Monday, 3 February 2014

Refutation to Ila Patnaik's article on Banking Transaction Tax

The Indian Express has published an article by Ila Patnaik opposing the proposal to replace all taxes with a single Banking Transaction Tax. The article can be accessed here

This blogpost seeks to refute various objections to Banking Transaction Tax made in the said article. The excerpts from the article are in bold italics and my own refutation in ordinary roman

Why is this not a good idea? Transaction taxes are often referred to as “sand in the wheels”. They are meant to discourage certain kinds of transactions. The original “Tobin tax” on currency market transactions was intended to reduce the magnitude of currency trading turnover. Those who argue for transaction taxes do so on the grounds that they will reduce transactions.
This is economic orthodoxy at its worst. Just because transaction taxes have hitherto been used to discourage certain transactions, it doesnt mean that they shouldnt be used for the simple objective of raising revenue. Comparison with Tobin Tax is pointless as it was not used as solo tax which is what is purported to be done with BTT. In any case, use of Securities Transaction Tax in India hasnt really discouraged stock market transactions.

In other words, it is well understood that when the government starts taxing certain kinds of transactions, people move away from them towards other kinds of transactions. If one method of making payments involves being taxed, people will choose other methods.
Transactions on the street will shift to dollars, gold, bitcoins and other unexpected things. For example, bottles of Tide detergent are reportedly popular as a currency in underworld transactions in the US because they are untraceable. Cigarettes can be used for small transactions. A one cubic centimetre piece of gold weighs 19.1 grams and is worth approximately Rs 56,350. These could be used for larger transactions. This would result in the further decline of the Indian rupee as a trusted vehicle for the storage and transportation of value.
People will always compare the cost of a transaction tax with cost of other methods of transacting. If BTT rate exceeds the costs and inconveniences with other modes of payment, then this doomsday scenario predicted by Ila Patnaik will occur. The example of Tide detergent used by underworld is not germane here.All tax evaders do not belong to underworld. Doing away with tax evasion will not automatically eliminate the underworld. Tax evaders have a legal source of income , income from which is kept off records. Underworld also keep  their income off records but the source is not legal. Thus, Ila Patnaik makes the error of tarring all tax evaders as "underworld". Ila Patnaik suggests that to evade a 2% BTT , people will carry several Kgs of gold to effect real estate transactions. This seems far fetched. The costs of handling such huge amount of gold clearly exceeds the 2% tax(I personally think that rate should be between 0.1% to 0.5%).

Commentators have highlighted that the international experience of transaction taxes shows that they do not support revenue collection of more than 2 per cent of the GDP, and even this declines over time. Most countries have given up on transaction taxes. Such taxes do not yield the 10 per cent of GDP that even a minimal government, such as the one that Modi is said to want to oversee, will need as revenue.
International experiences are irrelevant as nowhere BTT has been used as the only single tax but alongwith other taxes. If used with other taxes, people will definitely protest as it increases the tax burden . There is nothing sacrosanct that taxes should be 10% of GDP. Existing taxes require huge fiscal bureaucracy which BTT will eliminate. 

But lest it be thought that this tax is only dysfunctional in foreign lands, let’s take the example of an Indian  transaction tax — the stamp duty. If property is bought or sold, a set percentage of the value of the transaction is supposed to be paid as tax. Only if the transaction takes place through the banking system is it recorded, necessitating the payment of the stamp duty. So what do people do? They transact partly in cash. This part of the transaction is unrecorded and therefore the tax on it is not paid. Of course, this is illegal — the amount that is declared as the value of the transaction for the property is less than what it actually is and duty is being evaded. Does the inconvenience of counting, transporting and paying in notes of, say, Rs 500 prevent this cash transaction from taking place? No, it does not. In fact, in the real estate sector, it is difficult not to transact in cash. Tax evasion has become the norm. This has numerous downstream consequences — a network of illegality in real estate, weakness of the property tax, etc. Public finance experts believe that stamp duty should be eliminated to reduce black money in real estate.
Rather than encourage compliance, the stamp duty incentivises people to move away from the formal economy 
Comparing stamp duty and BTT are like comparing chalk and cheese. Stamp duty involves property valuation issues...issues of disputable tax base which BTT does not.  And remember stamp duty is not being used as a solo tax but along with other taxes leading to "tax fatigue" and evasion.  And stamp duty will go with all other taxes in BTT regime.

With the proposed banking transaction tax (BTT), this is likely to become the norm for the bulk of the economy as there will be a “stamp duty” on all transactions routed through the banking system.
But minus the valuation issues that bedevil the stamp duty at present .   And it will be the only tax.

