Inheritance taxes: A key step towards reducing economic inequality

Even as PM Modi communalises the debate on inheritance taxes, it is imperative that we understand what the tax implies and how it can help the nation.

Daily wagers waiting for work, in Mumbai on June 11, 2021. Prospects for many people are drastically worse as salaried jobs vanish, incomes shrink, and inequality rises. | Photo Credit: RAFIQ MAQBOOL/AP

A feature of the ongoing election to the 18th Lok Sabha is an extraordinarily communal campaign led by Prime Minister Narendra Modi. The debate on the reintroduction of inheritance tax and wealth tax in the country is an example of this. The Prime Minister began by misinterpreting an old speech of former Prime Minister Dr Manmohan Singh to the effect that ghuspaithiyas (infiltrators) and those “with more children” (Muslims) will have the first claim on the country’s resources.

Days later, when Sam Pitroda, the entrepreneur, mentioned the need for a debate on inheritance taxes, Modi twisted that too out of shape by claiming that the mangalsutras of women and the homes of the common people would be robbed. In this context, let us look at the issue under discussion.

What are inheritance taxes?

An “inheritance tax” is a one-time tax charged on high-value inheritances. It is different from “wealth tax”, which is an annual tax charged on wealth when the owner is alive. Sometimes, inheritance tax is contrasted with “estate tax”; the difference is that while inheritance tax is charged on the wealth received by the heirs, estate tax is charged on the wealth transferred by the donors. In other words, estate tax is paid out from the estate of the deceased before the money is transferred to his or her heir, while inheritance tax is paid by the person who inherits money or assets. All these taxes can coexist in an economy.

While the suggestion of an inheritance tax was received with shock in the country, it has been commonplace in the advanced economies of the West and the East for more than a century. The economist Thomas Piketty has called progressive inheritance taxes the “second major fiscal innovation of the twentieth century” after progressive income taxes.

While inheritance tax has a long history, it was after the First World War that it was introduced in many countries, with high rates at the top level. If the top inheritance tax rates in the US and the UK were about 20 per cent in the 1930s, they were raised to 70-80 per cent between the 1930s and the late 1970s. Germany and France had relatively lower top rates—between 30 per cent and 40 per cent—through this period. Such inheritance or estate taxes were an important reason for the reduction of inequalities in these countries after the late 1940s.

Today, several economies have inheritance tax, ranging at the top level from 55 per cent in Japan, 50 per cent in South Korea, 45 per cent in France, 40 per cent in the UK, 34 per cent in Spain, 33 per cent in Ireland, and 30 per cent in Belgium and Germany.

In the US, inheritance taxes were slashed at the top level substantially after the 1980s. In 2023, federal estate taxes applied only to property valued above $13 million. Only 12 US States levied estate taxes and only six States levied inheritance taxes. Interestingly, the slashing of the top inheritance tax rates in the US coincided with a sharp rise in the share in national income of the top 10 per cent of the people: from 33 per cent in the 1980s to 47 per cent by 2010.

Why inheritance tax?

The primary objective of inheritance tax was the redistribution of wealth in unequal capitalist societies. In the 19th century, John Stuart Mill, the English philosopher and political economist, was a powerful proponent of limiting inheritance. According to Mill, the right to inheritance was not part of any natural right over property. One’s absolute right over property ended with one’s death.

Writing in the Political Science Quarterly in 1893, Max West argued that while parents may support, educate, and assist children during their lifetime, there was no moral justification for the view that the parents must leave their children as wealthy after their death. In short, what you inherit is not what you “earned”. It was “unearned”, over which you have no perpetual right.

In short, the inheritance tax originated in capitalist economies. Piketty has argued that progressive inheritance taxes are “an ideal compromise between social justice and individual freedom”, and represent “a relatively liberal method for reducing inequality”, where the state neither prohibits or expropriates wealth nor disrespects free competition or private property.

Advantages of inheritance tax

There are philosophical and economic justifications for the existence of the inheritance tax. To begin with, unlimited inheritance across generations leads to the persistence of wealth inequality and an accumulation of extreme “unearned” wealth. Consequently, there is no “equality of opportunity”, as inheritors enjoy an unfair headstart over others. The possibilities of social mobility are also diminished. By helping equalise inter-generational wealth distribution in the long run, inheritance tax enhances equality of opportunity and social mobility.

Secondly, inheritance tax increases horizontal equity in the fiscal sphere. When two persons receive the same amount of assets, they must be taxed similarly irrespective of whether the assets were earned or inherited. In the absence of inheritance tax, earnings and inheritances are treated differently, which leads to horizontal inequities.

Thirdly, inheritance tax helps increase vertical equity in taxation. Those with a higher ability to pay taxes must pay more. When inheritances are taxed, that too progressively, vertical inequity declines.

Fourthly, inheritance taxes reduce the misallocation of capital. There is no certainty that all heirs are good entrepreneurs. Inheritance tax promotes competition and motivation across generations and incentivises heirs to work and save better.

Fifthly, via the “Carnegie effect”, inheritance tax may incentivise large wealth holders to donate more to charities during their lifetime rather than pay inheritance tax at death. In the 1880s, the American steel magnate Andrew Carnegie advocated a 100 per cent inheritance tax. Carnegie said that a man who did not give away his riches during his lifetime “dies disgraced”, and the state’s taxation of his estate marked its “condemnation of the selfish millionaire’s unworthy life”. His views were cited by Warren Buffett when he donated $31 billion in 2006 to the Bill and Melinda Gates Foundation.

