Income inequality in India

Inequality in income is at a very high level in India and has further increased over the past two decades. The increasing per capita income of the country should not lull us into complacency as we see that the lowest strata of society has got only a small portion of the development pie. We should also recognize that a good growth in the GDP does not mean good for the population at large and unless direct measures are taken by the government, this inequality would only increase.

The Gini index measures[1] the extent to which the distribution of income or consumption expenditure among individuals or households within an economy deviates from a perfectly equal distribution. A Lorenz curve plots the cumulative percentages of total income received against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and a hypothetical line of absolute equality, expressed as a percentage of the maximum area under the line. Thus a Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality.

The World Bank has computed India’s GINI (%) at 37 in 2005. The progressive increase in the Gini index [2]over the past few years shows that income inequality in India is only increasing.

Gini Levels	Early 1990s	Late 2000s (↘)			Years
OECD	0.30	0.31		6.3	2008
Indonesia	0.39	0.37		-6.7	2005-2009
India	0.32	0.38		16.0	1993-2008
China	0.33	0.41		24.2	1993-2008
Russian Federation	0.40	0.42		6.0	1993-2009
Argentina	0.45	0.46		0.9	1992-2009
Brazil	0.61	0.55		-9.4	1993-2008
South Africa	0.67	0.70		3.1	1993-2008

Another way to describe inequality is by looking at changes in household income for different groups [3], notably those at the bottom, the middle and the top of the distribution. Larger rises in income for those at the bottom and middle of the income distribution may, in particular, signal that opportunities and equalization are both growing. The truth in the case of India is that incomes of the rich are increasing at a greater rate than those of the poor, thereby exacerbating the income differential further.

There are several reasons for this persisting inequality. Some of the key sources include a large and persistent informal sector, widespread regional divides (e.g. urban-rural), gaps in access to education, healthcare and nutrition, and barriers to employment and career progression for women and weaker sections of society.

It is incumbent on the government of the day to take measures to address the issues causing inequality. It is however seen that the benefit and tax systems in India are far from effective in easing market driven inequality. The coverage and generosity of social protection systems is very poor as is evident from the low allotments for health and education in the budgetary spending.

At the same time, the tax system delivers only modest redistribution, reflecting such problems as tax evasion and administrative bottlenecks to collect taxes on personal income.

Reducing inequality while working towards higher growth in the country requires a multipronged approach. The approach should include: 1) provisions of social assistance that target those most in need; 2) spreading the rewards from education; and 3) preparing to finance higher social spending in the future.

It is important to underline that tackling inequality goes beyond the remit of labour, social welfare and tax policies. Other policies, such as those aimed at improving the business environment, product market regulation, infrastructure development, health care and public administration reforms also have a role to play in reducing inequality.

Conditional cash transfers may be particularly well suited to reducing inequality and promoting social mobility in the country. The fact that they could combine income support with the requirement to maintain investment in human capital and child health means that they can be useful tools not only for tackling household poverty, but also for promoting school enrolment and improving healthcare for children.

Addressing inequalities in both access to, and quality of, education can also make an important contribution to lowering inequality in labour income.

Enhancing the distributive capacity of the tax system would require an emphasis on improving revenue collection procedures and strengthening the extent to which taxpayers comply voluntarily with their obligations. A focus on the fight against corruption would also help improve tax collection.

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[1] http://en.wikipedia.org/wiki/Gini_coefficient

[2] http://dx.doi.org/10.1787/888932535432

[3] http://dx.doi.org/10.1787/888932535451

Inequality and Capital Gains Tax structure in India

The capital gains tax structure in India benefits the rich and the upper middle class and tends to increase the inequality in society.

A capital gains tax is a tax on capital gains, the profit realized on the sale of an asset that was purchased at a cost amount that was lower than the amount realized on the sale. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

For equities, our legislation specifies differential tax rates as compared to rates on capital gains from sale of other assets. As of 2008, equities are considered long term capital if the holding period is one year or more. Long term capital gains from equities are not taxed if shares are sold through recognized stock exchange and Securities Transaction Tax, or STT, is paid on the sale. However short term capital gain from equities held for less than one year, is taxed at 15% (w.e.f. 1 April 2009) (plus surcharge and education cess). Many other capital investments (house, buildings, real estate, bank deposits) are considered long term if the holding period is 3 or more years. Short term capital gains are taxed just as any other income and they can be negated against short term capital loss from the same business.

Among the sale of various asset classes the sale of stocks in positively discriminated against. The definition of long-term is discriminatory in that stocks held for an year are considered long-term while other assets need to be held for at least three years to be considered long-term. The rate of taxation on long-term capital gains from other assets is 20% while a long-term gain from stock sale is not taxed. The discriminatory treatment continues for short-term capital gains. Short term capital gains from other assets are taxed at normal rates while short-term gain from sale of stock is taxed at 15%.

