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Tax rates and inflation
September, 19th 2011

In the past several months, the Reserve Bank of India has raised interest rates nearly a dozen times to curb inflation. The rise in interest rates is meant to curb liquidity in the system.

It has no doubt worked well to some extent. While monetary policy has been active, fiscal policy is not. Inflation means large cash chasing limited stocks. A higher direct tax rate could have been thought of to curb conspicuous consumption on the part of the rich. Our income tax rates have been practically stabilised at 33 per cent for nearly 15 years. Prof. Arun Kumar of the Centre for Economic Studies and Planning of New Delhi points out that if the Managing Director of a company gets Rs 30 crore as salary, bonus, commission etc., but gets Rs 1,000 crore as dividend, his tax liability is only about Rs 10 crore. This will amount to a tax rate of 0.01 per cent of the total income. Indian corporate houses account for 0.1 per cent of the population but control 20 per cent of the national income. They enjoy tax expenditures of over Rs 5 lakh crore. Corporate houses pay an average tax of 23 per cent of their legally declared taxable incomes, and not the official rate of 33 per cent.

All this accounts for the low tax-GDP ratio in India.

In Europe, UK
Mr Warren Buffet wrote to the New York Times on August 14, that the US should stop coddling' the rich and raise the top tax rate in order to reduce the deficit. His call found loud echoes across Europe. Sixteen of France's wealthiest people signed a petition urging the French Government to tax them more. Welcoming the French initiative, about 50 wealthy individuals in Germany started campaigning for a higher top tax rate and styled themselves as a group representing the Initiative of the Wealthy for a Wealth Tax. The French President, Mr Nicolas Sarkozy, announced a 3 per cent increase in the tax on the wealthiest individuals.

Britain levies 50 per cent tax on the Super-rich. This is paid by 300,000 people earning more than $2,45,000 a year. The Economist points out that larger number of affluent British feel hard hit by tweaks to tax allowances, as well as higher taxes on pension contributions, capital gains and house sales. The British Chancellor described tax evaders as leeches'. Liberal Democrats advocate rebalancing taxation away from earned income towards unproductive assets generated by the long property boom. Advocating higher property taxes, they point out that Mansions can't run away to Switzerland.

For the first time the British Government was able to secure an agreement with Switzerland under which the UK was able to collect billions of pounds from those who have far too long evaded their responsibility to pay UK tax by abusing Swiss banking secrecy laws. Hereafter, under the agreement, the Swiss will tax the bank accounts of UK citizens at rates ranging between 19 per cent and 34 per cent the principal sum hidden, depending on how long the account has been running. The tax will be transferred to the UK without revealing the identity of the account holders. The UK authorities struck a similar deal with the Government of Liechtenstein, a tax haven. America has been able to force Switzerland to reveal the names of holders of secret Swiss bank accounts under threat of reprisals. Names of thousands of secret accounts holders in Swiss banks will be revealed to the US authorities. Failure to comply with the mandate from the American IRS could have meant a fine up to $2.6 billion on the Swiss banks. The US rejected the Swiss proposal to tax money kept by American residents in secret Swiss accounts and also to introduce a withholding tax on future interest earned.

The Indian Scene
For the first time, the Swiss National Bank (SNB) disclosed towards the end of July, 2011 that Indian deposits in secret Swiss bank accounts amounted to 1945 billion Swiss francs ($2.5 billion at the end of 2010). It is also now known that there has been a perceptible flight of funds of Indian holders from Swiss banks to those in Singapore, Dubai and Mauritius.

Indian policy makers should wake up to the changing tax scenario across the globe. Even the British Conservatives have concluded that the so called free market is a corporatist racket for the few'.

It is free only for the very rich who can move their money at will. Can the Finance Minister do something to make our tax system more progressive? The Estate Duty was never meant to be abolished permanently. The exemption for long-term capital gains tax in shares and securities has led to abuse. Dividends in the hands of captains of industries must be brought back to tax.

There is also an urgent need to look into the tax rate remaining stagnant at 33 per cent for nearly 15 years. Fiscal policy must aid monetary policy to flight inflation.

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