A case for inheritance tax, by Nikhil Kamath

A progressive tax structure can help in ensuring redistribution of wealth, approaching a fairer economic equilibrium, and encouraging more entrepreneurial ventures, the cofounder of True Beacon and Zerodha writes

By Nikhil Kamath

Published: Jan 13, 2022 02:42:48 PM IST

Updated: Jun 28, 2023 06:42:04 PM IST

A major cause of high social inequality is the wealthy top percentile, who acquire their riches primarily through inheritance

Image: Shutterstock

On a cold February morning in 1985, then finance minister Vishwanath Pratap Singh said in his Budget speech, “The estate duty has not achieved the twin objectives to reduce the unequal distribution of wealth and assist the states in financing their development schemes. While the yield from estate duty is only about ₹20 crore, the cost of administration is relatively high.” By the third week of March, estate tax was scrapped. For more than 30 years preceding this, inheritance tax was in vogue in India. If you came into a lot of money because an old uncle kicked the bucket and left you his riches, you had to pay inheritance tax on it. That’s not the case anymore. So, what is this tax and what does it entail?

Inheritance tax or estate duty is a form of taxation that is levied against assets gained as part of inheritance. When someone’s property and assets pass on to their legal heirs, the latter must pay inheritance tax for inheriting such property or assets. While this is the norm in many countries, India scrapped the law in 1985 due to implementation issues. It was riddled with loopholes that allowed the unscrupulous to play the system and slip through the cracks.

There was a brief attempt to revive the taxation, just four years after it was taken down. The Wealth (Inheritance) Duty Bill, 1989 aimed to tax property that passed on after one’s death. It was widely believed that this act was more practical and feasible than its earlier avatar. Even the rate of tax, 10 percent at its highest, was seen as moderate; but Parliament was dissolved and the Bill slipped into obscurity, never to be heard from again.

Making the case

By the looks of it, inheritance tax is based on solid foundations of jurisprudence, morality and cold, hard logic. It levels the playing field for the uber rich inheritors and the not-so-fortunate. It also rests on the principles of utilitarian economics, which posits that an optimal social state can be achieved through a redistribution of initial endowments. The disparity caused by inherited wealth has been at the root of much of the economic inequality we are so used to seeing around us. Inheritance taxation promises to weaken it, if not destroy it completely. Countries such as England, France, Germany, the USA, and Greece have been taxing inherited wealth at as high as 40 percent.

The world is waking up to the benefits of this kind of taxation because of the growing awareness of the extreme disparity that exists. Such high levels of inequality have contributed to a plethora of global crises, not excluding the subprime mortgage crisis of 2008. Andrew G Berg and Jonathan D Ostry, both IMF economists, have demonstrated through their research that if an economy exhibits high levels of inequality, it is unlikely to sustain a high growth path in the future. A major cause of this inequality is the wealthy top percentile, who acquire their riches primarily through inheritance. In fast-developing economies such as India, this gulf is even more pronounced.

Need of the hour: A resurrection

This level of selective prosperity can be attributed to defective tax policies pursued over several decades, where wealth taxation doesn’t contribute a fair share to the exchequer. There are a few very persuasive reasons why inheritance taxes should make a comeback in India.

First, it will allow for a more efficient dispersion of wealth. In India, wealthy families from different walks of life have one thing in common—inherited wealth. This is not only unhealthy from an economic perspective, but also restricts social mobility. A proper implementation of inheritance taxes can remedy this malaise to a considerable extent.

Second, this approach to public finance also aligns with the egalitarian ideals enshrined in the Constitution of India. The Right to Equality is one of the chief guarantees of the Constitution, and equitable wealth taxation is an important step in that direction.

Third, most of India’s tax revenues accrue from indirect taxes, which have further intensified on the economically weaker sections. More direct taxes are the need of the hour, and inheritance tax is an important part of this. It can raise a significant quantum of revenue for the exchequer.

Fourth, by this additional tax revenue accrued, the Government of India would have the liberty of reducing the basic income tax liability on the economically weaker sections of the country. This could help combat the high barrier to entry to starting more entrepreneurial ventures.

Up and ahead

It has often been questioned if taxing the uber-rich can spiral differently by diminishing investments, capital expenditure, and savings that might directly impact the economy. It all depends on how efficient the implementation turns out to be. In a thriving, forward-looking economy such as the US, the Taxation Review Committee of 1975 said that inheritance taxation can “support the progressivity of the tax structure by the indirect means of progressive levy on wealth once a generation”, which will remove the “undesirable social consequences” of inherited wealth. With the Indian wealthy growing at a dizzying rate, this kind of progressive tax structure can go a long way in ensuring redistribution of wealth, approaching a fairer economic equilibrium, and encouraging more entrepreneurial ventures.

The writer is co-founder, True Beacon and Zerodha