The dream of getting rid of myriad tax collectors is a good one — but it requires a great deal of action at the level of state governments, which have their own tax administrations. A constitutional amendment is needed to take away the taxation powers of states. The negotiations of the empowered group of state finance ministers regarding the GST — one of the few truly good ideas in tax policy in India — have been a long saga over the 2004-13 period. How will all state governments ever be persuaded to abolish their taxes in return for a slice of the BTT?
This is a legitimate point. The greatest incentives for state Government to support Constitutional amendments and move to new BTT regime is instant credit of their share of BTT by collecting banks. GST is only reform of the obsolete. It has all the weaknesses of declaratory taxes and burdens end consumer.

No country in the world has eliminated all taxes and replaced them with a BTT.
Ok. So Indian genuises who invented zero and infinity should have instead given the excuse "No one in the workd uses zero in numerals". There is no case that something should be a success elsewhere and then only be tried out in India. India should be the pioneer and the leader.

If a government wishes to reform India’s tax system and reduce evasion, there are better ways to do this and simplify the system. The right strategy combines a flat low rate of income tax on individuals with an EET (exempt-exempt-taxed) treatment of savings, a removal of myriad exemptions, a clean and simple GST and the removal of most existing taxes so that we end up with exactly two taxes — an income tax on individuals and a GST on firms.
All these are reforming the obsolete!!! These taxes are unfit for modern times as they generate a workload too big for any bureaucracy to handle. They ignore technological developments in banking sector.  No amount of simplification will work as taxes are evasion-prone with tax bases prone to dispute and litigation

Many expert tax and public finance committees have recommended this based not just on rigorous economic theory, but also on international evidence.
Economic theory  has failed in realm of taxation. What we need in "regulatory psychology" which would predict how people will respond or react to (f)laws.!!! The amount of litigation that goes on as to what constitutes " income" is legendary and economists have failed to address real world taxation issues.

Tax reform is an important and serious issue and can have a huge impact on economic conditions in India.
Agree and that is too serious a  business to be left to economists.

Thursday, 16 January 2014

Rejoinder to "If every bank transaction were to demand a tax"-PART II

Part I of the rejoinder to Indian Express Article was posted here

Objection 4:It would be highly regressive subsidising the rich at the expense of the poor
Wonderful argument!!!! What about Income-Tax !!The very epitome of social justice!!! And other taxes like sales tax !!! Very surprising that a very evasion-prone tax like Income-Tax is model of social justice!!!! Very surprising that double digits sales tax paid by poor is model of social justice!!!! Present evasion-prone taxes can never be model of social justice. That tax is regressive which is evasion-prone and cant be collected. That tax is fair and just which can be collected. TAX TO RAISE REVENUES. SOCIAL JUSTICE  CAN BE TAKEN CARE OF ON THE EXPENDITURE SIDE OF BUDGET

Object 5:Schemes like Direct Cash transfer will be first casualty
Pay outs can be given to such accounts periodically to offset partially or wholly the tax collected from such accounts. Tax exemptions create a mess.

Objection 6:Only advantage tax experts see is the speedy and transparent collection of taxes
This is the biggest advantage that any tax needs!!!!! Present taxes being evasion-prone and litigation-prone and hassling lack (i) collection (ii)speed (iii)transparency !!!!! 

Objection 7:BTT envisages ban on any cash transaction above would require an army of inspectors
Not at all. It is not a ban. It is just that party paying in cash cant enforce contract/assert his rights in courts by filing cases/complaints!  In fact , Kerala HC has suggested  a ban on large cash dealings to curb black money!!! May be Rs.2,000 is too small a limit. Give inspection the limit needs to be at least Rs.20000. Even today I buy jewellery and I dont take pucca bill to save sales tax...I do so at my risk. If I am robbed of that jewellery, I will not be able to register FIR with police!!! FAIR ENOUGH!

Objection 8: A person cannot be prosecuted in the new dispensation for keeping large bundles of cash
Where is the law of the new dispensation which says this? Even under current dispensation, where is such a provision? But this is a useful  suggestion...perhaps the only thing in the whole article which makes sense! In an Indian Express article full of drivel, this does make sense. Such provisions for prosecution should be there. Onus should be on everyone to justify that cash balance above particular limit is from tax paid bank withdrawals.

