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The finance ministry is rightly worried about the fiscal situation, and the urgent imperative to guide public finance to better health. But taxing the rich is not the way forward. The peak personal income tax rate in India is already quite high when compared with, say, Singapore or Dubai. If we charge an income tax of 40 per cent for the rich (suitably defined), it could touch off three reactions, none of which are good for the country.
The first problem would show up in effort and risk-taking. Why should a person work hard and take risk, if she will only get Rs 60 upon success, and nothing in case of failure? High income tax rates undermine entrepreneurship and the willingness to undertake risky financial portfolios. Entrepreneurship is key to India's growth and development. The creative effort and hard work of entrepreneurs in creating new firms and new products are crucial for transforming the lives of millions. We must avoid the indolence and stagnation of continental Europe, where high tax rates have had a subduing effect on individual initiative. The second problem is that of evasion. People are presented with the choice of complying with the law, and keeping Rs 60, versus breaking the law, and keeping Rs 100. At high tax rates, the incentive to break the rules is higher. What India needs most is to build a culture of compliance and the organisational capacity in the tax department to enforce sensibly. High tax rates undermine these long-term institutional foundations and fuel the black economy. The third issue is that of commitment to India. India needs rich people to grow roots in the country. When India has high tax rates, however, the rich are more likely to buy houses in Singapore and Dubai and shift more of their activities there. People will contribute towards building the country where they spend time and where their children go to school.