Taxing the rich: How to impose taxes on the wealthy

Soak the rich" is a popular tax policy theme. However, let's get the first principles of taxation sorted out. Here's a short guide, and an assessment of India's record.

Why Do We Have Taxes

There are only three valid reasons. The rest are subterfuges. One, we want governments to provide, or fund, some goods and services. Tax fatigue, or reluctance to pay taxes, is largely because these services aren't satisfactorily provided. If you leave national security aside, most of these services are supposed to be provided by state or local governments. Note, however, that a gargantuan share of tax revenue is collected by the Centre, and all this goes into a black hole known as the Consolidated Fund. Therefore, in many cases, it makes sense to charge a fee for a public service, rather than use tax revenue. The quid pro quo is clear for fee-based services.

The second valid reason for taxation is the better-off must contribute more. "Taxing the rich" debates are part of this principle of progressive taxation. Thirdly, we want taxes to discourage things like smoking, or incentivise certain other things - green technology, for example.

Silly Taxes on the Rich

There have been hundreds of wrong or plain silly taxes, many of them imposed on the wealthy. The list of the silliest taxes imposed on everyone, not just the wealthy, would include Vespasian's tax on urine used for tanning, salt taxes and the tax on blueberries imposed by Maine in the US. Silly taxes on the rich have usually focused on items of perceived luxury consumption. They have all failed. England had a tax on printed wallpaper.

So, builders and people used plain wallpaper and painted them later. England also had a house tax that was a function of the number of windows. The idea being that houses of the rich would presumably have more windows. People responded by building fewer windows. In some European countries, taxes on houses became a function of width of staircases. People responded with narrow staircases and wider windows, so that furniture could be moved in and out through windows.

Silly Indian Taxes on the Rich

Pre-reform India's tax rules never understood this: if you tax so-called elitist consumption items more, you (a) make some items pricier and take them beyond the reach of the non-rich and (b) encourage unlawful behaviour because those with money will find a way to get around the law. Post-reforms tax policy is smarter, but not wholly smarter.

Take service tax proposals for the 2011-12 budget. The assumption is that hotels, irrespective of where they are located, that charge more than Rs 1,000 per day must be only for the rich. And hospitals that have 25 or more beds and air-conditioning must also be catering only to the rich. Or maybe the assumption was that the middle class can be made to cough up as well, to fill the exchequer. The point is, high indirect taxes - taxes on goods and services - are a terrible way to tax the wealthy.

Source: Economic Times