Objection 9:BTT will be undoing what has been done for financial inclusion
Not at all. Au contraire, more money will be there in banking system. See responses to Objection 3 and Objection 5 above

Objection 10:Penetration of banks in India is very low
This is not irremediable. RBI plans to overcome this deficit by 2016. May be BTT can be introduced in 2017

Objection11:This move will lead to taxation of agricultural income
So be it. No reason why rich argiculturists shouldnt be taxed. Help to sector can flow from expenditure side from higher revenue.

Objection 12:Existing taxes being reformed
Thats reforming the obsolete

 Except one important point, none of the objections raised in the article has any serious merit. But path will not be a rosy path ahead. Next blogpost detailing hurdles in the way.

Wednesday, 15 January 2014

Rejoinder to "If every bank transaction were to demand a tax"-PART I

Today's Indian Express carried this article in nice easy-to-read FAQ form titled "If every bank transaction were to demand a tax" . Pity however is that the objections to proposal of replacing all other taxes except customs duties with  BTT  are not informed objections. They are in the category of "its trash because I tell you so". I shall now deal with the objections raised one by one

Objection 1-"Any tax should be on income or production in an economy. BTT is on neither......."
My Response: Who says so?  Law? Constitution of India? As far as Constitution goes, it doesnt say tax should be on income or production Economists? Do economists realise the amount of litigation that takes place on what falls within the scope of the term "income"? So, you have a  tax base which is prone to dispute and litigation. Further, you have in income-tax a tax which is prone to evasion. Its said to advance social justice. But it really is a reverse Robinhood tax- rich are able to evade or avoid it by paying top notch tax lawyers. Burden falls on smaller mortals who  dont have the ability to do so. Taxes on production-excise, sales tax, VAT, GST are not really evasion-prone either. They too have litigation-prone tax bases. The rates of these indirect taxes are in double digits rates and fuel inflation for common man- petrol/diesel prices are very high because of these taxes. Further, all the taxes on income or production are papered taxes or declaratory taxes...involving lot of paperwork and hassles. In fact, paperwork and hassles including facing biased Assessing Officers who proceed on assumption that taxpayer is dishonest contribute more to tax non-compliances/evasion. Its all these hassles which bother taxpayers more than the tax itself. Whatever the tax should be on, it shouldnot be on time, energy and honesty of an individual-This is where taxes on income and production have been spectacular failure. Economists with their doctrinaire approach to taxation have been spectacular failures in giving us a DREAM TAX....a tax which (i) is evasion-proof (ii) with a large litigation-proof tax base (iii)requiring minimum bureaucracy to collect (iv) costs less to collect (v)collected at source---at starting point (vi)miniscule tax rates to discourage evasion (vii)can give real-time credit of tax collected to Government.
BTT replacing all taxes is a thought born from this desire for a Dream Tax System which replaces multiple high rate taxes with lot of paperwork and hassles and which require huge bureaucracy and cost of collection and which have litigation-prone tax base with ONE SINGLE miniscule rate tax with wide litigation-proof tax base which is evasion-proof and easy to collect and hassle-free with minimum paper-work-Banking Transaction Tax satisfies all the requisites of a dream tax. Whats more the BTT with uniform rate will do on economic plane to India what Sardar Patel did on political plane-economic unification-Indian common market!!!!

Objection 2-BTT ...simply taxes movement of cash within the same recipient .So it penalises  movement of money and consequently impacts the efficiency of economy
A miniscule rate BTT said to be 2% (in my opinion it should be in the range of 0.1% to 0.5%) is said to possess all these evils. Current High rate taxes in double digits dont have these evils? Current taxes with huge paperwork, litigation, facing assessing officers & bureaucracy, corruption (not to mention) dont impact efficiency? Inter-state trade distortions due to differing rates of VAT dont penalise movement of money?''

Objection3-Volume of bank deposits in India is 70,60,182 crores and will require a 35% tax to raise current level of tax revenue of Centre & States combined
Who says it will tax only credits/deposits and not debits? Secondly even 35% tax is better-one tax without all hassles of paperwork and multiple taxes at present adding up to more than 35%. But the objection misses three  vital points---(i)There is currently a huge black money parallel economy due to current  multiple hassling high rate taxes. All this money will flow into banking system ...thus bank deposits will be several times the current level---Cash handling is risky and a proper tax regime will dissuade people from cash transactions and use banking system (ii)India will be a virtual tax haven ---bringing in huge foreign inflows through banking system. This will also increase bank transactions several times current level (iii) Tax Bureaucracy will be down-sized saving Government expenditure...instead of scrutinising millions of tax returns, scrutinise tax returns of only a few banks (iv)More disposable incomes in people's hand generating more jobs, more banking transactions etc. So, India will go into a virtuous circle mode

