The honest taxpayer’s dilemma: When rules become a disadvantage in investing

The response was extraordinary. Reader after reader shared stories that revealed something far more troubling than inflated property prices—a parallel economy where tax evasion isn’t just common, it’s systematic, accepted, and often rewarded. The message was clear: being an honest taxpayer in India has become a disadvantage, particularly when it comes to building wealth.

Consider the responses I received. A mutual fund distributor lamented paying a 32% income tax plus an 18% GST while watching coconut vendors earn lakhs daily through UPI transfers with no apparent tax scrutiny. This represents a fundamental breakdown in economic fairness.

The implications for honest savers and investors are profound. When you’re competing for assets—whether property, businesses, or investment opportunities—against people whose effective tax rate is zero while yours approaches 50%, you’re not operating on a level-playing field. Your compliance with the law artificially reduces your purchasing power.

This creates what economists refer to as adverse selection in investment markets. The people with the most available capital for investments aren’t necessarily the most productive or deserving; they’re often those best at evading taxes. Meanwhile, salaried employees whose taxes are deducted at source find themselves priced out of investment opportunities by competitors with undeclared wealth.

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The real estate market exemplifies this distortion, which extends far beyond the realm of property. Private equity investments, art markets, and even traditional businesses often involve cash components that exclude honest taxpayers. The entrepreneur who meticulously documents every rupee finds herself at a disadvantage when competing against someone whose books exist parallel to reality.

Several readers suggested solutions ranging from abolishing high-denomination currency notes to creating property exchanges with dematerialised documents. While these ideas have merit, they miss a crucial point: the problem isn’t just technical but cultural. We’ve normalised tax evasion to such an extent that honest taxpayers are viewed as naive rather than principled.

This cultural acceptance has created perverse incentives throughout the economy. Why invest in productivity improvements when manipulating tax obligations offers better returns? Why focus on genuine value creation when wealth can be generated through opacity and connections? The result is an economy where the most honest participants are systematically disadvantaged.

For individual investors, this presents a genuine dilemma. Do you compromise your principles to compete effectively, or do you accept that your ethical choices will constrain your investment returns? Most readers who wrote to me have chosen the latter, diligently paying their taxes while watching others prosper through tax evasion.

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However, there is a deeper issue that affects everyone, including those who benefit from the current system. An economy where tax compliance becomes a competitive disadvantage eventually destroys trust in institutions and markets. When people lose faith that playing by the rules leads to fair outcomes, the entire system becomes unstable.

The digitisation that has transformed banking and payments offers hope for other sectors, but only if implemented with genuine political will. Every UPI transaction leaves a digital trail, yet readers report vendors earning lakhs daily with no apparent tax consequences. The technology exists; the enforcement doesn’t.

What can honest taxpayers do in the meantime? First, recognise that your long-term interests align with systemic reform, even if short-term profits might be lower. Second, support transparency initiatives wherever possible. Third, diversify your investments to include assets where cash transactions are difficult—mutual funds, listed shares, and bank deposits remain relatively clean investment avenues.

Most importantly, don’t abandon your principles. The current system may favour tax evaders, but systems change. When transparency finally arrives—and it will, given technological trends—those who built wealth honestly will have sustainable advantages over those whose fortunes depend on opacity.

The government has demonstrated its ability to digitise complex systems when it chooses to do so. Until then, playing by the rules may seem like a disadvantage, but it’s also an investment in a more equitable future. Your compliance today isn’t just about following the law; it’s about building an economy where merit matters more than manipulation, where transparency trumps opacity, and where the next generation doesn’t inherit a system that punishes honesty. That’s worth the short-term competitive disadvantage.

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Dhirendra Kumar is founder and chief executive officer of Value Research, an independent investment research firm.