The participation of retail equity investors in India is abysmally low. The presentation made by Dr.N.C.Maheshwari[1], President of the Association of National Exchanges Members of India, has states that only 1.3% of the country’s population participates in the Equity market (2010). 

Countries	Latest Year Available	%of population
Australia	2008	41
Hongkong	2008	21
UK	2008	18
China	2007	10.5
India	2010	1.3
Taiwan	2008	39.5
Korea	2009	9.6
US	2009	27.7

(Source: URL in the footnote)

Retail investors began participating in the stock markets in a small way with the dilution of the FERA in1978 and over the next few year participation increased on account of increasing transparency on account of introduction of technology in the operations of stock markets and other factors. Retail investors’ share in the market was 16.5 per cent at the end of March 2009, but has been declining since.

It is evident that the percentage of population participating in the stock market is extremely low and the benefits of low taxation on capital gains are flowing to only a small number of the rich.

The moneylife has interesting article[2] on the issue of low participation of retail investors in the stock market. I quote verbatim here

“The SEBI chief is worried about poor retail participation. …

The Securities and Exchange Board of India (SEBI) has finally woken up to the fact that it has fallen short in its key role to develop the capital market and increase the base of investors. Today, SEBI chief UK Sinha admitted as much, saying that the market regulator would take steps to get retail investors back into the market….

In India, the retail participation in the stock market has declined from 20 million in the 1990s to 12 million in 1999, and just around 8 million in 2009, according to official data, this despite the fact that the Sensex has grown by 20 times during this period. As a percentage of the total population, the retail investor participation is just 1.3%, whereas in the US and China it is 27.7% and 10.5% respectively, according to the Bimal Jalan Committee report. The SEBI chief has targeted an optimistic figure of 8% for retail participation in India. 

In August last year, Union minister of state for finance, Namo Narain Meena, revealed in Parliament the reality of the Indian 'equity cult'. He said around 50% of the cash market transactions on the National Stock Exchange (during April-June 2010) came from a shockingly low 451 investors, of whom 156 were proprietary traders, while 50% of the trading in NSE's derivatives segment came from just 106 investors of whom 58 were proprietary traders. Only 6% of client accounts contributed to 90% of the trading in the cash segment. 80% of turnover came from just 41,654 investors. In other words, 1,50,546 investors (78%) accounted for just 10% of trading turnover. ”

Evidently, most of the stock market operations and the profits flowing there from are benefit only a negligible minority of the population thereby increasing the wealth of a negligibly small rich population. This has an impact on increasing inequality in society. The middle class usually has access to other asset classes like property, gold etc. Capital gains on these asset classes are taxed at rates higher than normal rates applicable for salaries. Hence the system has the effect of taxing the rich at a less rate and the poorer at a higher rate.

Hence, I feel that capital gains should be taxed at higher rates than presently taxed, especially those that accrue from the stock sale.

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[1] www.assocham.org/events/recent/event.../Dr_NC_Maheshwari.pptx

[2] http://www.moneylife.in/article/increasing-retail-investor-base-sebi-has-a-tough-job-ahead/16977.html

FIscal Stimulus or Deficit reduction

Economies of most countries in the world are facing recessions or at least slowdown in growth. The growth rate of the Indian Economy is expected to be around 5%. Many economies in the developed world are also facing contraction in GDP. The contraction or even slowdown is effecting the sentiment of investors negatively. Investors include those that invest in the brick and mortar Industries and not those in the stock market. Investment in the secondary markets does not directly bring in cash to the Industry. This investment goes more to enhance investor value and thereby creating the right environment for people to invest when called for by the company.

Money investment in the primary market directly goes to the account of the companies and actually helps the running or expanding of businesses. The recession has vastly reduced the money mopped up from the primary market by companies. Companies are also finding it difficult to raise money by way of debt, both from the market as well as from financial institutions.

This is the case for companies who actually want to invest further into the business.

The same is not the case with most companies as they have put most of their investment decisions on hold on account of contraction in demand or fear of the same happening in the short run.

There are two schools of thought prevalent in the discourse as to the right way to address the issue. The first school of thought seeks to promote increase in government spending so as to increase aggregate demand. There are differences in thought even in this stream of thought on issues of quantum and duration of the stimulus. The second school of thought believes that the recession is on account of the large debt burden of individuals as well as governments and they feel that the only way out of the recession is to balance the budget and reduce the debt burden all around.

There does not seem to be any compromise on the matter anytime soon.