Inheritance taxes: A key step towards reducing economic inequality

Inheritance taxes: A key step towards reducing economic inequality

A feature of the ongoing election to the 18th Lok Sabha is an extraordinarily communal campaign led by Prime Minister Narendra Modi. The debate on the reintroduction of inheritance tax and wealth tax in the country is an example of this. The Prime Minister began by misinterpreting an old speech of former Prime Minister Dr Manmohan Singh to the effect that ghuspaithiyas (infiltrators) and those “with more children” (Muslims) will have the first claim on the country’s resources.

Days later, when Sam Pitroda, the entrepreneur, mentioned the need for a debate on inheritance taxes, Modi twisted that too out of shape by claiming that the mangalsutras of women and the homes of the common people would be robbed. In this context, let us look at the issue under discussion.

What are inheritance taxes?

An “inheritance tax” is a one-time tax charged on high-value inheritances. It is different from “wealth tax”, which is an annual tax charged on wealth when the owner is alive. Sometimes, inheritance tax is contrasted with “estate tax”; the difference is that while inheritance tax is charged on the wealth received by the heirs, estate tax is charged on the wealth transferred by the donors. In other words, estate tax is paid out from the estate of the deceased before the money is transferred to his or her heir, while inheritance tax is paid by the person who inherits money or assets. All these taxes can coexist in an economy.

While the suggestion of an inheritance tax was received with shock in the country, it has been commonplace in the advanced economies of the West and the East for more than a century. The economist Thomas Piketty has called progressive inheritance taxes the “second major fiscal innovation of the twentieth century” after progressive income taxes.

While inheritance tax has a long history, it was after the First World War that it was introduced in many countries, with high rates at the top level. If the top inheritance tax rates in the US and the UK were about 20 per cent in the 1930s, they were raised to 70-80 per cent between the 1930s and the late 1970s. Germany and France had relatively lower top rates—between 30 per cent and 40 per cent—through this period. Such inheritance or estate taxes were an important reason for the reduction of inequalities in these countries after the late 1940s.

Why inheritance tax?

The primary objective of inheritance tax was the redistribution of wealth in unequal capitalist societies. In the 19th century, John Stuart Mill, the English philosopher and political economist, was a powerful proponent of limiting inheritance. According to Mill, the right to inheritance was not part of any natural right over property. One’s absolute right over property ended with one’s death.

Writing in the Political Science Quarterly in 1893, Max West argued that while parents may support, educate, and assist children during their lifetime, there was no moral justification for the view that the parents must leave their children as wealthy after their death. In short, what you inherit is not what you “earned”. It was “unearned”, over which you have no perpetual right.

In short, the inheritance tax originated in capitalist economies. Piketty has argued that progressive inheritance taxes are “an ideal compromise between social justice and individual freedom”, and represent “a relatively liberal method for reducing inequality”, where the state neither prohibits or expropriates wealth nor disrespects free competition or private property.

Advantages of inheritance tax

• There are philosophical and economic justifications for the existence of the inheritance tax.
• Unlimited inheritance across generations leads to the persistence of wealth inequality and an accumulation of extreme “unearned” wealth.
• Inheritance tax enhances equality of opportunity and social mobility by equalizing inter-generational wealth distribution in the long run.
• Inheritance tax increases horizontal equity in the fiscal sphere by treating two persons who receive the same amount of assets similarly, irrespective of whether the assets were earned or inherited.
• Inheritance tax helps increase vertical equity in taxation by ensuring that those with a higher ability to pay taxes contribute more.
• Inheritance taxes reduce the misallocation of capital by promoting competition and motivation across generations and incentivizing heirs to work and save better.
• Through the “Carnegie effect”, inheritance tax may incentivize large wealth holders to donate more to charities during their lifetime rather than pay inheritance tax at death.

Criticism of inheritance tax

• One criticism is that inheritance taxes are a tax on capital and could lead to a depletion of capital stock after each generation. However, even a high rate of income tax can potentially lead to a depletion of capital, and all inheritance taxes are not necessarily paid by disposing of capital.
• Another criticism is that inheritance taxes amount to double taxation, but all taxes may be construed as disincentivizing entrepreneurship in one way or another.

The Indian case

Independent India in the late 1940s was a highly unequal society, with inequality high in land and asset ownership. Consequently, estate taxes were introduced in 1953, wealth taxes in 1957, and gift taxes in 1958. These taxes were withdrawn in the 1980s and 1990s due to their low contribution to the gross tax revenue, high administrative and compliance costs, and the presence of double taxation.

However, economic liberalization after 1991 substantially transformed the situation. The new economic policies encouraged private accumulation through reforms in land laws and the ease of doing business. Corporate and income taxes were cut. New estimates show that asset inequality greatly increased after the 1990s.

The wealth share of the bottom 50 per cent of the population fell from 10.9 per cent in 1981 to 6.5 per cent in 2023. Even the middle 40 per cent saw a fall in wealth share from 44.1 per cent in 1981 to 29 per cent in 2023. At the other end, the wealth share of the top 10 per cent rose from 45 per cent in 1981 to 64.6 per cent in 2023. For the top 1 per cent, the wealth share rose from 12.5 per cent in 1981 to 39.5 per cent in 2023.

In 2022-23, the top 1 per cent of the population owned assets

SDGs, Targets, and Indicators

SDGs Addressed in the Article:

• SDG 1: No Poverty
• SDG 5: Gender Equality
• SDG 10: Reduced Inequalities
• SDG 16: Peace, Justice, and Strong Institutions

Specific Targets Based on the Article’s Content:

1. Target 1.4: Ensure that all men and women, in particular the poor and the vulnerable, have equal rights to economic resources, as well as access to basic services, ownership, and control over land and other forms of property.
2. Target 5.1: End all forms of discrimination against all women and girls everywhere.
3. Target 10.1: By 2030, progressively achieve and sustain income growth of the bottom 40% of the population at a rate higher than the national average.
4. Target 10.2: By 2030, empower and promote the social, economic, and political inclusion of all, irrespective of age, sex, disability, race, ethnicity, origin, religion or economic or other status.
5. Target 16.6: Develop effective, accountable and transparent institutions at all levels.

Indicators Mentioned or Implied in the Article:

• Income and wealth inequality
• Ownership of land and assets
• Value of assets owned by the top 1% of the population
• Wealth share of different population groups
• Contribution of inheritance and wealth taxes to tax revenue

Table: SDGs, Targets, and Indicators

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Fuente: frontline.thehindu.com

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