with the normal process of economic growth. In the film Serious Men, based on the similarly titled book by Manu Joseph, Nawazuddin Siddiqui’s character makes the following statement to his wife: “It takes four generations for a man to summit the social ladder in India.” Nawaz makes an analogy with spectrum generations (2G, 3G, 4G etc.) and posits that he and his wife are 2G, while their child will be 3G. Their grandchild (4G) will reach the summit and hopefully have no need to seek employment to further the dynasty.

Unfortunately, the spectrum analogy assumes every generation will be more successful than the previous one with certainty, and that the spectrums will reach an upper limit at 4G. We currently live in a world of 5G. In 5G, Narayana Murthy has already gifted his newborn grandson a share in Infosys which puts this infant’s net worth at over Rs 240 crore. If this tidy sum grows at 5–6 per cent for the next 18 years, young

Ekagrah can choose to indulge in his passions and interests while living off the money that ‘works’ for him, and likely his own grandsons. Meanwhile, a big chunk of Indian society is so far behind that the state has to provide them with piped water, food grains and LPG cylinders.

The gap is simply too large.

If indeed one wants to create a society based on merit and equality of opportunity, then the state has to intervene in mitigation of further wealth concentration. At a more realistic level, wealth concentration creates advantages before getting transmitted—the rich find better schools, foreign education, top healthcare and social networks that endow their kids with advantages simply inaccessible to others.

As the gaps amplify, a large part of the population is locked out permanently—just ask any newly-salaried professional about purchasing a home using their salaries. India is a low per-capita income country. But asset prices (mainly real estate) in big cities are close to levels in developed economies. Between 1950 and 1980, the gap between the world’s richest and India’s elite grew. For a few decades now, that gap is being reversed. While India’s richest had fallen behind relative to the world between 1950–80, today that divergence has been reversed and plenty of billionaires and multimillionaires inhabit India’s big cities.

Once we acknowledge the importance of inheritance in perpetuating inequality of opportunity, the role of inheritance taxation becomes dual: revenue and social cohesion. In a landmark book about taxation titled Taxing the Rich, political scientists Kenneth Scheve and David Stasavage found that the implementation of estate taxation in the early 20th Century in the western hemisphere was driven by the accountability of the rich to the rest who were going to serve in World War I.

It was America, the great home of capitalism and free markets, that innovated on this front—using inheritance taxes as an answer for merit compared to the more dynastic-minded Europeans. A common refrain against these taxes today is the fact that the US has diluted them into near irrelevance. True, but American per-capita income (adjusted for inflation and cost-of-living) was around $8,000 when these taxes were implemented, which is near India’s own per-capita income (in PPP terms) today. Top marginal tax rates only increased for the next several decades, but instead of falling behind, America became the world’s pre-eminent economic superpower. The parallels are quite similar, as India responds to the Robber-Barons with its own Billionaire Raj.

In terms of revenue, these taxes may have limited impact; but this is a question of strategic creativity of policymakers. Reducing income tax on the lower tax brackets and replacing it with a low starting inheritance tax rate might prove to be politically popular. As only a fraction of Indians are white collar taxpayers, the lowest brackets of the income tax code starts at just 1.5 to two times India’s per capita GDP. There are only two further questions: how much inheritance is likely to fall into the net, and whether there is any way to prevent evasive tactics like trusts or an outflow of high net-worth individuals.

The annual flow of inheritance as a fraction of national income is determined by the mortality rate (death creates inheritance), the ratio of wealth of the old (who transmit) to the young and the ratio of private wealth to national income. India’s mortality rate for all age-groups has been stabilising downwards over the course of economic development and the ratio of private wealth to national income has been rising since the 1980s. Thus, there is a reasonable amount available as revenue (between 0.3 and 0.8 per cent of GDP) at thresholds that only tax extremely large inheritances.

Regarding the point about invasion, tax authorities can in fact incentivise participation by acting as the point of registration of new ownership especially as a lot of private wealth in India is immovable real estate (which cannot be jetted to Switzerland), or financial assets which require disclosure, and permitting exemptions for primary residences. This can help extend the arm of the taxman to inequality in rural India—note that the Estate Duty between 1953—1985 also included large holdings of agricultural land thus making it the only direct tax in the agrarian sector.

Obviously, there will always be evaders. But one must ask what the point of all the claims about digitisation and formalisation (even demonetisation) is if tax authorities cannot track illicit wealth which resides visibly in India. The technology of the tax authorities has clearly come a long way since the 1980s when the original Estate Duty was abolished.

In fact, opting for a one-time levy on inheritance is less hostile than an annual wealth tax which will require frequent valuation and liquidation of assets, besides the fact that prior to a cumbersome exercise of valuation, no one knows how much they are worth. Whether the wealth tax is a non-starter, the appropriateness of an inheritance tax in India’s future can simply not be ignored.

Bollywood movies of the pre-1990s era are passe. We live in the post Hum Aapke Hain Kaun era where money-making is valued and is the unifier of purpose. A tax on inheritance seen as socialist, a relic of the past, a knife to the entrepreneurial midriff, or a belligerent against money-making is incorrect. It is a social contract to remind everyone that our class positions at birth are not of our choosing. With the right calibration, it is something everyone should be able to live with.

(The author writes about the wealth distribution in India and teaches economics at The University of Massachusetts in Boston)

(The opinions presented belong solely to the author.)