A rise in inequality was probably kept in check. But absolute levels of wealth inequality remained high. The persistence of wealth inequality also had an inbuilt caste dimension.  | Photo Credit: MOHAMMED YOUSUF

Criticism of inheritance tax

One of the criticisms of inheritance taxes is that they are a tax on capital, and could lead to a depletion of capital stock after each generation. This is a baseless criticism because, firstly, even a high rate of income tax can also potentially lead to a depletion of capital, and all inheritance taxes are not necessarily paid by disposing of capital.

Secondly, even when heirs are forced to sell a part of the capital to pay inheritance taxes, there is no diminution of the country’s capital as a whole; there is only a change in their ownership.

Another criticism is that inheritance taxes amount to double taxation, that is, you tax a person’s wealth during his/her lifetime and then tax him/her again after death. Getting taxed twice is nothing new; for instance, we all pay a GST on goods that we buy with our incomes for which an income tax has already been paid. In inheritance taxes, the concern disappears if we disregard the deceased wealth-holder’s perspective. If we consider just the heir’s perspective, there is no double taxation because he/she pays an inheritance tax only once during his/her lifetime to obtain access—as if in an asset purchase—to an unearned asset.

Some others argue that inheritance taxes discourage entrepreneurship. But if we logically allow this criticism, we may also be explicitly violating the “equality of opportunity” principle. Be that as it may, all taxes may be construed as disincentivising entrepreneurship in one way or another. In fact, a one-time inheritance tax can only be a smaller disincentive to entrepreneurship than other annually charged taxes.

The Indian case

Independent India in the late 1940s was a highly unequal society, with inequality high in land and asset ownership. Inequalities were also high in the ownership of buildings, precious metals, and financial savings because of the legacy of the princely classes.

Consequently, estate taxes were introduced in 1953, wealth taxes in 1957, and gift taxes in 1958. These taxes were withdrawn in the 1980s and 1990s. Three reasons are usually cited for their withdrawal: one, their contribution to the gross tax revenue was less than 0.25 per cent; two, the costs of administration and compliance were unduly high; and three, the concurrent presence of wealth and estate taxes amounted to double taxation.

In fact, the poor revenue flow from estate, wealth and gift taxes was not surprising. India’s overall economic growth was only about 3 per cent per year, and industrial and financial growth was concentrated in the public sector. A rise in inequality was probably kept in check. But absolute levels of wealth inequality remained high. The persistence of wealth inequality also had an inbuilt caste dimension. Almost all land- and asset-holding groups belonged to the dominant castes.

However, economic liberalisation after 1991 substantially transformed the situation. The new economic policies encouraged private accumulation through reforms in land laws and the ease of doing business. Corporate and income taxes were cut. New estimates show that notwithstanding absolute rises in the average value of assets owned, asset inequality greatly increased after the 1990s.

The wealth share of the bottom 50 per cent of the population fell from 10.9 per cent in 1981 to 6.5 per cent in 2023. Even the middle 40 per cent saw a fall in wealth share from 44.1 per cent in 1981 to 29 per cent in 2023. At the other end, the wealth share of the top 10 per cent rose from 45 per cent in 1981 to 64.6 per cent in 2023. For the top 1 per cent, the wealth share rose from 12.5 per cent in 1981 to 39.5 per cent in 2023.¹

In 2022-23, the top 1 per cent of the population owned assets valued at a whopping Rs.499 lakh crore. Land and buildings comprised about 90 per cent of these assets. Such a vulgar rise in asset inequality after the 1990s reignited discussions around the reintroduction of wealth and inheritance taxes in the country.

An estimate for 2018 showed that a 2 per cent wealth tax and a 33 per cent inheritance tax on just the top 1 per cent of private individuals in the country (that is, less than 1 crore persons) could fetch Rs.12.1 lakh crore as additional tax revenues annually. These revenues can be used to establish a comprehensive social security net for the poor covering employment, food, education, health, and old age pensions.²

Distorting the debate

It would be morally repugnant for any modern society to allow the vulgar levels of inequality, as they exist today, to persist. Any progressive welfare state must implement a progressive system of inheritance taxes. It is thus only correct that it is openly and fully discussed.

However, the urge of the BJP to communalise all suggestions from the opposition has effectively killed the space for reasoned debate. Any discussion on inheritance tax will now be miscommunicated with the bizarre claim of wealth transfer across religious communities.

While inheritance tax applies only to high-value inheritances of the top 1 per cent of the population, the Prime Minister’s false claim that the mangalsutras of women will be snatched away is meant to promote an irrational atmosphere of fear among the middle classes. He and his party have equated the demand for equality as a “Maoist” agenda, and those who raise it as “urban naxals”. Such condemnable interpretations have caused enormous harm not just to the cause of socioeconomic equality but also the welfare of the poor and downtrodden.

R. Ramakumar is a Professor at the Tata Institute of Social Sciences, Mumbai.

Notes

¹ See Nitin Bharti, Lucas Chancel, Thomas Piketty and Anmol Somanchi, “Income and Wealth Inequality in India, 1922-2023: The Rise of the Billionaire Raj”, World Inequality Lab, 2024.

² See Prabhat Patnaik and Jayati Ghosh, “For a Set of Universal Economic Rights”, in We the People: Establishing Rights and Deepening Democracy, edited by Nikhil Dey, Aruna Roy and Rakshita Swamy, Penguin Books, 2020.