Singh, Ram, ‘Are the rich underreporting their income? Using General Election Filings to Study the Income-Wealth Relationship in India”, World Inequality Lab Working Paper No. 2023/01, January 2023
gEconomic inequality is a major concern in most developing countries and India is no exception. According to Oxfam, the richest 1% in India own more than 40% of the country’s total wealth, while the poorest 50% share only 3%. One of the proven ways to alleviate economic inequality – which has been linked to a number of social and political ills – is progressive taxation, where the higher your income, the higher the tax rate. This approach would allow for some form of redistribution to the poorest strata through state-funded social protection schemes and investments in social infrastructure, which is key to reducing inequality. However, for this approach to work, reported income must be accurate. Otherwise, a progressive tax system on paper may not be so in practice. For example, what happens if a significant portion of an individual’s income is never declared? He would never be taxed. Therefore, income reporting behavior is a central issue in public finance.
The extent of inequalities
This research paper by Ram Singh models the relationship between wealth and reported income for individuals in different economic strata. For the first time, affidavits filed by candidates in the Lok Sabha elections have been used for such a study. They provide income and wealth data for a large number of Indians – 7,596 households (HH) and their adult members. The dataset is surprisingly inclusive, with earnings ranging from ₹178 to ₹206 crore. Singh supplements this data with the Forbes (FL) list of billionaires and statistics published by the Central Board of Direct Taxes (CBDT). Taken together, they cover the full spectrum of India’s wealth and income distribution, as well as regional and rural-urban population distribution.
The main conclusion of the paper, which has implications for public finance, inequality studies, and tax design, is that the wealthier the individual or family, the greater the reported income relative to wealth. is weak. Specifically, the study found that “a 1% increase in family wealth is associated with a more than 0.5% decrease in reported income as a wealth ratio.” While it is not surprising that the income-to-wealth ratio declines as one moves up the wealth ladder – the poor, by definition, hold few assets – the sharp decline in income-to-wealth ratios of rich, and how this, in turn, leads to an ever-lower tax burden for the super-rich, highlights major shortcomings in the tax system. It also suggests that economic inequality in India – extreme as it is – is still underestimated.
For example, the study found that “the total income reported by the poorest 10% of families ‘accounted for more than 188% of their wealth’, while in contrast, the 5% and 0.1% of families the wealthiest reported incomes that were barely 4% and 2% of their wealth, respectively.For the wealthiest Indian families on the Forbes list, their total reported income averaged less than 0.6% of their wealth. In addition, reported income-to-wealth ratios for the top 20% were less than a third of the national average, and for the top 0.1% it was just 12% of the national average. listed on the Forbes list, it is one-twentieth of the national average.
Capital gains
As the author notes, “even controlling for average returns to capital, incomes reported by affluent groups are well below expected levels.” Do the richest earn so little? Or do they simply live off their fortune? Or is it possible that their income somehow disappeared from tax records? Singh’s article shows that much of the income of the wealthiest families tends to “miss out”, and this is usually a form of income called capital gains, or income from the appreciation of all active. The study finds that the total income declared by the richest 0.1% of families is only about one-fifth of their capital income, and “at least 80% of their capital income is not declared in the tax returns”. This is a huge sum since the richer a person, the greater the share of capital income in his total income. In other words, the richer a person, the greater the share of undeclared income. So how does such a part of capital income disappear from declared income?
The document explains that the wealthiest groups “hold most of their wealth in the form of equity, non-farm land, and commercial property. This asset class allows owners to manipulate the distribution of capital income between what must be declared and what can legally be undeclared. The enabling accounting feature here is that under Indian tax law, capital gains on an asset are treated as “unrealized” unless they are exchanged or sold. Capital gains “are therefore neither taxable nor required to be reported in ITRs. This means that as long as an investment is not sold, it is not tax payable, regardless of the amount of appreciation in the value of the asset due to capital gains latent. In fact, even when the asset is eventually sold, the effective tax rate on the accrued capital gain is much lower than other forms of realized income. Thus, to reduce their tax burden, the rich tend to avoid realizing capital gains. They do this by staying invested in stocks and commercial properties.
The Indian tax system
The paper also explains how the wealthy manipulate other forms of capital income, such as dividends (profits distributed to shareholders). A common tactic here is to reinvest profits, as this not only avoids any additional taxes, but also increases the market value of the company’s shares. “Looking at these gains, wealthy groups want to reinvest most of their profits in group companies by keeping their dividend payouts as low as possible…Such manipulations of capital income in response to the dividend tax are an international phenomenon.” Of course, that’s not to say that only the wealthy underreport their income. This behavior is found in all strata. For example, the report finds that “people in all wealth groups report some taxable labor income as farming income to avoid paying taxes,” which may explain why some people develop a sudden interest in farming. after achieving success and wealth. The paper points out that India’s tax system, which appears progressive “in the sense that the marginal tax rate…increases with declared income”, is in fact regressive when assessed against the total income of the wealthiest. rather than their declared income. For it to become truly progressive, “the taxable income reported by the top 0.1% must increase by at least 60%”.
A final implication of this study concerns the estimation of inequalities. Most estimates are based on taxable income reported in ITRs. But since total income is always greater than reported taxable income, and the gap between the two widens for the wealthiest groups, the paper points to “a staggering level of difference between measures of income that informs existing studies on inequality and real income”. of the most prosperous Indians. Put simply, income inequality in India is worse than most estimates, and the effective tax rate, which is not truly progressive on income, is even less so on income. the wealth. The study concludes by noting that for India’s tax system to be truly progressive, it needs to be redesigned so that it can fit into the tax net the huge amounts of capital income that currently tends to “miss out” from reported income of the wealthy. .
