Column: Tax data and Piketty inequality

By: | Published: January 23, 2016 12:17 AM

Piketty is likely to be grossly wrong in his speculation about Indian inequality being among the worst in the world

On his visit to India, Thomas Piketty, quoting the Credit Suisse (CS) report and his own considerable work on income inequality, stated that “India has one of the worst inequalities in income and wealth globally”, in comparison with the high inequality countries like South Africa and Brazil. Is this true?

First things first. Wealth, as defined by the CS report, is the “value of financial assets plus non-financial assets (principally housing) owned by individuals less their debts”. Given that human capital is a major wealth asset for most individuals in the world (other than the top 1% in the Western world, or the 62 world billionaires of which, the CS report kindly informs us, 53 were men), this is a rather glaring omission. It is likely that if education was included as wealth (why not?) the results will not be as drastic, and therefore less ‘saleable’ as the following ‘rich are getting richer, poor are getting poorer’ polemical CS and Oxfam conclusions:
* While the bottom half of adults collectively own less than 1% of total wealth, the richest decile holds 87.7% of assets, and the top percentile alone accounts for half of total household wealth.
* The richest 1% have now accumulated more wealth than the rest of the world put together.
* Since the turn of the century, the poorest half of the world’s population has received just 1% of the total increase in global wealth, while half of that increase has gone to the top 1%.

In contrast, while Piketty approvingly quotes the heavily-flawed CS report, his, and his associates, work on income inequality, is brilliant and compellingly correct. Piketty uses income tax data to derive inferences, and conclusions, about income inequality. The problem with household data, as done by CS, is that individuals tend to understate their income; income tax data, on the other hand, are considerably more accurate about the distribution of income.

Piketty speculates that income distribution in India is likely to be close to the Brazil-South Africa, i.e., among the worst in the world. According to latest household data, that would place India among the five most unequal economies in the world. The South African Gini of 70.1 is the worst and Brazil’s Gini of 60 is close to the tenth-worst.

Is Piketty right in his speculation about inequality in India? There are two methods of estimating household income inequality in the absence of credible household data. The first is by estimating it from available consumption inequality data; the statistical rule of thumb is to add 6 Gini points to consumption inequality, and this would place Indian inequality around 42, i.e., squarely at the world mean (and median) of household inequality. A movement of India from the worst 1 percentile to the 50th percentile, if correct, is a very large speculative Piketty error.

There is, of course, the Piketty method of deriving income distribution from tax data. There are two major problems with the use of income tax data (even when available!) for countries like India. The first widely noted problem is that in India, very few individuals are in the tax net, and of these, only about half pay taxes. In case you are dumb-founded by these low figures, note the following. The universe of Indian tax-payers is not the total population but the worker population, and this is 40% of the total. Second, only non-farmers pay income taxes, and farmers are about 10%; so the relevant population universe is 300 million, not a billion. Further, of these 300 million, only about 80 million workers are eligible to file tax returns—the eligibility criteria based on a minimum income level of Rs 2.5 lakh a year. This means that, even with full compliance, there will be tax data for only 7% of the population. But compliance ratios in India, though improving, are still around 50 %, i.e., Piketty, and I, and others, will only have tax data for 3.5 % of workers in India. One will have to be bravely foolish to estimate an income distribution on the basis of such scarce tax data. It can be done, but only with recourse to household distribution data which the tax-based income distribution logic explicitly rejects.

And even with heroic assumptions, the estimate of tax based income inequality in India is likely to be an over-estimate, and possibly an over-estimate of large proportions. This is because examination of Indian tax data will reveal, that tax-compliance in India is in the nature of a U—people with incomes between Rs 2.5 lakh andRs 5 lakh have relatively high compliance ratios, as do the rich (incomes greater than Rs 10-15 lakh). The large middle of the tax paying public (around the 90-95 percentile of the worker income distribution) and comprising of professionals and other tax absconders, has considerably less compliance ratios.

Piketty also made a plea for release of income tax statistics in India. Irrespective of the robustness of the conclusions that could be drawn using this data, this request for release of income tax data is supported by most Indian observers—I, myself, in several articles published over the last few years, have argued for the same. In an article titled “Blinded by Tax Revenue” (The Financial Express, January 12, 2013, bit.ly/1PIMPKH), I stated that “Sensible policy can only be made if the data are credible. Can there be a right to information about aggregate income tax data for each year, as done in most of the world except perhaps China?” The fact that a renowned tax and income distribution expert is requesting the same should increase chances that sometime the Indian government will conform to basic international standards of transparency. But I wouldn’t bet on that for the Indian tax department in the ministry of finance has been known, and independent of the political party in power, to be the most obtuse and convoluted tax department in the world.

What the Indian tax department has never answered is why, and how, they or anybody else will lose if tabulated tax statistics, with no information about individual tax payers, are released. It is also surprising that no RTI has been filed for aggregate tax data to be released. Think about it—the government makes plans on revenues and tax rates, the CAG periodically disseminates the number of tax payers and aggregate tax collected for three or four income ranges, yet more complete data are not made available. Why?

Even if not very useful for derivation of income distribution, the fact remains that aggregate Indian tax data should be made public. On this request, Piketty is spot on. Regarding speculation about Indian inequality being among the worst in the world, I am afraid Piketty is likely to be grossly wrong.

The author is contributing editor, The Financial Express, and senior India analyst, The Observatory Group, a New York-based macro policy advisory group

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition