Why India loves to hate inheritance tax and estate duty—wrongly

No tax goes down well with taxpayers. But the inheritance tax is an especially detested one across the world. It is also a highly misunderstood tax. 

In popular discourse the inheritance tax is seen as ‘left/communist/socialist’, but it is in fact rooted in liberal economics; it is probably the most fair and progressive tax there can be.  

Critics of inheritance tax say it amounts to double taxation. But every tax does that: The goods and services tax, or GST, for instance, is paid out of taxed income. Inheritance tax stands out because it is among the least distorting. 

Unlike income tax, inheritance tax does not erode the incentive to work. Unlike capital-gains tax, it does not discourage savings and investments. And unlike the GST, it is progressive: the poorest and those better off pay GST at the same rate, but inheritance tax is by design only for the ultra rich.

The inheritance tax targets inequality at birth and responds to the rhetorical question: what have heirs done to deserve the money that comes their way at birth?

Death taxes

There are many variations of what are called death taxes. 

Estate tax is paid by a deceased individual’s estate before the money is transferred to their heirs. Inheritance tax, on the other hand, is paid by the person who inherits the deceased person’s money and assets. This tax is normally levied above a high threshold level of inheritance, which keeps out most of the population other than the uber rich.  

The inheritance tax is, thus, a guard against a permanent elite based on little more than the accident of birth and genealogy rather than merit—the very essence of market-led economies—as it aims to lower entry barriers and open up opportunities to the non-elite.

Remember, besides material wealth, the wealthy pass on a variety of visible and invisible advantages to their children, which gives the next generation an edge over the children of the non-rich: from elite education to access to influential networks. 

Rise of billionaire-inheritors

The number of billionaires who are not self-made but are heirs is on the rise across the world. The Economist magazine reports that annual flows of inheritance in France have tripled as a proportion of that country’s GDP since the 1950s, while half of Europe’s billionaires have inherited their wealth.  

One of the reasons India’s 1991 financial reforms are celebrated is that they levelled the playing field to such an extent that companies floated by meritorious entrepreneurs from the middle class are now able to build businesses more valuable than those managed by inheritors in old-economy, promoter-run business houses. Infosys Ltd is frequently cited as the poster boy of this change.  

But the trouble with inheritance tax is that it is notoriously expensive to collect for tax administrators. The wealthy tend to be good at exploiting loopholes as they are able to afford savvy tax lawyers. Revenue from such taxes in OECD nations as a share of total government revenue has fallen sharply since the 1960s. That’s why countries have been abolishing it. 

Not a communist agenda

There are not many examples of communist countries having an inheritance tax. China does not have it. The mecca of capitalism, the US, on the other hand, imposed a federal death tax thrice to provide revenue on a short-term basis to finance military action (during 1797-1802, 1862-1870, and 1898-1902), only to repeal it soon after and reintroduce it in 1916 during the World War I. 

The US has had the tax since then. Now, according to a tax-reform plan passed by the US House of Representatives, the death taxes in the US would be abolished by 2025.

The egalitarian Swedes also decided in 2004 to abolish their inheritance tax.  

In India, the Congress government led by Rajiv Gandhi abolished the estate duty in 1985 during the first spurt of economic reforms that had preceded the 1991 P.V. Narasimha Rao-Manmohan Singh reforms. The reason given in the budget speech by then finance minister V.P. Singh was that collections from the tax were too meagre to justify the cost of collecting it.

In the debate in the ongoing Lok Sabha election campaign over inheritance tax, the Bharatiya Janata Party (BJP) has charged that the estate duty was abolished to help Gandhi escape paying the tax on the inheritance from Indira Gandhi, who was assassinated on 31 October 1984. The estate duty was, however, abolished for deaths occurring on or after 16 March 1985. 

Politics in play

The BJP has also cautioned voters about the possibility that the Congress, if elected to office, will introduce the inheritance tax. 

The Congress has sought to assure voters that it has no such plans. The head of the party’s manifesto drafting committee, former finance minister P. Chidambaram, said on Thursday that the manifesto does not have a word on the ‘re-distribution of wealth’ or ‘inheritance tax’.

Also read: Burying Nehruvian legacy, Congress manifesto warms up to private sector

A perusal of the Congress manifesto by Mint SnapView confirms this. On the contrary, the manifesto promises priority for policies that would allow for “the creation of wealth". 

Also read: The one thing that stands out in BJP’s manifesto is aviation. Can promises fly?

That said, the concept of death taxes should be more amenable to the BJP’s political narrative as its criticism of the Congress centres on the party’s culture and legacy of dynasty and family-inheritance. 

Which is why perhaps prominent supporters of the BJP from the business community have been advocating over the years that it should introduce an inheritance tax.