INCOME-WEALTH RELATIONSHIP IN INDIA’

ChinmayaIAS Academy - Current Affairs January 31, 2023 Government Policy, GS3 Leave a comment 259 Views

Growing economic inequality is a major concern in most developing countries and India is no exception.
According to Oxfam, the richest 1% in India own more than 40% of the country’s total wealth while the bottom 50% share just 3% of it.
One of the proven ways to alleviate economic inequality — which has been associated with a number of social and political ills — is progressive taxation, where the greater your income, the higher the rate of taxation.
This approach would enable some form of redistribution to the poorer sections through state-funded welfare schemes and investments in social infrastructure, which is key to reducing inequality.
However, for this approach to work, reported incomes need to be accurate. Otherwise a progressive tax regime on paper may not prove to be so in practice.
For instance, what if a major chunk of an individual income never gets reported It would never get taxed. Therefore, income reporting behaviour is a central issue in public finance.

The extent of inequality

This research paper by Ram Singh models the relationship between wealth and reported income for individuals from different economic strata.
For the first time, affidavits filed by contestants for elections to the Lok Sabha have been used for such a study.
They provide income and wealth data for a large number of Indians — 7,596 households (HH) and their adult members.
The dataset is surprisingly inclusive, with incomes ranging from ₹178 to as high as ₹206 crore. Singh supplements this data with the Forbes’ List (FL) of billionaires, and statistics published by the Central Board of Direct Taxes (CBDT).
Taken together, they cover the full range of India’s wealth and income distributions, as well as regional and rural-urban population distribution.
The paper’s key finding, which has implications for public finance, inequality studies, and taxation design, is that the wealthier the individual or family, the lesser is the reported income relative to wealth. Specifically, the study found that “a 1% increase in family wealth is associated with a decrease of more than 0.5% in the reported income as a ratio of wealth.” While it is not unexpected that the income to wealth ratio would decrease as one goes up the wealth ladder — poor people, by definition, hold few assets — the steep decline in the income-wealth ratios of the affluent, and how that, in turn, leads to a smaller and smaller tax liability for the super-wealthy, points to major lacunae in the tax regime. It also suggests that economic inequality in India — extreme though it is — is still an underestimation.
For instance, the study found that “the total income reported by the bottom 10% of the families “amounted to more than 188% of their wealth” whereas, in contrast, the wealthiest 5% and 0.1% of families reported incomes that were just 4% and 2% respectively of their wealth. For the wealthiest Indian families from the Forbes List, their total reported income was on average less than 0.6% of their wealth. Also, the total income-wealth ratios reported by the wealthiest 20% were less than a third of the national average. For the wealthiest 0.1%, it was just 12% of the national average. For families on the Forbes List, it is one-twentieth of the national average.

Capital gains

As the author notes, “even considering the average returns on capital, incomes reported by wealthy groups are far below the expected levels.” Are the wealthiest earning so little
Or are they just living off their wealth? Or is possible that their income somehow goes ‘missing’ from tax records? Singh’s paper shows that a big chunk of the wealthier families’ income does tend to go ‘missing’, and it’s typically a form of income called capital gains, or income earned from the appreciation of any asset.
The study finds that the total income reported by the wealthiest 0.1% of families is only about a fifth of the returns from their capital, and “at least 80% of their capital income goes unreported in the income tax returns”.
This is an enormous amount since the richer a person, greater is the share of capital income in their total income. In other words, the richer a person is, greater is the share of unreported income. So, how does so much of capital income disappear from reported incomes
The paper explains that wealthier groups “hold most of their wealth as equity, non-agricultural land, and commercial properties. This class of assets enables owners to manipulate the split of the capital income between what is required to be reported and what can go legally unreported.”
The enabling accounting feature here is that under Indian tax law, capital gains from an asset are treated as ‘unrealised’ unless they are exchanged or sold. Capital gains “are thus neither taxable nor required to be reported in the ITRs.
This means that as long as an investment is not sold out, it is not a tax liability regardless of the quantum of appreciation in the asset’s value on account of the unrealised capital gains.”
In fact, even when the asset is eventually sold, the effective tax rate on the cumulative capital gain is much lower than other forms of realised income. Hence, to reduce their tax liability, the wealthy tend to avoid realising capital gains. They do so by staying invested in equity and commercial properties.

The Indian tax regime

The paper also explains how the wealthy manipulate other forms of capital income, such as dividends (the profits distributed to shareholders).
Here a common tactic is to reinvest the profits, as it helps to not only avoid any additional tax but also boosts the market value of company stocks.
“Eyeing these gains, wealthy groups want to reinvest most of their profits into group companies by keeping their dividend pay-outs as low as possible….such manipulations of capital income in response to the dividend tax are an international phenomenon.”
Of course, this is not to suggest that only the wealthy underreport their income. This behaviour is seen in every stratum.
For instance, the report finds that “people across wealth groups report a part of the taxable labour income as agricultural income to avoid paying tax”, which may explain why some individuals develop a sudden interest in farming after attaining success and wealth.
The paper points out that the Indian tax regime, which seems progressive “in that the marginal tax rate ….increases with the reported income” is actually regressive when evaluated against total income of the wealthiest rather than their reported income.
For it to become truly progressive, “the taxable income reported by the wealthiest 0.1% has to go up by at least 60%.”
One final implication of this study is regarding inequality estimation. Most estimates rely on taxable income reported in ITRs. But since the total income is always more than the reported taxable income, and the gap between the two grows wider for wealthier groups, the paper underscores “a staggering level of difference between the income metrics that feed into existing studies on inequality and the actual income of the most prosperous Indians.”
Put simply, income inequality in India is worse than most estimates, and the effective tax rate, which is not really progressive with regard to income, is even less so with regard to wealth.
The study concludes by noting that for India’s tax regime to be truly progressive, it needs to be reengineered so that it can bring into the tax net the enormous amounts of capital income that currently tends to go ‘missing’ from the reported incomes of the affluent.

SOURCE: THE HINDU, THE ECONOMIC TIMES, PIB

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