The Conversation We Are Now Having On An Inheritance Tax Is Simply Useless

The assumption that we can have a sane conversation on any important issue during election time is seriously flawed.

Elections are swayed by emotions, ranging from hope to fear, and hence rational conversations are near-impossible.

This is the case with the issue of imposing an inheritance tax, where one side is talking about the other side grabbing your hard-earned money or even making a grab for women’s necks (the mangalsutra), and the other is pretending that it has no such intentions, and, in fact, it was a minister in the BJP government before 2019 who brought up the subject.

The conversation we really need to have is about three or four crucial things.

One, why do we even want an inheritance tax? What is the purpose?

Two, if we do have one, what kind of tax should it be?

Three, are there better alternatives to an inheritance tax, which scares a lot of rich people?

To answer the first question (why do we want such a tax), I believe that such a tax may be helpful to nudge the rich into thinking about those who are less fortunate if they have not already done so.

But, and it’s a big but, even this may not be a good enough reason if it destroys business confidence or squashes an emergent startup culture just when it is about to take off. 

Also, one must be clear that an inheritance tax is not about to swell revenues for the exchequer, as evidence from our own history with wealth tax and estate duty shows (which is why it was abolished in the mid-1980s).

In the US, which has some of the highest “death tax” rates, but also offers generous exemptions and loopholes, federal estate tax accounts for less than 1 per cent of revenues.

In India, the mere possibility of the imposition of inheritance tax will drive the rich out of the country or they will hide their estate using existing and future loopholes in the law.

So, no, the tax will not generate much revenue. It will probably be simpler raising taxes on high-consumption items with inflexible demand (petrol, alcohol, etc) to achieve the same additional revenues very easily.

This means the tax will be useless as a tool to redistribute incomes or assets, and may, in fact, damage the economy’s ability to generate new resources for redistribution. Especially if entrepreneurs see their hard work being taxed away.

In short, higher revenues and redistribution are not a reason to impose the tax. There are better ways to help the poor.

The best reason to have an inheritance tax is the issue of moral hazard. Ask yourself: assuming you are a rich person, is it right for you to gift your children endless supplies of pocket money?

Most first-generation rich people do not blow away their wealth on mindless self-aggrandisement or luxury, because they know how they got their wealth.

Sensible well-to-do parents know that making life too easy for their children by giving them lots of cash or goodies could turn them into super-brats, and possibly become a menace to society.

The moral reason for having an inheritance tax is the same: it should be partly earned through hard work, and not just inherited in full.

Next, if we do have one, what kind of tax should it be? Like the parental example above, the best inheritance tax would not necessarily be a tax at all.

If, say, 10 per cent of a rich billionaire’s assets (mostly shares) are put in escrow and the inheritors asked to create enough value to buy it back at a future date at today’s value, this would be a good enough incentive for them to keep growing the wealth instead of frittering it away.

It would work something like ESOPS. Those who don’t want to be so challenged can just pay the tax and do their own thing with what is left.

Third, are there better alternatives to an inheritance tax? Yes, there are, and here Gandhi’s philosophy of trusteeship comes in handy.

If the rich are, for example, are asked to leave their wealth in trusts for the benefit of society (to run free schools or hospitals or skilling centres), and the amounts (duly audited socially and by accountants) are shown to be much higher than the inheritance tax, they can get an exemption.

The reason why this may be a better alternative than the tax is simple: money left in government’s care tends to do less good work than money in private hands.

We can see how state governments, despite spending thousands of crores, run schools poorly. The same budgets, when supplemented by private management and cash top-ups (paid for by the rich) would make our state schools much better. Ditto for hospitals or skilling centres.

All that the government needs to do is to prepare a list of places where money can be invested to provide public goods like education and health, and the rich will probably gladly do it. Especially when they see themselves as pillars of society.

The last thing we need to discuss is timing. If a tax is to come, when should it be introduced? Clearly, the time is not now, when we are barely at $2,000 in terms of per capita income. We can wait for a decade and then introduce it, once our per capita tops $5,000.

Until then, encouraging effective private contribution to social causes is a better alternative. But we should start having this conversation now so that in 2034, we are ready to do the right thing.

What we can say for sure right now is that the Congress is wrong to talk of redistribution when it has not thought through the implications of its proposal. And this applies to the socio-economic caste surveys too.