Transaction costs

If the securities transaction tax must stay, it needs to be made more broad-based

A proposal to impose a commodity transaction tax has encouraged extreme arguments from both sides of the debate. This discussion needs to be nuanced in view of the most desirable option and what is possible in the coming budget. The movement towards low taxation of savings and investment was assisted by the lowering of the capital gains tax in 2004. Unfortunately, this was seen as a package deal alongside the introduction of the securities transaction tax (STT). First principles of economics would urge that in a country like India, consumption should be taxed and investment encouraged. Those with higher incomes should be encouraged to save and invest, for that generates productive capacity and jobs for the country at large.

The taxation of securities transactions is undoubtedly a troublesome venture. But at the end of eight years of UPA laxity on expenditure, there is a fiscal crisis almost reminiscent of 1991 or 2001. It is, hence, not easy to give up Rs 8,000 crore of tax revenue. In addition, there is a danger that removing the STT will lead to the taxation of capital gains — and that is likely to be a bigger evil than the STT. Another dimension lies in market surveillance, given low quality regulators in India: taxing transactions helps deter circular trading.

If the STT must stay, it is clear that it needs to be a broad-based tax on all manner of financial trading. In recent years, capital and labour have moved into commodity futures trading and currency futures trading, given that there is an STT on equities trading. Commodity futures turnover in India — which is almost all in gold and crude oil — is now bigger than equities trading in India, and this is a distortion in the market. We need domestic trading to discover the price of equities, but we can free ride on the price of gold or crude oil that is discovered on exchanges abroad. Hence, it is essential to scale up the STT into other areas. Identical rates should apply to equities and commodities, so that the government is not pushing the private sector to favour one or the other. A reduced rate should cover all currency trading (over the counter and exchange). Overall, it is possible for the government to go from Rs 8,000 crore of collections at present to Rs 16,000 crore by extending the STT at the identical rate to commodity futures, and by choosing an appropriate rate structure for currency trading. This would be a rare initiative in tax reform that yields more revenue while reducing distortions in the economy.

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