The present inequality in India reminds me of philosopher Jean-Jacques Rousseau saying, “When the people shall have nothing more to eat, they will eat the rich.” He was speaking during the French Revolution, in response to widespread starvation and executions in 18th-century France.Inequality is a global problem, and several reports (World Inequality Report and Oxfam) have shown that the COVID-19 pandemic has exacerbated existing inequalities across the world. This problem is more profound in India than elsewhere. The Oxfam report considers India to be one of the most unequal countries in the world – 21 richest Indians hold as much wealth as the bottom 70 crore Indians. Since COVID-19, the wealth of Indian billionaires has increased by Rs 3,000 crore, or rather by 131 percentage points, each day, but at the same time India has become the new poverty capital of the world, overtaking Nigeria.

The Gini coefficient, a standard measure of income inequality that ranges from 0 (when everybody has identical incomes) to 1 (when all income goes to only one person) has risen by 50%, from 0.33 to 0.45, over the last eight years. The Inclusive Development Index (2018) (growth, development and inclusion indicators) of the World Economic Forum placed India in the 62nd position out of the 74 emerging economies. It is well below its neighbours such as Nepal (22), Bangladesh (34) and Sri Lanka (40).

Taxes and transfers are key policy levers to influence distributional outcomes.

There are two main reasons behind India’s rising inequality. The first and foremost reason is its regressive taxation system, and the second is the reduced social spending by the Union government.

The reliance on indirect taxes such as GST and fuel tax –  which taxes all citizens, both poor and rich, equally – as a source of income is hurting the poor badly, thereby increasing inequality and suppressing demand. Indirect taxes have gone up from around 45% of total tax revenues in 2014, to as much as 59% in 2020-21 and have remained high at 54% in 2021-22.

According to an Oxfam report, the bottom 50% of the Indian population contributes to about 65% of the overall indirect tax collection. For example, rural households earning in the bottom 50 percentile spend 8.5% of their total income on indirect taxes, which is 24 times higher compared to the 0.35% spent  by urban households in the top 10 percentile income range. As per findings of a research paper published by Naren Prasad of the International Labour Organisation, comparing the effect of taxes and public expenditures on income inequality between six Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico and Peru) and OECD countries, identified that direct taxes decreased the Gini coefficient by 0.6% while indirect taxes increased it by 0.5%.

This additional level of expenditure enforced on the poor and lower middle class (who otherwise have negative or zero savings) by indirect taxes reduces their consumption level. As per an Organisation for Economic Co-operation and Development (OECD) study published in 2014, high inequality can impede economic growth in the long run by as much as 10% of the total GDP, because when inequality increases, it transfers income from low-income households – which have virtually zero savings – to high-income households – with high levels of savings. When income moves in this direction, demand naturally falls. This is why India suffers from a 28% unemployment rate (highest in Asia) and factories are operating at not more than 70% capacity. Therefore, to keep inequality under check, the Union government should redesign its taxation system.

As per the RBI’s Database of Indian Economy, Public Finance Statistics 2022-23, India’s current tax to GDP ratio – which has hovered around 15% to 16.7% over the past six years – is one of the lowest in the world. Most Western countries have a tax to GDP ratio of about 30% to 50%. Therefore, the aim should be to increase India’s tax to GDP ratio, but such an increase should not result from an increase in indirect taxes, which hurts the poor. Increased tax revenue should be by making the elites pay more tax for their wealth and income. In the long run, the target should be to increase direct tax revenue – the contribution of direct taxation towards overall tax poll should be well above 80%.

At a time when returns of capital on the economy was much higher than returns on labour, India was wrong to abolish the wealth tax in 2015. Also in India, its unique caste-based cleavages have resulted in intergenerational persistence of inequality. Therefore, the Union government should introduce a wealth tax and inheritance tax, as suggested by Thomas Piketty and other experts.

In India, dividend income is tax-free in the hands of the receiver. Unlike any other major countries, capital gains made after one year from sale of listed shares are tax exempt. India is the only major country with this exemption. The marginal tax rate on capital gains in most OECD countries ranges from 19% to 44%. Even Greece charges 16%. India, instead of taxing capital to create a more equal society, is now contemplating extending capital gains tax exemption to VCs and investors in unlisted companies.

Spend more on education

Another main transmission mechanism between inequality and growth is human capital investment. There is a clear correlation between income level and numeracy scores. Higher inequality leads to lower attainment of education/ training skills. This leads to lower productivity of human capital, thus reducing the overall productivity of an economy. In the 1910s, Sweden used to be one of the world’s most unequal countries; today it is one of the most equal countries in the world. That was made possible by redesigning its tax system into a progressive one, redeveloping a system of public health and education like nobody had seen before.

Therefore the onus is on the Union government to increase the budget expenditure on education and health. Most developed countries spend around 6% of GDP on education, however in India the spending for education has hovered around 2.5 to 3%. Taxing the top 100 billionaires with a 2.5% surcharge would generate additional Rs 1.2 lakh crore; this amount can take the Indian education budget expenditure to about 6%. Most developed countries, such as Germany, spend about 7% of their GDP on health. But India spends less than 2.5% on health and its expenditure on health (controlling for inflation) reduced last year. Levying an additional tax of 1.5% on the top 21 richest Indians can increase India’s health budget by at least one percentage point.

More welfare

Apart from reforms to taxation, government spending on welfare/cash distribution (something similar to minimum) is associated with positive externalities (reduces inequality). A research paper from The Institute for the Study of Labor in Bonn and the International Journal of Economics Politics Humanities and Social Sciences identified that a 1% increase in government social spending in terms of GDP results in a decrease of 0.0015% in the Gini coefficient. More social welfare spending will also give employees the possibility to fight for a fair wage.

However under Prime Minister Narendra Modi, since 2014, India’s expenditure on welfare schemes has reduced. Even in 2021-22, contrary to the advice of economists such as Abhijit Banerjee, who opined that money should be put in the hands of the poor, the Union government reduced spending on social schemes in terms of GDP. For example, the funds allocated for the MGNREGA were lowered by 25.2%, from Rs 10,0000 crore to Rs 73,000 crore, in the budget. Similarly, funds allocated for most schemes such as the food security act and fertiliser schemes, were reduced by about 25%.

Putting money in people’s hands to increase consumption will be crucial to propel growth, create demand and provide employment for the youth.

More social justice

Cleavages based on caste and gender have also made inequality in India more multidimensional in nature. The Global Gender Gap Index ranks India 135 out of 146 countries. At 18%, India has one of the lowest female participation in the labour force in the world. A paper in the Indian Journal of Labour Economics also identified extreme wage disparity between male and female workers in India. The latter were paid only 63% of what the male workers earned. Therefore, it is pertinent for the budget to focus on programmes that empower women.

A country’s growth cannot be judged solely based on a a single metric such as the GDP. The Union government should thrive for equitable and inclusive growth, whereby people irrespective of income differences, caste, religion or gender see the possibility of social mobility.