Inheritance Tax in India: Promoting wealth redistribution and ensuring a level playing field amid rising inequality

In recent years, the global discourse on wealth and inequality has gained momentum, with India, boasting a burgeoning economy and a diverse socio-economic landscape, being no exception. As the wealth gap widens, there is a pressing need for policies addressing the concentration of wealth among a few and promoting a more equitable society.

Inheritance tax, a levy imposed on the transfer of wealth from a deceased person to their heirs, serves as a tool used by governments worldwide to redistribute wealth and reduce economic inequality. However, in India, the inheritance tax was abolished in 1985.

Rising inequality in India

Globally, according to Oxfam's Inequality Inc report (January 2024), the fortunes of the richest five men in the world have doubled since 2020, while nearly five billion people have experienced a decline in wealth during the same period. This stark contrast underscores the pervasive hardship and hunger faced by many worldwide, with poverty projected to persist for another 230 years, despite the possibility of having the world's first trillionaire in the next 10 years.

India's economic growth post liberalisation (1990s) has undeniably lifted millions out of poverty and created a vibrant middle class, yet it has also resulted in a disproportionate accumulation of wealth. Oxfam's 2021 report revealed that the top 10% of the population in India possesses 77% of the total national wealth, while the bottom 50% owns a mere 6%.

According to the Credit Suisse Global Wealth Report (2021) and research by scholars, including Thomas Piketty (2023), India's wealthiest citizens now control 40.1% of the country's wealth, the highest proportion since 1961, with their share of total income reaching 22.6%, the highest since 1922. This staggering statistic underscores the alarming levels of inequality prevalent in the country, posing significant challenges to social mobility and economic development.

Some people just have too much

Inherited wealth exacerbates these disparities by perpetuating privilege and entrenching socio-economic inequalities, thereby hindering social mobility and undermining meritocracy. Consequently, the absence of a robust inheritance tax system allows the wealthy to pass on their riches to future generations without significant redistribution.

Understanding Inheritance Tax, Wealth Tax, and Estate Tax

An "inheritance tax" is a tax imposed on valuable inheritances, payable only once when the assets are passed down to heirs. This tax differs from a "wealth tax," which is levied annually on an individual's total wealth while they are alive. Sometimes, people confuse inheritance tax with "estate tax," but there's a clear distinction: inheritance tax is paid by the person inheriting the money or assets, whereas estate tax is taken from the deceased's estate before it's passed on to the heir.

In simple words, inheritance tax is paid by the recipient of the wealth, while estate tax is paid by the deceased's estate. Technically, It's possible for all these taxes to exist simultaneously in an economy, serving different purposes in wealth distribution and revenue generation.

Inheritance tax: Historical and Philosophical context

The English philosopher and political economist JS Mill extensively expounded upon the concept of progressive income tax and advocated for limitations on inheritance. According to Mill, individuals should have the freedom to bequeath their wealth, but not to receive substantial inheritances. He proposed imposing an upper limit on the amount each person could inherit, asserting that one's absolute right over property ceases upon death. The primary objective of inheritance tax, as posited by Mill, was the redistribution of wealth in unequal capitalist societies.

Later, in 1893, Max West published his thesis titled "The Theory Of Inheritance Tax," wherein he proposed setting an absolute limit on the amount any individual could acquire through inheritance or bequest to prevent the perpetuation of immense fortunes. Max West contended that while parents may support, educate, and assist their children throughout their lives, there is no moral justification for ensuring that children inherit significant wealth upon their parents' demise.

Nobel laureate Amartya Sen has also advocated for inheritance tax as a means to address inequality and promote social justice, as discussed in his renowned book "The Idea of Justice" (2009).

More recently, Thomas Piketty has argued that progressive inheritance taxes represent an optimal balance between social justice and individual freedom. In his view, such taxes serve as a relatively liberal method for reducing inequality, wherein the state neither prohibits nor expropriates wealth, nor disrespects free competition or private property.

What’s happening globally?

The inheritance tax in some form or the other has been implemented in many countries. Across the OECD, 24 countries have an inheritance or an estate tax (total 38 countries in OECD). As per the tax foundation report the US has the fourth highest estate or inheritance tax rate in the OECD at 40%; the world’s highest rate, 55 percent, is in Japan, followed by South Korea (50%) and France (45%).

In developing countries like Brazil and South Africa, inheritance tax has played a crucial role in addressing inequality and funding social welfare programs. Brazil, for example, implemented inheritance tax in 1964, with revenues contributing to education, healthcare, and poverty alleviation initiatives. Over the years, the tax has been instrumental in financing social policies and reducing wealth disparities.

In various global jurisdictions, the transfer of assets through inheritance may entail immediate payment of capital gains tax on any unrealized increase in asset value, as observed in Canada, notwithstanding the absence of an inheritance tax. Conversely, in jurisdictions where both capital gains tax and inheritance tax are implemented, inheritances typically remain exempt from capital gains tax obligations.

An additional illustration of inheritance tax can be found in Greece, where it is structured in a progressive and staggered fashion. For instance, as reported by iclg.com, the marginal inheritance and gift tax rates vary based on the degree of kinship: 10% for spouses, parents, and children, 20% for close relatives, and 40% for all others. Moreover, monetary gifts are subject to flat tax rates of 10%, 20%, and 40%, depending on the degree of kinship between the donor and the recipient.

Ensuring a level-playing field

Central to the argument for inheritance tax is the concept of creating a level playing field. In a society striving for equal opportunities, it's imperative that individuals from diverse backgrounds begin from a comparable starting point. Permitting significant intergenerational wealth transfers without taxation may reinforce advantages for the already privileged, thereby impeding the advancement of those with fewer resources. This logic mirrors the principles behind reservation policies, which aim to ensure fairness and equal access to opportunities for all members of society.

What do critics have to say?

Critics of inheritance tax assert that it stifles entrepreneurship and impedes wealth creation by discouraging savings and investment, although proponents argue that it reduces the misallocation of capital. Also, there is no certainty that all heirs will have the same entrepreneurial capability as their grantors. Thus inheritance tax may foster competition and motivation across generations, encouraging heirs to perform better. Furthermore, economists contend that moderate levels of inheritance tax have minimal adverse effects on economic growth while significantly contributing to reducing inequality.

Moreover, inheritance tax can be structured in a manner that minimises its impact on small businesses and family farms through exemptions and graduated tax rates. By targeting solely the wealthiest individuals and estates, the tax can effectively fulfil its redistributive purpose without disproportionately burdening the middle class.

Estimation of revenue from inheritance tax

In 2022-23, the top 1% of the population owned assets valued at a whopping Rs 499 lakh crore (approx. $6.74 trillion). Land and buildings comprised about 90% of these assets. R Ramakumar, a Professor at the Tata Institute of Social Sciences, Mumbai, said in his article that an estimate for 2018 showed that a 2% wealth tax and a 33% inheritance tax on just the top 1% of private individuals in the country (that is, less than 1 crore persons) could fetch Rs 12.1 lakh crore (approx. $163 billion) as additional tax revenues annually. Professor Ram Kumar has also provided insights on how these revenues can be used to establish a comprehensive social security net for the poor, covering employment, food, education, health, and old-age pensions.

Inheritance tax serves as a vital instrument in addressing inequality within India's socio-economic landscape, though it does not singularly remedy all existing challenges. Echoing this sentiment, economist Thomas Piketty regards progressive inheritance taxes as the second significant fiscal innovation of the twentieth century, following progressive income taxes.