Why a Billionaire Tax Doesn’t Make Any Sense for Politicians

Incentives.

In the end everything boils down to it.

In the run up to the annual budget of the union government presented by the finance minister Nirmala Sitharaman, on February 1, many economic commentators suggested that the government should resort to a one-time billionaire tax.

The idea being that the stock market has rallied big time during the course of this financial year. Hence, while the income of the average Indian has fallen thanks to the economy contracting, the super-rich have become richer.

This one-time tax could fund a lot of extra expenditure in the budget in 2021-22, as the government tried to act as the spender of the last resort in an environment where private spending has slowed down and industrial expansion isn’t happening at the same pace as it was.

If you are the kind who practices first level kind of thinking, this makes perfect sense. The rich have grown richer. So, let’s take money from them and give it to those who need it. It also leads to greater equality, at least in your head. This kind of Robinhood thinking has prevailed for centuries. Hence, there is no reason for it to go away in 2021.

Nevertheless, if you are the kind who practices second level thinking and at the same time thinks about the incentives on offer, you would know that something like this doesn’t make sense and is also unlikely to happen.

Let’s try and understand this pointwise.

1) It is important to understand that billionaires don’t have cash lying around to pay this tax. So, one way they would have raised cash to pay this tax would have been to sell some of their shares. Of course, given the sudden increase in supply of shares in the market could have led to the stock prices falling.

2) Actually, more than the billionaires selling their stake to pay up the tax, the stock market would have seen this move of the government in a negative way and sold off, even before billionaires would have started thinking about how to pay the tax. In fact, in the run up to the budget, the stock market did worry about new taxes and there was a sell off last week. This was its way of telling the government, please, no new taxes. It has been rising this week, since it realized that no news on the tax front is good news.

3) Currently, the government needs the stock market on its side, with its plans to raise Rs 1.75 lakh crore through the disinvestment route next year. And that is only possible if the stock prices continue to remain at high levels. Hence, it would have made no sense for the government to disturb the status quo. If the market would have fallen, it would have impacted the ability of the government to raise the amount of money it wants to through disinvestment. This would have, in turn, impacted its ability to spend.

4) These were the near-term reasons. But there are more issues at play here. Most Indian billionaires finance political parties both on record and off record. In their eyes they are already paying a billionaire tax. A lot of this money finds its way into the economy and is spent, during election time. In that sense, billionaire money is pump priming some part of the Indian economy all the time, given that elections to state governments happen every year.

Of course, no billionaire does this as a social service. They are looking for a quid-pro-quo from the government. That needs to be kept in mind as well.

5) It’s important to look at this entire idea from the point of view of the incentive at play for a politician as well. Politicians exist to win elections. For this they need money, a massive amount of it. They can’t win elections by spending money within the limits set by the Election Commission. Where does this money come from? To a large extent from billionaire businessmen who operate in spaces where they need to deal with government all the time. Hence, why would any politician in his or her right mind try to disturb this equation by irritating the main funders through a high one-time income tax. It just doesn’t make any sense.

6) Finally, a high-income tax, one-time or otherwise, is always a bad idea. One it leads to a narrative of inconsistent tax policy, which the Indian government anyway suffers from. Two, it also leads to high income earners, who can leave the country to leave the country, and move to tax havens. The highest income tax rate in the country currently is greater than 40%. Hence, not surprisingly, a whole bunch of high-income earners have moved or want to move to places like Dubai. This obviously means they no longer pay their income tax in India.

Given these reasons a billionaire tax didn’t make any sense. Having said that, there is a case for clear rationalization of tax rates that is needed. You can’t have a small proportion of the salaried paying the highest marginal rate of more than 40% or even 30%, whereas those who can use the benefit of indexation while paying income tax, not paying any tax at all or a very low rate of tax. This needs to be corrected.

