India's conundrum: Greater the wealth, lesser the tax burden

Ahead of every budget, there is a clamour for reducing top income and corporate tax rates. Some demand outright scrapping of the income tax regime. Representatives of the corporate sector orchestrate their criticism of the multiple taxations of income from capital and excessive tax rates and cess on the top income levels.

Notwithstanding the “backbreaking features” of the income tax regime, the tax-GDP ratio remains low compared to several developing countries. Besides, very few of the wealthiest Indians figure among the highest income-tax payers. 

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Going by media reports, the list of top taxpayers is dominated by celebrities such as Akshay Kumar, Amitabh Bachchan, Salman Khan and cricketers. This means that the affluent groups do not report the highest income as the tax payment goes hand-in-hand with the income reported to the tax authorities.

Wealth and reported income

A recent study explains the paradox of the so-called excessively taxed wealthy Indians not paying the highest taxes. On an average, the wealthier a family is, the smaller the reported income relative to its wealth. Similarly, affluent individuals pay relatively less tax.

For the 5 per cent least wealthy individuals and families, the reported income is more than five times (500 per cent of) their wealth. In contrast, for the top 1 per cent of families, the total reported income amounts to just 3-4 per cent of their wealth. For the wealthiest 0.1 per cent, the reported income adds up to less than 2 per cent of their wealth. For the most affluent Forbes-listed families, the reported income adds up to just above 0.5 per cent of their wealth.

This means that the reported income of the wealthy groups as a ratio to their wealth is far below the national average. The total income-wealth ratio reported by the top 20 per cent of the wealth pyramid is less than a third of the national average. The ratio reported by the wealthiest 0.1 centiles is just above one-sixth of the national average.

Meagre taxable income

The situation is even worse if we consider the income reported as “taxable” – people report a part of their income as tax-exempt. The income reported by the wealthiest 1 per cent of families as taxable is merely 2 per cent of their wealth. For the Forbes listed group, the taxable income is less than 0.5 per cent of their fortunes.

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Similar is the case for individual wealth versus the value of income reported as taxable. Specifically, the wealthiest Indians are not the same as those who report the highest incomes. Out of the 100 wealthiest individuals in the General Election data, only 35 per cent have reported income levels belonging to the top 100 income levels in the dataset.

In simple terms, Indian billionaires pay a tiny tax relative to their wealth, just like Jeff Bezos, Elon Musk and Warren Buffett do in the US.

Going by the national income accounts, the average rate of returns on private capital in India is more than 7.2 per cent. One can easily get this kind of return even from fixed deposit accounts. Mutual funds and stocks provide much higher returns. Average returns on equity tend to be much higher, typically more than 15 per cent.

Equity factor

Because equity has a dominant share of the wealth portfolio of wealthy groups, their capital income has to be at least 10 per cent of their wealth, even after factoring in the corporate taxes. This inference is further evidenced by the fact that during the last two decades, the average GDP growth rate has been upward of 6 per cent. Historically, the returns on capital have been several percentage points higher than the growth rate.

Simply put, even if we disregard the labour income earned by the Indian affluent groups, their total income should be at least equivalent to one-tenth of their wealth simply on account of their capital income. However, the income levels reported by them are strikingly low – as low as less than one-hundredth of their wealth. This begs the question: What explains the small proportions of income reported by the top wealth groups?

The answer lies in the tax regime applicable to capital income under which the unrealised capital gains are neither taxable nor required to be reported in the tax returns. This means the wealthy groups have a strong incentive to avoid realising capital gains to reduce their tax liability. They do so by staying invested in equity capital and its by-products. This is the primary reason why year after year, the realised capital gains remain a tiny fraction of the returns from capital held by the wealthy.

Dividend payouts

Guided by similar considerations, wealthy groups minimise the dividend payouts — they minimise the distribution of profits among the stockholders. Profits distributed as dividends have to be reported as personal income and hence invite tax liability for the recipient. 

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In contrast, the reinvested profits lead to significant benefits for the stockholders. One, they reduce the tax obligation while propelling the value of equity, resulting in hefty tax-free capital gains for the stockholders. Unsurprisingly, corporate tycoons want to keep their dividend payouts as low as possible to reinvest most of their profits into the group companies. They, as CEOs, board members, or promoters of group companies, decide whether and how much of the profits will be distributed as dividends. In other words, their incentive to keep their income in the company accounts is backed by the authority they enjoy in the hierarchy of corporate governance.

Indeed, compared to many other countries, dividend payouts by Indian companies are meagre. The average dividend yield of the top 100 private listed companies amounts to a dividend income of just 0.85 per cent of the value of their equity assets; the dividend yield for companies controlled by the Forbes listed families is even smaller.

Deliberately suppressed dividend yields are one of the primary reasons why the reported equity income is a small fraction of the actual equity income of the wealthy groups. On top of this, a part of the dividend income might be received indirectly in the accounts of financial intermediaries like limited liability partnerships and kept away from individual accounts.

Capital income

Due to such creative accounting, only a tiny proportion of the actual capital income of the wealthy groups gets reported. In contrast, a more significant fraction of the returns from their capital income goes missing from the individual income reported to tax authorities.

What is interesting is that the wealthy groups have the ability to choose their labour income, unlike average Indians, whose wages and salary are determined by market conditions. Media reports abound about how year after year the wealthy groups keep a freeze on their salary, perquisites, allowances and commission received from their group companies. Such decisions appear charitable but are part of the tax-saving strategies of the affluent.

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In contrast to the CEOs in the banking sector and their bankers infamously seeking hefty pay packages, the business tycoons pay themselves too little. An average taxpayer’s burden can be reduced while improving the tax-GDP ratio if affluent groups take out higher pay and dividends.

Tax strategy

The tax managing strategy of the wealthy makes the direct tax regime regressive. The above-cited study shows that at the top wealth levels, the wealthier the taxpayer, the smaller the tax liability relative to wealth. Even if we ignore salary and consultancy fees received by the wealthy groups, the average tax paid by the wealthiest 5 per cent amounts to less than one-fifth of their capital income. The tax liability of the top 0.1 centiles is less than one-tenth of their income. The tax liability for the super-wealthy Indians is smaller than the relative tax liability of middle-wealth groups/

True, a part of the wealthy group’s income is taxed multiple times. However, this is a small fraction of their total income. The rest of their income – kept as undistributed profits in company accounts — is taxed at a rate much lower than the top tax rates applicable to the salaried class. Whichever way we look at the issue, the affluent Indians are not overtaxed.

We have to recognise that the risk-taking investments by the wealthy groups are critical for the growth and prosperity of the country, and they need to be rewarded for it.

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However, reducing the tax rates is not the way forward. The investment-rewarding growth strategy requires reducing the regulatory load on the corporate and allocating a higher share of tax revenue to fund capital expenditure to improve economic and legal infrastructure.

Moreover, the Finance Minister could use Budget 2023-24 to rationalise and standardise the tax rules for capital gains by streamlining the holding period and unifying tax rates across various asset classes, among others. These measures are in sync with the government’s agenda to make taxation citizen friendly and would lead to improved compliance.

(The author is a Professor in the Delhi School of Economics and Director, Delhi School of Public Policy and Governance.)

(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the articles are of the author and do not necessarily reflect the views of The Federal)