We need something better than soak-the-rich taxation

Pranab-da’s direct taxes code (DTC), which kicks in a new tax regime from 2012-13, is a semi-washout. For one, it is not as radical as it was originally intended to be by raising tax thresholds and eliminating tax-breaks. When a tax regime is complicated, it distorts saving and spending patterns and encourages corruption.

My second peeve relates to the proposed changes in wealth tax. Though the measure involves raising the exemption limit from Rs30 lakh to Rs1 crore, it is actually going to end up harassing more people since the definition of wealth has been expanded, as it now includes things like costly watches (price above Rs50,000), art works, et al. The draft DTC had proposed an exemption limit of Rs50 crore and a 0.25% wealth tax. The gap between intent and reality is glaring.

The idea of expanding the scope of wealth tax always appeals to jholawallas and the unimaginative Left, because it sounds redistributive in nature. There will always be a broad political consensus on soak-the-rich taxes. Populism goes down well on the election trail. It won’t, of course, achieve anything because wealth will suddenly start going underground. Phony trusts and non-profits will sprout to redistribute the wealth holdings so that taxes can be minimised.

The tax official scrutinising wealth tax returns will laugh all the way to the bank, for he will enter your home to figure out what you Husain or gold heirloom is worth.

I am on the side of both the soak-the-rich crowd and the man trying to protect his riches. But I would like the rich to soak themselves by doing charity work rather than allowing the government to do it for them. Wealth in private hands usually does more good that the same wealth in government hands.
Last week I talked about how the government used over Rs2,80,000 crore of taxpayer money to subsidise fuel for everybody (rich and poor) — thus encouraging overconsumption of fossil fuels. Add more money to the government’s kitty and babus and netas will discover more voter giveaways at the cost of the country’s long-term interests.

There has to be a better way to redistribute wealth. Let me throw a simple idea here. Ask yourself: why do we collect taxes? Presumably, it is the price we pay for governance, including redirecting resources towards the needy. Governance happens when the cost of administration is kept to a minimum, and the bulk of the resources are funnelled to the poor.

The reality, though, is that the bulk of the taxes go to feed the bureaucracy and keep politicians in power. Politicians soak the rich in the name of the poor, but in our kleptocracy, some of the money comes back to the rich through corruption and kickbacks. The poor fall through the cracks.

So, here’s the idea. Let the government legislate a tax regime where any rich person contributing 1% (or even 1.25%) of his wealth directly to a bonafide charity or official schemes of the government is exempt from wealth tax. The jholawallas have a role to play here. They can be part of social audit teams that police these contributions. Hopefully, they will develop a vested interest in enabling the delivery of services to the poor instead of merely fulminating against the rich.

I see two advantages in this. One, society’s actual needs will be catered to with a sense of accountability. Two, those with a conscience may actually contribute more when they see their money directly helping the poor. Wiping the tears of the downtrodden and helping them build marketable skills is more beneficial for the country than running Mother Teresa schemes - which romanticise charity instead of investing in capacity-building.

If this experiment of direct private sector involvement works (one should review it after, say, five years), we can change the goalposts and even redefine the purpose of government and taxes. Currently, governments are focused on collecting taxes and channelling it to areas they think is right. They are thus keen on raising more money and upping the tax-GDP ratio.

But what matters to the poor is what reaches them at the end of the pipeline. There is no need for the babu to play middleman and raise the cost of service delivery when the money can be routed directly to social sector schemes. More important than the tax-GDP ratio is the welfare-to-wealth ratio, which is the amount of public and private money spent on social security, education and health as a proportion of national wealth. Maybe our jholawallas can work on ways to measure this ratio rather than merely focusing on hatred of the rich.

A good place to begin is by offering this direct charity contribution option as an alternative to wealth tax. If it works, society benefits. If it doesn’t, wealth tax can return. No one loses.