Kaala Dhandha Gore Log – Why politicians are not serious about black money

kaala dhandhaVivek Kaul

Sometime in the mid 1980s, I vaguely remember spending a few days with my family, in one of the many small coal producing towns that dot what is now known as the state of Jharkhand. As was common in those days, we had hired a VCR and had decided to go on a movie watching spree.
One of the movies on the list was
Kaala Dhandha Gore Log. The movie was directed by Sanjay Khan. That is the only bit about it that I still remember. I don’t know why, but I found the title of the movie very fascinating and was really looking forward to watching it.
But the adults in the family threw a spanner in the works and banned us “kids” from watching the movie, without really going into the reasons for it. Around three decades later I can speculate as to why we weren’t allowed to watch the movie.
I guess the movie must have had a few scenes with the heroine mouthing the most famous cliché of the eighties,“
mujhe bhagwan ke liye chhod do,” or it must have had songs we now call “item numbers”.
Those were days when cable television hadn’t come to India (that would happen only in late 1991, early 1992). Middle class India still hadn’t discovered
The Bold and the Beautiful or Santa Barbara for that matter, two shows that went a long way in Indian parents becoming a lot more liberal in deciding what their kids could watch on television.
For some reason the title of the movie has always stayed in my mind, and I have speculated now and then, on its possible storyline. As the title of the movie suggests, the story could possibly be about businesses run by white people (meaning foreigners) which throw up black money.
Three decades later, reel life seems to have turned into real life. There is a great belief in this country that all of the black money generated over the years is now with foreigners. It has been transferred into foreign banks operating out of tax havens. The prime minister Narendra Modi has promised to get the money back.
In an earlier piece I had explained why getting this money back is not a feasible proposition, even though it might sound possible. And a better thing to do would be to simply concentrate on unearthing all the black money that is there in the country. I had also said that a lot of black money which has gone abroad over the years is possibly now being round-tripped to India, given that the chances of earning a good return are better in India.
Nevertheless, there are two questions that arise here? First, why has the black money problem been allowed to become so huge? Second, will the politicians choose to do anything about it? Let me answer the second question first.
Political analyst Mohan Guruswamy shared some very interesting data
in a recent column in The Asian Age. Between 2004-05 and 2011-12, national political parties collected Rs 435.87 crore as donations. Of this the Bhartiya Janata Party received Rs 192.47 crore from 1,334 donors and the Congress Rs 172.25 crore from 418 donors.
Corporates made 87% of these donations. Interestingly, over and above this, the parties received donations from unknown contributors as well. The Congress party received a total of Rs 1,185 crore in three financial years (2007-08, 2008-09, 2009-10) and the BJP received around Rs 600 crore during the same period.
It is worth remembering that in the period between 2004-05 and 2011-12, there were two Lok Sabha elections and many elections to state assemblies. It doesn’t take rocket science to come to the conclusion that the amount of donations declared by the political parties were clearly not enough to fight so many elections.
In fact, a study carried out by Centre for Media Studies in March earlier this year estimated that around Rs 30,000 crore would be spent during the 16
th Lok Sabha elections which happened in April and May 2014. Of this total, the government would spend around Rs 7,000-8,000 crore to conduct the elections through the Election Commission and the home ministry.
The remaining amounts would be spent by the candidates contesting the elections and the political parties they belonged to. Candidates standing for Lok Sabha elections are allowed to spend only Rs 70 lakhs for fighting an election in bigger states. For other states, the amount varies from anywhere between Rs 22 lakh to Rs 54 lakh.
These amounts are peanuts when it comes to fighting elections. Even candidates from major political parties fighting state level elections spend more money than this. Candidates stay within these limits officially, but political parties spend much more money outside the set limits, during the course of campaigning.
What this tells us clearly is that political parties have got access to funding beyond what they have declared in the public domain. This money that comes to them is black money. This black money can possibly be the money that politicians have accumulated through corruption or money handed over by crony capitalists looking at possible favours in the days to come.
Hence, a crackdown on black money within the country would lead to the major source of funding for political parties and politicians being impacted. Guruswamy put it very aptly in his column when he said “
Their own taps will run dry.”
Now, let me try and answer the first question, which was that
why has the black money problem been allowed to become so huge? Why has it been left unattended for so many decades? As Daron Acemoglue and James A Robinson write in Why Nations Fail—The Origins of Power, Prosperity and Poverty “Political institutions determine economic institutions…Extractive political institutions concentrate power in the hands of a narrow elite and place few constraints on the exercise of power. Economic institutions are then often structured by this elite to extract resources from the rest of the society. Extractive institutions thus naturally accompany extractive political institutions. In fact, they must inherently depend on extractive political institutions for their survival.”
So what does this mean in the Indian context? It means that the Income Tax department, which is supposed to be unearthing the black money in this country, is corrupt because the politicians running this country are corrupt. The way the economic incentives of politicians have evolved has led to a situation wherein they simply cannot become active in cracking down on black money.
It explains why only 3.5 crore individuals out of a population of 120 crore pay income tax in this country.
To conclude, the question worth asking is, what will it take for politicians of this country get serious about unearthing black money?

The column originally appeared on www.equitymaster.com on Nov 14, 2014