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 http://indianexpress.com/article/opinion/columns/not-by-babanomics/

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.