Piketty's Soak-The-Rich Tax Will Dent Wealth Creation: It Must Be Avoided Like The Plague

It is surprising how bad ideas have a way of returning whenever the world faces economic challenges. The latest one is the call for imposing wealth taxes on the rich in order to address the issue of inequality in India.

It was bad enough that Rahul Gandhi and his Congress party indirectly called for inheritance taxes in their election manifesto, but we now have intellectual ballast from a global paper written by Thomas Piketty (and three others).

Piketty published a rickety modern equivalent of Karl Mark’s Das Kapital in his 2014 book, Capital in the 21st Century.

His co-authors in the new paper recommending the imposition of wealth and inheritance taxes on India’s rich are Lucas Chancel (Harvard Kennedy School), Anmol Somanchi (Paris School of Economics, which is the institution to which Piketty himself belongs) and Nitin Kumar Bharti (New York University).

They are all bedfellows in a project called World Inequality Labs. (These extortion projects are called Labs in order to give one the impression that their output is scientifically kosher, even though this can never happen in any of the social sciences).

Never mind that no country has actually succeeded in taxing the rich enough to reduce inequality. If some countries have less inequality, it is largely because of their robust social security systems funded by high income taxes. It is almost never due to the collection of wealth taxes.

The main recommendation of Piketty & Co is that India should collect wealth tax at a minimum rate of 2 per cent for those with wealth over Rs 10 crore. To this is added an inheritance tax of 33 per cent for estates valued at over Rs 10 crore (ie, when the current owner passes away).

They recommend higher levels of taxes in “moderate” and “ambitious” versions of their tax-the-rich proposals, but let us stick to the base case. The authors suggest that these taxes would impact just around 0.04 per cent of the Indian population (around 5.6 lakh people) and generate additional resources equivalent to around 2.7 per cent of gross domestic product (GDP). 

Since nominal GDP, according to the last estimate made in February 2024, works out to Rs 293 lakh crore in current rupee terms, 2.7 per cent of that means additional taxes of nearly Rs 8 lakh crore. Paid by 5.6 lakh people.

Some hope. Piketty & Co clearly live in La-La land. They assume that this baseline rate of wealth tax will result in the following:

One, the super-rich will hand over this kind of money to the exchequer without a fight. This writer cannot claim to be an admirer of Raghuram Rajan, whose recent statements on the Indian economy seem driven more by his political affiliations than common sense, but he is bang on to challenge Piketty on his proposals.

Rajan asked Piketty to “Show me one country which has actually collected serious wealth taxes anywhere… Take any meaningful wealth tax and show me one country that has collected more than a pittance on it." 

Two, this planned expropriation will not impact entrepreneurship and wealth creation, which hold the key to any redistributive ideas that welfarists can think of. India has been haemorrhaging millionaires by the thousand for years now, and in 2023 some 6,500 were estimated to have opted for greener pastures.

While one can create and run companies in India even by being a foreign citizen, nobody can deny the friction involved in such capital arbitrage where the capitalist stays outside and his capital works in India.  

Rajan’s points were demonstrated to telling effect (with actual data) in the late Arun Jaitley’s second budget presented in February 2015. Jaitley said:

“The total wealth tax collection in the country was Rs 1,008 crore in 2013-14. Should a tax which leads to high cost of collection and a low yield be continued or should it be replaced with a low cost and higher yield tax? The rich and wealthy must pay more tax than the less affluent ones. I have, therefore, decided to abolish the wealth tax and replace it with an additional surcharge of two percent on the super-rich with a taxable income of over Rs Rs 1 crore. This will lead to tax simplification and enable the department to focus more on ensuring tax compliance and widening the tax base. As against a tax sacrifice of Rs 1,008 crore, through these measures the Department would be collecting about Rs 9,000 crore from the two percent additional surcharge. Further, to track the wealth held by individuals and entities, the information regarding the assets which are currently required to be furnished in wealth-tax return will be captured in the income tax returns. This will ensure that the abolition of wealth tax does not lead to escape of any income from the tax net.”

The Narendra Modi government has thus focused on extracting more from income tax, especially the rich.

In the last budget, tax exemptions on capital gains were reduced (one no longer gets indexation benefits on debt funds), and dividends are now being taxed in the hands of the individual at his tax bracket.

Thus Adani and Ambani pay more taxes on the dividends they receive from their dividends than others at lower tax brackets. 

A Motilal Oswal study of the trend in revenues from personal income tax shows that two-thirds of the increase came from this one measure of taxing dividend incomes in the hands of receivers instead of being a pre-emptive charge at the corporate level. 

In the goods and services tax, which hit the Rs 2 lakh crore mark for the first time in April (ie, relating to transactions in March 2024), luxury goods (cars, etc) are levied an additional cess. And if we assume that these taxes are paid largely by the super-rich, clearly they are paying more in terms of higher indirect taxes.

Of the two taxes proposed by Piketty & Co, I must admit that I do not have a strong argument against inheritance tax, but I am dead opposed to an annual wealth tax. Reason: wealth tax is a tax on stock, not flow. It is a tax on inert capital, not actual new incomes.

Inheritance tax, on the other hand, is a tax levied on the inheritor, and not the creator of wealth. Hence it is more morally sound. Even so, I believe that it must be moderate, and nothing as extortionate as the 33 per cent sought by Piketty. 

Wealth tax, on the other hand, is dangerous and highly contentious. For example, if I own Rs 10 crore worth of shares above the exempt limits, I will have to pay Rs 4 lakh every year if my share prices stay put. I pay more if the share price rises, and less if it falls. But all this when the shares are merely lying in my demat account. Why should an inert asset be taxed, when its value could fall? Will the tax be reversed if my asset actually loses value in subsequent years?

Even in the case of inheritance tax, I believe that the effort must be to get the rich to spend more of their wealth on charity, with appropriate incentives and social acclamation, and not just taxed like incomes are.

Most super-rich anyway have foundations and charity trusts that channel their wealth for social causes. The attempt must be to increase these donations to reduce inequality rather than use the blunt instrument of an inheritance tax.

But wealth tax must be shunned like the plague. There is no tax worse than one that is paid annually on the stock of wealth rather than incomes. It will ultimately become a tax on wealth creation itself, leading to outflows of capital and entrepreneurship.