Inheritance tax: A key to economic equity or a barrier to growth?

Inheritance tax: Milton Friedman, an economist who was awarded the Nobel Prize in 1976 long back in his book titled “Capitalism and Freedom”, dubbed the inheritance tax useless and unjust way back in 1962. Back home in India, cut to 2024, the debate about the feasibility of implementing an inheritance tax has picked up steam. With Sam Pitroda’s entry into the picture, the debate surrounding inheritance tax and redistribution of wealth has heated up.

Advisor to former Prime Minister Manmohan Singh, Pitroda, in a flurry of tweets, dissected the rationale for having inheritance tax in India. “I mentioned US inheritance tax in the US only as an example in my normal conversation on TV. Can I not mention facts? I said these are the kinds of issues people will have to discuss and debate. This has nothing to do with the policy of any party, including Congress.” Pitroda said in a tweet on X.

I mentioned US inheritance tax in the US only as an example in my normal conversation on TV. Can I not mention facts ? I said these are the kind of issues people will have to discuss and debate. This has nothing to do with policy of any party including congress.

— Sam Pitroda (@sampitroda)

"Inheritance tax is an income tax on the value of the property which is inherited by the children from the parents. It was abolished in India in 1985 and at that time the tax was as high as 85 per cent. It was abolished because it did not achieve its purpose of ensuring equitable distribution of wealth, which it sought to achieve," said Vivek Jalan, Director of The Bengal Chamber of Commerce and Industry and Chairman of The Ease of Doing Business Committee.

"Even today, it is our view that the implementation of inheritance tax may not achieve its purpose because the value of the properties which are inherited in India or the cost of the properties which are inherited in India are still very low as compared to developed countries," Jalan added.

The world of inheritance

Since the experts are vouching for the implementation of inheritance tax in India, it is imperative to know how other countries are going about inheritance tax.
Sweden, New Zealand, and Norway abolished inheritance tax years ago. Australia followed suit long back.  When the world was reeling under the global financial crisis, Austria decided to abolish the basic provisions of inheritance tax.

Similarly, the world’s largest democracy, India, and its neighbour China, also have a zero-rate inheritance tax. On the flip side, the US and Ireland have higher inheritance tax in their countries.

The inheritance tax is also considered a non-contributor to the tax kitty. Take the example of the US where despite higher inheritance tax, its contribution to the US tax kitty is 0.4 per cent. The United States (US) imposes an estate tax on the transfer of a decedent’s taxable estate at death. US citizens and residents dying after 31 December 2012 are subject to a top estate tax rate of 40 per cent and are entitled to a $10 million estate tax exemption, which is adjusted annually for inflation.

“India initially followed a socialist and somewhat communist economic model post-independence, including heavy taxation like inheritance, wealth, and gift taxes. However, these policies hindered economic growth. Realising this, India abolished inheritance tax in 1985, gift tax in 1998, and wealth tax in 2016. This shift has contributed significantly to India's economic growth trajectory,” said Ved Jain, Past President of The Institute of Chartered Accountants of India.

India's approach to inheritance tax?

The inheritance tax, once a notable component of India's tax system, was abolished by the Rajiv Gandhi Government in 1985. This tax, also referred to as estate duty, was imposed on assets inherited by individuals, aiming to address wealth inequality.

Despite calls for its revival by people from various quarters of the economy, including considerations of its potential to mitigate economic disparities and boost government revenues, successive governments have rejected its reinstatement.

Former Finance Minister Arun Jaitley, amongst others, has cited the comparatively lower value of inherited assets in India compared to developed countries as a reason for its impracticality.

India abolished the Estate Duty Act, which was akin to an inheritance tax, in 1985. The abolition of estate duty in India was driven by a combination of factors, including its limited revenue contribution, administrative complexities, impact on business succession, competitiveness concerns, and broader policy objectives of economic liberalisation.

The estate duty did not yield significant revenue for the government. It was found that the cost of administering and enforcing the tax often outweighed the revenue generated from it. The low revenue yield made it less attractive from a fiscal perspective.

Estate duty laws were complex and prone to evasion and avoidance. The administrative burden of enforcing these laws was high, and the government faced challenges in effectively implementing them. The complexity of the tax system led to inefficiencies and loopholes.

Estate duties have implications for the transfer of family-owned businesses between generations. Many argue that the tax burden on inherited businesses could hinder their growth and continuity. This was particularly important in a country where family-owned businesses play a crucial role in the economy.

How does inheritance tax work in the US?

An inheritance tax is a state-imposed levy on assets received from a deceased individual. Unlike an estate tax, which is paid by the deceased's estate before distribution, an inheritance tax is shouldered by the recipient of the inherited assets. This tax is relatively uncommon in the United States, with only six states enforcing it as of 2023: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

The taxation rate depends on factors such as the state of residence of the deceased, the value of the inheritance, and the beneficiary's relationship with the deceased. Notably, there is no federal inheritance tax in the US Inheritance taxes vary from estate taxes, which are imposed on the estate itself.

While the federal government may tax large estates directly through estate taxes, it does not impose inheritance taxes on the recipients of assets from an estate. The assessment of inheritance taxes is contingent on the laws of the state or states where the deceased resided or owned property.

How do relationships and state laws influence payments?

Inheritance taxes are calculated based on the portion of an inheritance that surpasses a predefined exemption amount. Beyond these thresholds, taxes are typically levied on a sliding scale. The tax rates usually commence in the single digits and escalate from around 15 per cent to 18 per cent. The exemption you receive, and the tax rate applied may vary depending on your relationship with the deceased, rather than solely on the value of the inherited assets.

Generally, the closer your familial ties to the deceased, the higher the exemption and the lower the tax rate you'll encounter. Surviving spouses are exempt from inheritance tax across all six states where it's enforced. Additionally, domestic partners enjoy exemption in New Jersey. Descendants, however, are only subject to inheritance tax in Nebraska and Pennsylvania.

In most states, inheritance tax applies to inheritances exceeding specific thresholds. These thresholds vary depending on the state and the familial relationship between the deceased and the heir. For instance, in Iowa, estates valued at less than $25,000 incur no tax, while in Maryland, inheritances from estates smaller than $50,000 are exempt.

Inheritance tax in India: Opportunity or obstacle?

Implementing an inheritance tax in any country is a complex decision that involves considering various economic, social, and political factors. In the case of India, it would depend on the specific goals and priorities of the government, as well as the current state of the economy and society, say countries and how they've implemented and managed such taxes could provide valuable insights for India, say experts.

"See, the possible ramification in case inheritance tax is introduced in India will be that our growth will hamper our, what we call dream of making India as a manufacturing capital of the world will be hampered. And the 7 per cent plus growth which we are projecting and which we intend India should do will never happen because people will not have that many resources, that much capital in their hand. And another reason is that, as I said in the beginning, taxes are levied not for the sake of taxes that should be levied," Ved Jain, President," Ved Jain, Past President of The Institute of Chartered Accountants of India.

"Taxes are levied to meet the expenditure of the country. In case the resources of the country, the income of the country from other taxes is sufficient to meet the expenditure, including capital expenditure, including the expenditure which is required for growth, for the infrastructure, then there is no need to introduce a tax which could hamper growth. And that's why there is no need to introduce inheritance tax in India," Jain added.

The introduction of inheritance tax may face opposition from certain segments of society, particularly those directly affected by it. Public perception and acceptance of the tax would be an important consideration for policymakers.

Ultimately, whether it's the right time to implement inheritance tax in India depends on a careful assessment of these factors and a thorough consideration of the potential benefits and drawbacks in the Indian context. It would also require broad-based consultations with stakeholders and careful planning to ensure its effective implementation.