Why an inheritance tax can be an eminently bad idea (2024)

Right after the controversy over Rahul Gandhi's promise to conduct a financial and institutional survey to ascertain who is in possession of the wealth of the country, and then undertake an exercise to redistribute the wealth, another senior leader, Sam Pitroda, Chairman of Indian Overseas Congress, has stoked it further.

Pitroda proposed inheritance tax as a way to redistribute wealth. "In America, there is an inheritance tax. If one has $100 million worth of wealth and when he dies he can only transfer probably 45% to his children, 55% is grabbed by the government. That's an interesting law," he said. He later said he was just giving an example. Congress leader Jairam Ramesh said that Pitroda's comments do not reflect the party's position.

Ever since the inheritance tax was abolished in 1985, it keeps hitting the news from time to time. Many times it is speculated before the presentation of the Union budget if the finance minister would re-impose the inheritance tax. Many countries impose inheritance tax in different ways. Contrary to what Pitroda said, the US government does not impose any inheritance tax but only six states do (and one of them is abolishing it next year) and the tax rate varies from 1% to 20%, There are several big exemptions for close relatives and family-owned businesses and also loopholes that can be exploited to avoid the tax.

A dysfunctional tax?
Exemptions, carve-outs and generous lifetime donations mean inheritance and estate tax is a minor source of revenue in most countries and often make inequality worse, a study by Organisation for Economic Co-operation and Development (OECD) had said a few years ago.

Among the worst offenders is the United States, where only 0.2% of estates pay inheritance tax while nearly 80% of the wealth is in the hands of the top 10% richest households. Inheritance or estate tax make up only 0.5% of overall tax revenues on average across the 24 countries in the OECD group of mostly developed countries that have such levies.

The OECD said a majority of estates escaped tax altogether in some countries because of generous exemptions for close relatives and assets such as family-owned businesses.

Policies varied widely among OECD countries, with exemptions on transfers to children ranging from $17,000 in the Brussels region of Belgium to $11 million in the United States. Heirs' tax bills could be avoided or reduced in some countries thanks to in-life gifts that often get more favourable tax treatment, the study said. As a result, the effective tax rates paid are often significantly lower than statutory tax rates. In the United States and Britain, the wealthiest households were taxed at lower rates than other wealthy donors.

India's inheritance tax was repealed in 1985 because it neither helped bring down economic inequality in society nor did it contribute significantly to the exchequer. In 1984-85, the total tax collected under the Estate Duty Act was Rs 20 crore, but the cost of collection was very high because the complex calculation structure spawned a lot of litigation.

India levied an inheritance tax between 1953 and 1985. A glance at the budget documents for the early 1980s reveals GoI collected only Rs 2-4 crore in revenue from the tax every year, amounting to about 0.02% of all tax revenue, as per Jay Vinayak Ojha, a project fellow at Vidhi Centre for Legal Policy, "If applied to figures for 2022-23, this would mean a revenue of about Rs 600 cr. For comparison, it costs over Rs 10,000 cr a year to collect direct taxes. Even if the addition of this complex tax did not add to this expenditure, all the revenue generated from it wouldn't even keep its administrators going for a month," Ojha has said.

Why inheritance tax doesn't come up to its promise
While ostensibly inheritance tax makes sense since it is levied only on the super rich and promises large collections, in reality it fails to come up to its promise. Many experts think inheritance tax in India at this stage is a bad idea.

Rupesh Satnaliwala, MD and CEO, Universal Trustees, had told ET a few years ago that the developed countries which impose inheritance tax have a structured social security and retirement plans in place unlike in India. "India is a developing country and still has a long way to go to become a developed economy. We struggle with basic infrastructure issues in India. At the current juncture, we need to keep incentivising entrepreneurial spirit so that more private investment happens, leading to employment and allied opportunities," he said.

Moreover, such a tax can lead to the exodus of the high net worth individual to countries without this tax. These rich individuals will not only take their money out of India but also their entrepreneurial skills which India needs so much when it aims to consistently grow at higher rates.

It is not difficult to dodge the inheritance tax. When in 2017 the buzz about reimposition of inheritance tax started, the rich started devising novel methods to dodge the tax. One such method is forming a family trust which insulates their assets. Family trusts would fall outside the scope of inheritance tax—if it is introduced—because there is no transfer in ownership of assets, only a change in the trust shareholding.

The tax also entails some practical problems. Levied on the value of the deceased's assets and paid by their heir, the tax can translate into a sudden huge financial burden for the heir. When a property that has appreciated several times over decades gets passed down to the heir, the heir might have to sell the property to generate the amount he would be required to pay as tax on the property. Also, it may be very difficult to assess the value of some inherited assets such as family antiques. Ojha cites a famous tax dispute in which the US Internal Revenue Service insisted that rights to Michael Jackson's 'image and likeness' were worth over $400 mn, and that his heirs owed the government hundreds of millions. However, a tax court found the real value was around $4 mn.