High I-T will not secure social justice

Finance Minister Nirmala Sitharaman has increased the marginal tax rate on high net worth individuals (HNIs) from about 35 percent till now to 42.7 percent.

"Marginal" rate of 42.7 percent means that the taxpayer will have to pay income tax of 42.7 paise out of every Rs 1 rupee earned by him or her above an income of Rs 5 crore. On the face, this is a step in the right direction.

The rich earn money from the country and they have a greater responsibility towards our people. However, globalisation has created a totally different dynamics of taxation because the HNIs can migrate to other countries where the tax rates are less.

They can continue to do business in India as "foreign" nationals. Say a person had invested Rs 100 crores in a business and making a profit of Rs 6 crores per year. He would have to pay an Income Tax of Rs 2.49 crores as an Indian national as per the new rates announced by the Finance Minister.

Now let us say, he migrates to Abu Dhabi, pulls out his investment from India, then sends that money back to India as "Foreign Investment" and continues to run his business as previously.

But now the income earned by him in India will be taxed in Abu Dhabi. The catch is that the Income Tax in Abu Dhabi is zero. Therefore, if you become an Abu Dhabi citizen, you do not have to pay tax on your income in India.

The rate is lower if not zero in most developed countries. The marginal rate of Income Tax is 30 percent in the United States of America.

These lower-than-India tax rates provide a huge incentive for HNIs to migrate out of India. According to one report, about 5,000 HNIs have been migrating every year from India.

These HNIs are taking their wealth with them. Once abroad, they have less incentive to invest in India. In this way, the high tax rates will harm investments in the Indian economy.

T V Mohandas Pai, chairman of Manipal Global Education says: "Tax terrorism is the foremost cause of millionaire exodus. Most of those who have left were from Mumbai and Delhi… said tax harassment had peaked; so much so that it had created a fear psychosis among them."

The other grouse is the deteriorating quality of life in India. The HNIs say that air quality, traffic condition and other parameters of good living environment have gone from bad to worse over years, says Pai.

The bullet train is leading to cutting of large numbers of mangroves; the National Waterway Project on the Ganga is leading to killing of dolphins and turtles; forests in the Aravallis are being cut for housing projects...

The list goes on and on. The result of these "development" activities is that the quality of life has deteriorated and HNIs are migrating.

A friend of mine was living in Delhi. His wife's weight came down from 45 kilo to 22 kilo. Then he migrated to Dehradun. Her weight came back without requiring any medications. The same with HNIs.

The third reason for migration of HNIs is that they are looking at investing and building assets overseas. The best way to do this is to become an overseas resident, says Pai.

The economic growth is down in India and there are few investment opportunities. For these reasons, the raising of Income Tax rate will only lead to an exodus of HNIs from India and boomerang as lower collections of Income Tax, lower investments and lower rates of GDP growth.

It is impossible to sustain high Income Tax rates once we have opened our economy to global capital flows. Today every country is reducing the tax rates to attract HNIs. To increase tax rates in this scenario will be suicidal.

The Finance Minister, however, rightly said that the HNIs must contribute more to the building of the economy. The question is how? I have three suggestions to make.

First, the Finance Minister must tax luxury consumption — especially that which adds to pollution and deterioration of quality of life. For example, we could have a "progressive" pricing of petrol. Those buying more than 5 liters could be charged a higher price.

The electricity charges could be made much more progressive. The electricity price in UP, for example, is Rs 4.90 per unit for first 150 units while above 500 units the rates are Rs 6.50 per unit. The upper rates could be raised to, say, Rs 15 per unit.

Luxury consumption goods like chocolates and sodas could be taxed heavily. Polluting goods like plastic bags could also be taxed heavily.

The HNIs would barely notice these taxes but the Finance Minister would get revenues and the reduced consumptions of the polluting goods would make it more attractive for HNIs to remain in India.

The second step the Finance Minister can take is to honour simplicity and charity. To earn is good. To indulge in ostentatious consumption is not.

The display of wealth builds anger among the poor. On the other hand, the income earned by HNIs will have a socially smoothening effect if part is used in charity.

The Finance Minister could institute national- and State-level awards along the lines of Padma Awards for HNIs living a simple life and for those giving in charity. That would act as an incentive for other HNIs to remain in India. They will feel respected and wanted rather than disrespected and haunted.

The third step that the Finance Minister could take is to reduce the salaries of the government employees. My assessment is that the common man of the country does not see the HNIs as their enemy. We have outgrown socialism.

They recognise that the HNIs take risks and contribute to the economy. Their ire today is against the government employees who not only live, relatively speaking, "ostentatious" lives compared to the common man, but also extort bribes on every pretext.

It is wonder for one and all to see that a government employee drawing a salary of, say, Rs 50,000 per month, and having a corruption income of, say, Rs 1 lakh per month, is deputed to serve the common man earning Rs 10,000 per month.

The idea that government employees, 98 percent of whom are corrupt, will control the businessmen, only 50 percent of whom are corrupt, is self-evidently flawed.

Therefore, the Finance Minister should institute an external evaluation system to track and dismiss corrupt government employees and honour and respect HNIs. That will encourage HNIs to stay in India and help attain higher growth rates.

Author was formerly Professor of Economics at IIM Bengaluru