Why we need lower taxes on capital gains We are no longer the country that approves centralisation of economic power. We are a nation where everyone aspires to be rich. Our policies must recognise and reward the capability of households to be in charge of their financial futures
Uma Shashikant
Chairperson, Centre for Investment Education and Learning
As a household’s income grows, its contribution to the larger community should also increase. Equitable taxation policies begin with this noble idea. The government assumes a central role in managing tax contributions and their distribution. But then it loses its way, endlessly tinkering with the rules as it’s pushed by varying lobbies and interest groups. Taxation of capital gains is one such idea that is routinely tossed around every time the Budget proposals are made.
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If there is an asset and it earns an income, we shall subject it to tax, says the government. The objective is maximisation of revenue for development, among others. So, capital assets like property, gold, equity shares, debt instruments, mutual funds are all subject to taxes, both on the income they generate (rent, dividend, interest), and the appreciation in value over time. Why not simply add capital gains to the tax return and tax these at the same rate as income? There are three reasons for this.
First, capital gains accrue over time and include the impact of inflation. If an equity share was bought for Rs.100 and sold after five years for Rs 200, a portion of that gain could be merely the time value of money adjusted for inflation. The current income and the one that has accrued over the years cannot be taxed at the same rate. Second, capital gains have already passed through many loops of taxation. The investor saves post-tax income to buy capital assets. The asset also pays its share of corporate and property taxes. To tax what the investor receives on selling, one must consider the fact that taxes on the capital asset have already been paid partially. Third, lower tax on capital gains encourages saving and investment as households postpone current consumption. Long-term assets are built to benefit both the household and the economy when savers are aware that the income they can earn in the future from these assets will be subject to lower taxation. The differential taxation of shortand long-term capital gains comes from this reasoning.
Every regime in the world uses multiple interpretations of these three positions and taxes capital gains accordingly. Nordic nations levy a high rate; tax havens don’t tax capital gains at all. We, in India, have tinkered with every aspect of these arguments almost every year. We have a cost of inflation index for capital gains on sale of property. We have modified the rates of capital gains tax almost every year. From long-term capital gain on equity being completely tax-exempt, we are now ratcheting up that rate. We introduced STT as a means to tax transactions rather than capital gains.
There is no right thing to do when it comes to capital gains tax. Every tax proposal will have its unintended consequences. What, for example, is the primary impact of lower tax rate on capital gains? The richest in the world pay lower tax rate overall because their primary source of income is capital assets built over time. The poor do not earn or save enough and, therefore, do not hold many capital assets. The rich argue that the incentive to create long-term wealth for the community comes from the ability to build businesses that will appreciate in value over time. Others argue that this model of development creates severe inequalities in income.
The tax regime in India operates on two primary premises: the government needs money, and the economy needs investment. The question is whether we are doing better with the power to allocate money in the hands of the population rather than the government.
Just about 40 years ago, we began the shift from being an economy that had the government as the single most important investor in all aspects of economy and business. We are now driven by private investment and consumption. The whole world watches in awe as the power of consumption of India’s large population drives its economy to new heights. The business landscape is dominated by small and big entrepreneurs, not seekers of government jobs for steady income. We need lower capital gain taxes because there is a large population that is capable of saving, investing, creating, growing and supporting businesses. We are no longer the country that approves centralisation of economic power, where the rich hide their wealth, evade taxes, and pretend to be entitled. We are a nation where everyone aspires to be rich and believes they can make it big on their own merit. Our policies must recognise and reward the capability of households to be in charge of their financial futures.
Capital gain is the reward for taking risk on an asset for the long term. We need households taking this risk for propelling themselves into the next rung of wealth by creating businesses, investing in other businesses, holding assets they can sell, use, revise and reallocate efficiently. Tax policy needs the bold approach that leans on consumption expenditure, widespread entrepreneurship and business growth as sources of both income and wealth.
What do we have instead? Properties are not sold for generations primarily because we don’t want to pay tax on capital gains. We have tax-saving bonds and facilities to reinvest in property, but most households kick the can to the next generation or let the asset lie. The real estate market features unsold dead stocks and black money cash transactions, both features tough to measure in data for their impact on the economy.
The holding period of an investment in equity or debt is primarily driven by how it will be taxed on its sale. Many businesses choose to remain small, borrowing informally and refuse to seek public capital. The market for corporate control operates with an eye on taxation of unlisted equity capital. We need lower taxes on capital gains because we have only begun creating and managing large-scale business and investment assets for ourselves, the community and the economy.
Tinkering on the edge hoping to make some pay a few more rupees is micro management without conviction. It leads to modifying definitions and rates too often. It creates confusion year after year about when to sell which asset to reduce capital gains tax. We can do better than that.
(The author is CHAIRPERSON, CENTRE FOR INVESTMENT EDUCATION AND LEARNING)
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This story originally appeared on: India Times - Author:Faqs of Insurances
