Higher capital gains tax: Who benefits the most?

Synopsis

Excluding tax havens such as Hong Kong, Singapore and the UAE, India’s capital gains tax remains one of the lowest globally, especially as the amount of capital gains increases.

The recent announcement in the Union Budget has brought higher capital gains tax rates is a welcome and logical change by the government. Under the new tax rules, stock investing will now attract a 12.5% Long-term capital gains tax (previously 10%) and 20% Short-term capital gains tax (previously 15%).

Excluding tax havens such as Hong Kong, Singapore and the UAE, India’s capital gains tax remains one of the lowest globally, especially as the amount of capital gains increases. And as Finance Secretary Somnath explains, analysis of the tax base shows that capital gains tax doesn’t really impact the middle class. 88% of the capital gains income is earned by individuals with an income above Rs. 15 Lakh and 62% by those with an income greater than Rs 1 crore. The investing community in India is a minority demographic that benefits from a tax rate much lower than the marginal rate, a standard tax rate for income earned by salaried and other business incomes. Even with the new rates, we’re still much below the marginal tax rate.

Being a developing country, India is still treading the tightrope between fiscal consolidation and growth. In this context, the government's strategy to remain committed to their fiscal targets by finding new sources of increased revenue while impacting the minimum number of citizens, particularly those who can afford it, makes good sense.

There is nothing wrong with the government capitalising on opportunities to reduce deficit by taxing the richest. The holdings of the company promoters, who own about half of the stock market today, will probably shrink to 20% in 30 years as the market broadens—similar to what has happened in developed markets like the U.S. Conservatively assuming the market (currently at $5trn) compounds at 8%, India stock market capitalisation could stand at $ 50trn in the next 30 years. Assuming promoters dilute staggeringly at a median value of $15trn, this could mean that roughly $5trn of gains from the stock market being sold and taxed in the next 30 years could end up as government revenue.

On the other hand, the real middle class (a much higher number in volume vs those paying capital gains tax) stands to benefit from the budget. Individuals earning Rs 10 lakh or more annually, will see an annual gain of Rs. 17500 from the new changes in tax slabs and increased standard deduction. Lower taxes also translate into reduced health and education cess, thereby bringing further relief to the real middle class.

Many a time, critics argue that the rich do not directly benefit from the taxes that they pay. However, with regard to the massive number of people below the poverty line and middle-class real income, policies aimed at fair distribution of wealth are necessary to be supported. Fiscal consolidation and responsible distribution of wealth is the key to India's growth on a sustainable basis.

Although these rates of capital gains tax are sounding heavy for some, this step is nevertheless fair and strategic for the economic stability and growth of the country. Embracing these changes can pave the way for a more balanced and equitable future for all citizens.

(The author Jaba Misra is Partner, Rational Equity Partner. Views are own)

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