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International NGO Oxfam released its annual inequality survey recently and the world was shocked to know that 82% of the wealth generated in 2017 was held by top 1% richest people in the world. For India, this statistic stands at 73%.  Like every year, this year as well critics of the survey questioned its methodology that calculates wealth as (assets-liabilities) and its intention behind focusing on rising inequality instead of talking about the decreasing poverty. No matter what side you are on this debate, one cannot argue that, inequality levels in India are high and that one must look for possible reasons and changes that could be brought in to narrow down the gap between the rich and the poor. This article seeks to look at how a country’s tax structure impacts its income inequality levels and also tries to compare some countries on these standards.

Let’s try and answer some basic questions

Why is tax policy important?

A country’s tax policy is crucial in deciding the fate of its citizens because, for any government, it is one of the most important sources of raising revenue which then determines government’s expenditure in areas that benefit the low-income groups. Other than this, expenses incurred from the tax revenue collected; make the government accountable to its taxpayers about the various activities and expenses that are undertaken. It is important to look at a country’s tax structure while analyzing income inequality because most experts agree that tax reforms, especially progressive taxes can help redistribute incomes and thus address inequality. According to a paper published by the OECD Observer,’ tax and transfer systems reduce overall income inequality in all countries. On average across the OECD, three-quarters of the reduction in inequality is due to transfers, the rest to direct household taxation.’[1]

What have been the trends in India over the years?

According to an intensive analysis by economists Thomas Piketty and Lucas Chancel[2], although Indian tax base has increased over the decades, there are some loopholes to be looked at. One of them and quite possibly an important one is the absence of any published tax records for the years 2000-2010. It is important to note that the sampling method underwent a major change during this period, but there is no official reason to opt out of publishing tax data.

According to their analysis, the income distribution in India has seen a significant change since the mid-80s and especially after the reforms of 1991. Till the 70s, the country saw a comparatively equitable increase in wealth, being the best phase for the middle-income earners but since the mid-80s, the share of the top earners has been on a continuous rise. From 1980 to 2014, the bottom 50% experienced an increase of 97% while the top 10% experienced an increase of 376% in their incomes.[3] Today, India is the 2nd most unequal country in the world where millionaires control 54% of the wealth. Recent Credit Suisse data shows that the share of top 1% is now around 50%, the highest since 1922 and the top 10% control almost 3/4th of the national income. The Gini coefficient which is most commonly used to measure inequality has increased from 0.43 in the 1980s to 0.49 in 2010.[4] Experts claim that a country can fight inequality with two basic steps- by following progressive taxation and by increasing social spending and India performs poorly on both these standards. The country could benefit from a more progressive tax structure because currently, direct taxes do not form the major part of the tax collected as it does in other developed economies which leads to an abysmally low tax to GDP ratio and very little social spending.

Given these statistics, we need to agree that there is substantial reason to revamp the tax policy and make it more progressive. When it comes to the effectiveness of tax system which can be defined as clear and unambiguous tax codes and can be measured as the difference between effective and marginal tax rate, India is in the bottom quintile in a survey of 90 countries conducted by a professor from Stern School of Business in New York.[5] The share of direct tax in total tax revenue is something that various governments have tried concentrating on but which remains a big problem. According to data released by the government in 2016, the direct tax share in the economy was at its decade low level of 5.47% in 2016-17 while in the financial year 2017, direct and indirect tax collection saw an increase of 12% and 25% which was attributed to demonetization and GST.

It is also crucial to note here that the importance of a progressive tax structure when it comes to inequality has also been questioned time and again. According to a 2012 paper by Hiroshima University, after using econometric models to study the relationship between tax and inequality, statutory corporate income tax rates are strongly negatively associated with economic growth and income inequality by controlling for various other determinants of growth and income distribution. However, personal income tax rates have no impact on economic growth and income inequality.[6]

Where does India stand in comparison to other countries?

According to International Monetary Fund, in 2017 large economies like India, China and USA saw an increase in inequality even though global inequality has seen a sharp fall in recent decades. According to their estimates, inequality has been decreasing in almost half of the countries for which data is available in spite of an increase in advanced economies. Thus, it is important to compare India with China which saw reforms in its economic policies around the same time but ended up achieving very different results.

The 2017 World Inequality Report by the World Inequality Lab talks about how inequality has risen by extreme levels since the opening up of the economy and deregulation in the 80s and 90s in India but only moderately in China as it chose to invest a substantial amount in education and health for its poor population. The reason for such a difference in inequality levels can also be found by studying tax structures. When it comes to tax structure and reforms, both these countries have seen pretty different histories and trajectories. For India, the reforms have been many and consistent while China has, for the most part, followed the same structure since the creation of an individual tax system in 1980 which means that the effective tax collection has been on the rise and the increase in exemption threshold level has been much less. All of this has added to China experiencing a transformation which is nothing short of a fiscal revolution. On the other hand, because of the general decline in Indian tax rates over the years, an increase in exemption threshold and a low number of the labor force working in the formal sector, the fraction of the taxpaying population has risen very slowly in India. Experts have called the Indian tax an elite tax while that of China a mass tax. To quote Thomas Piketty and Qian, ‘The combination of fast income growth and under-indexed tax schedule in China implies that Chinese income tax revenues grow very fast as a fraction of gross domestic product (GDP), while the constant adaptation of exemption levels and income brackets in India prevents the income tax from playing such a powerful role.’[7]

In conclusion, what can be said with certainty is that the levels of inequality in India are surely appalling. In spite of the success in the reduction of poverty over the years, the rich have cornered a huge piece of the national income pie for far too long. Steps need to be taken to address this problem and efficient tax reforms might be the solution.


[1] OECD Economics Department Policy Notes NO. 9, “Income inequality and growth: The role of taxes and transfers,” January 2012, Accessed January 8th, 2018, https://www.oecd.org/eco/public-finance/49417295.pdf

[2] Lucas Chancel and Thomas Piketty, Indian Income Inequality 1922-2014: From British Raj to Billionaire Raj?, September 7, 2017, accessed January 6th, 2018, http://wid.world/document/chancelpiketty2017widworld/

[3] Lucas Chancel and Thomas Piketty, Indian Income Inequality 1922-2014: From British Raj to Billionaire Raj?, Page number 25, September 7, 2017, accessed on January 6th, 2018, http://wid.world/document/chancelpiketty2017widworld/

[4] Rajul Awasthi, India’s Billionaire Raj Era: Time to reform personal income tax, September 20th, 2017, accessed on February 10th, 2018, https://thewire.in/179252/indias-billionaire-raj-era-time-reform-personal-income-tax/

[5] Kartik Shashidharan, “ Where Does India stand in terms of tax collection?”, March 2nd, 2015, accessed January 10th, 2018, http://www.livemint.com/Politics/A7rqdw9hjq7pAz9VXpijqL/Where-does-India-stand-in-terms-of-tax-collection.html

[6] IDEC Discussion Paper 2012, Hiroshima University, “The effects of tax structure on economic growth and income inequality,” accessed on January 7th, 2018.

[7] Thomas Piketty and Nancy Qian, ‘Income Inequality and Progressive Income Taxation in China and India, 1986–2015’, page 2, accessed January 6th, 2018, http://piketty.pse.ens.fr/fichiers/public/PikettyQian2009_AEJPP.pdf

Image source- http://www.quotemaster.org/Dividing+food#&gid=1&pid=19 


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Written By Pragya Mishra

Economics Graduate

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