Did We Need Piketty To Tell Us Indian Inequality Is Up? Here’s What We Need To Do About It

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R Jagannathan

Inequality is real, but the answers lie not in soaking legitimately earned wage, salary and skill-related incomes, but unearned wealth passed on to the next generation which may have done little to create it.

We need to protect incomes and wealth creation, not wealth transfers.

The Left loves Thomas Piketty, a French economist, who has been hailed as the Karl Marx of the 21st century, for his work on inequality. In his 2014 book, Capital in the 21st Century, Piketty says that inequality is increasing again as old wealth accumulated over the years yields higher returns than the overall rate of economic growth, on which depend the incomes of the aam aadmi.

You don’t have to navigate the tense prose of Piketty’s book to figure out that wealth is getting concentrated, especially when Wall Street hits the stratosphere while the rest of the global economy is struggling to grow, and quality jobs are disappearing. In India, you only need to step out of your cosy 2BHK in some distant Delhi, Bengaluru or Mumbai suburb to notice the inequities.

Piketty’s equation is, in a sense, simple. He says if r is greater than g, where rrepresents return on wealth and g is economic growth, inequalities will rise. And when this is the case, governments must tax wealth.

Given the data he has amassed while writing his book, Piketty has come back to plug us in the eye with a new report on India, titled Indian income inequality, 1922-2014, from British Raj to Billionaire Raj. In the report, co-authored by Lucas Chancel, he says that India’s income inequality now stands at 22 per cent as against the earlier 6 per cent in the early 1980s period.

Piketty’s definition of inequality is not the Gini coefficient, a statistical measure of income skews in a population. He uses the more rough-and-ready method of looking at the income share of the top 1 per cent based on the taxes they paid. Thus, 22 per cent inequality means the top 1 per cent of India’s rich earned 22 per cent of total incomes.

But this does not appear so obscene when you consider another statistic thrown up by the Piketty and Chancel study. They noted that the top 1 per cent accounted for a higher share of the economy’s growth than what their income share would indicate: they generated 29 per cent of the economy's growth, and the top 0.1 per cent generated 12 per cent. Clearly, higher contribution ends up generating higher incomes from the top 1 per cent.

The bottom half of the population saw its share of growth contribution fall from 28 per cent in the 1951-1980 period to just 11 per cent.

So, what should we conclude from this data, assuming it represents reality?

One, if we assume that the richest Indians probably are more adept at evading or avoiding taxes, their share of incomes could well be higher. We need to look at this data more closely, using better tools than just tax payment.

Two, the richest people derive their incomes not just from labour (including mental labour), but from investments in capital and other assets. For example, when taxes on dividends deducted at source are lower than on salary income, inequality is exacerbated. When the rich invest in tax-free bonds, they earn incomes without paying any tax, in contrast to middle class Indians who put their money in bank deposits and pay taxes.

To reduce the income skews in favour of the rich and the better off, incomes earned from capital investments ought to be taxed at least at the marginal rate of the taxpayer. Long-term capital gains taxes on equity should also be positive, and not zero as at present, though this gain can be adjusted for inflation. Broadly speaking, incomes earned on labour, whether manual, skilled, semi-skilled, or super-skilled, ought to be lower upto liberal limits (say, upto Rs 1 crore) than on income earned from investing capital, in order to reduce inequities.

Three, the super-low contribution of the bottom 50 per cent of the population is a reflection of the very low literacy and other skills of the poorer segments of the population. Clearly, education is the missing element and partial cause of this skew. Government and private investment must be loaded in favour of school, secondary, and skill-based vocational education, and subsidies for the IITs and engineering colleges could be gradually eliminated. Investments in make-work schemes like MGNREGA alleviate short-term poverty, but investing the same amounts (now touching Rs 50,000 crore every year) in improving education and skills can probably yield better dividends. It is the skills gap that makes inequality wider than it needs to be.

Four, the big driver of wealth inequality is inheritance. Capital compounds over generations, and when wealth is handed over from generation to generation, the accumulation will generate more incomes from capital even without any value-add from an entrepreneur. So, some people will be born with advantages over the rest.

This calls for the introduction of an inheritance tax, possibly an estate duty where basic exemptions can be high (say, Rs 10 crore per inheritor), but the balance is taxed at 30 per cent. The base for exemption can be raised in line with inflation every three years. In the US, estate duties payable on wealth transfers after death range from 18-40 per cent, depending on the amount inherited.

Inequality is real, but the answers lie not in soaking legitimately earned wage, salary and skill-related incomes, but unearned wealth passed on to the next generation which may have done little to create it. We need to protect incomes and wealth creation, not wealth transfers.