.........TO be CONTD IN PART II

Monday, 13 January 2014

Examination of objections to one Banking Transaction Tax replacing all others

My blogpost on one Banking Transactions Tax replacing all other taxes like Income-Tax, Sales Tax, Excise, Service Tax  here >> did attract comments. Customs duties on imports shall stay. Comments were of both types -favourable and unfavourable. Thats the beauty of public discourse...very enriching due to variety of views. In this post I would like to examine the objections. Objections in italics and my response in ordinary fonts

BTT can lead to downstream effects - suppose a company transfers money from its HO to its regional office and further to a branch to pay salaries - there could be build-up of tax. Further - it pays a supplier, who pays further to his vendors, and so on - there is a downstream effect.
If one cuts down these layers of transfers, the current estimates of potential revenue from BTT will collapse, because it is based on the volume of current transactions, which does include all these multiple levels of payments.
On the face of it, it seems a logical objection...transaction by definition cant be with oneself and there might be a case for excluding transactions between HO and Branch  from the scope of the tax. However, the commentator himself cautions us that the exclusion would play havoc as BTT depends on volumes. That precisely is the point. BTT has a very large tax base so that even a miniscule percentage can mop up huge revenues as it is evasion-proof,  hassle-free, zero costs of compliance to taxpayers, much reduced fiscal bureaucracy, real-time credit of respective shares of the tax by banks to Central Government, State Government and Municipalities. The tax rates being miniscule, cascade effects will be flea bite. Brazillian economists have calculated that a  1% tax transactions-receipts and payments will lead to a 3% cascade in the 19th downstream stage assuming a value addition of 50% at each stage. The transaction tax should ideally be between 0.1% to 0.5%...not more. In any case, advantages far outweigh the minimal cascade effects. Present indirect taxes have no way mitigated inflation...only fuelled it. Differences in VAT rates havent helped in economic integration of India. BTT replacing other taxes will remove distortions in inter-state trade

Further - it could encourage a barter system - trying to squeeze cash transactions and bank payments out of the system.
Barter system is too inconvenient for modern times. Financial payments being replaced by cash transactions is valid objection. This can be taken care of in two ways>>>One disintermediation will take place only when tax rate exceeds costs and risks of cash handling. Miniscule tax rates take care of this aspect. Further, one can provide that if cash payments exceeding certain amount made, the party cannot enforce  his rights legally in a court/tribunal. This way financial disintermediation threat can be taken care of. Moreover, black money creation due to abolition of present exhorbitant taxes will stop. More money will come into the system as India will approximate a tax haven.

Even more fundamentally, there is a paradox in the whole discussion on existing taxation system and its possible substitute. Suppose the substitute does not yield adequate revenues at par with earlier revenues, it means the people have been spared additional burden, and the Govt faces a revenue shortfall. If it yields as much or more, effectively there is no relief to the people at all - in some form or the other, they are finally still coughing up as much towards the Govt.
Well, it neednt be  a win-lose propositionas suggested. Government will be able to raise much more revenue with flea-bite burden to taxpayer, no compliance costs, time and energies to taxpayers.It will be a win-win situation.

Hence I feel the more fundamental issue to be addressed is how does the Govt reduce its expenditure - obviously by streamlining its grossly inflated activities - it must get out of things it ought not to be doing.
Obviously this needs to be done. New tax will contribute to this by reducing costs of collection.

Also, reduction in welfare schemes is essential - but then that is against popular sentiment, and any party declaring its intent to do so is unlikely to find favour among weaker sections - a part of the reason why BJP was voted out in 2004. So there has to be some better calibrated approach.
In fact, more money will be available for welfare spends. The whole idea of BTT is to get social justice out of revenue side and tackle it better through expenditures

Thursday, 9 January 2014

CM Sir, Its not about making India tax-free. Its about making taxation hassle-free

A newly elected CM from a new party recently ridiculed the idea of replacing Income-Tax, Excise, Service Tax, VAT etc with Banking Transaction Tax.

He ridiculed it by saying India cant be made tax-free. He got the entire debate wrong. It is not about making India tax-free. Its about making taxation hassle-free by replacing multiple myriad taxes with one tax-of fleabite amount, collected in a hassle-free manner without having to go through torture of fling returns, maintaining records etc for millions of citizens.

Everybody squirms  at the thought that all taxpayers big and small will pay same rate of tax on their banking transactions which is likely to be 2 % or even less than 1%. But today everyone-rich or poor pays double digit rates of a VAT/Excise/Service Tax.

What social justice is served if tax revenues dont come into the coffers due to evasion ? And evasion is due to high tax rates, myriad taxes, cumbersome paperwork, filing of returns, harassment by Govt officials? A tax which is theoretically sound on social justice plank and doesnt bring in revenues is no good at all. But a tax which, though not theoretically sound on social justice plank , brings in revenues can creat infrastucture, craet jobs and deliver social justice too!

And currently one pays VAT/Excise/Service Tax without being aware, BTT will be transparent and make every citizen conscious that he is paying a tax. And that will make him demand more accountability and transparency from Government.

Sunday, 5 January 2014

Transaction Tax replacing all other taxes such Income-Tax, Service Tax, etc-whether sound idea?

Recently, there were press reports to the effect that BJP, the main opposition party in India, if voted to power in 2014 elections has proposed to scrap all taxes such as Income-Tax, Service Tax, Excise, VAT etc and replace them with a @2% Banking Transaction Tax. The details of the proposal will be part of the party's Vision Document which is not yet available in the public domain. It is too well known that state cannot be run with empty coffers. So question arises whether this proposal will yield enough revenues to justify the scrapping of all other taxes?

The Revenue Potential of the Banking Transaction Tax is immense and sky is the limit.
Ever heard of the fraudster who tampered with bank's program so as to deduct one cent  from each transaction in customer's account  and credit his[fraudster's] a/c and made billions?A one cent deduction didnt rile the customers (they let it pass as rounding off errors) . But made the fraudster filthy rich!!!!! The tax seeks to take advantage of this very thing but for legitimate purposes. 

Advantages of Banking Transaction Tax
(i)Small insignificant amounts collected from large volumes of transactions. The taxpayer wont feel the pinch !
(ii)This tax will be collected by the banks and paid over to the Government. All the formalities and hassles like filing of returns, assessments, scrutiny etc transferred from millions of tax-paying citizens to few banks.  Thus, its hassle-free for the tax payer. PAY YOUR TAX AND RELAX
(iii)This tax is not inflationary. It is not passed on further downstream through the prices of goods and services
(iv)This tax is economical for the government. It will not require a large army of personnel to administer it and collect taxes.
(v)There will be savings in interest cost to the Government. Government can make arrangements with banks  to get monies transferred to its account on a daily basis through ECS, NEFT etc
(vi)Tax evasion will be practically zero. No one will waste his time in evading such miniscule amounts of taxes

Banking Transaction Tax-not a new experience- was there from 2005 to 2009
It is not the first time India will be imposing a BTT is BJP does win the elections and impose it . The Finance Act,2005 introduced a Banking Cash Transaction Tax which was repealed in 2009. The rate of tax was only 0.1% of  cash withdrawals in the aggregate exceeding Rs.25,000 in day from an account. Savings Bank Accounts were exempted. The proposed BTT will be on all banking transactions in all accounts and not merely on cash withdrawals exceeding specified amount on accounts other than savings bank account. Needless to say, BCTT was not a success as its focus was not raising revenues as it should be with a good tax policy! Its focus was to collect intelligence on large cash transactions! Needless to say, it flopped and was scrapped in 2009

Doctrinaire objections to replacing Income-Tax with BCTT
Income-Tax has the theoretical merit of being compliant with the "ability to pay" principle. Fact is those with larger ability to pay taxes pay their tax lawyers well and manage to get out of the tax net. Income-Tax, in fact, achieves the Reverse Robin Hood effect of putting more burden on small/middle-class people who cannot hire top tax lawyers to keep out of tax net. Tax evasion in turn creates black money and capital flight from India. 

This will not be my last blogpost on this issue. Will deal with this issue in greater detail in further blogposts

Friday, 1 March 2013

Investment allowance

The Budget 2013 announcement of   Investment allowance of 15% of investment for manufacturing companies who invest total Rs.100 Cr or more in next 2 Financial Years(the period from 1-4-2013-14 to 31-3-2015)  is most welcome.Accordingly, the Finance Bill,2013 proposes to insert new section 32AC titled "Investment in new plant or machinery" with effect from assessment year 2014-15

However, the Finance Minister  has missed a crucial point. Absent consumer purchasing power and demand for products, no amount of tax sops can incentivise a company to invest in new plant and machinery. 

Increase in IT exemption limit from Rs.2 Lakhs to Rs. 5 Lakhs would have reduced cost of collection of taxes, put money in people's hands, spurred investments by corporates and turned out cheaper and more effective than investment allowance. Increase in IT exemption limit would not only have achieved the objective behind investment allowance but would have achieved several other objectives in one stroke as detailed here