Banking Transaction Tax - Answering Naysayers

Banking Transaction Tax – the new hate symbol?

I have posted two write-ups on CRI on the Banking Transaction Tax (BTT) in the past few weeks (Here and Here). A couple of my fellow-commentators on CRI (Ajay Dave and Ghanshyam Sharma), have also posted pro-BTT write-ups (Here and Here). Another fellow-commentator of mine from CRI, Kalpesh Chavda, has posted a critical piece on BTT (Here). I am proudly part of CRI, which has triggered off a positive public debate on this concept so that people can evaluate it for themselves and make up their own minds.

I am writing this piece with a sense of dismay, because like I had quoted Times of India in my 2^nd piece on BTT, the dismissive rhetoric against BTT continues unabated. I used to respect Ajit Ranade a lot, until I read his anti-BTT piece (Here). An almost derisive piece is written in the Hindu (Here). In all my efforts to seek some constructive criticism, I have found only two pieces worthwhile, the one by Kalpesh Chavda, and the other by Ila Pattnaik (Here), an Economist I have respected for over a decade. I do not agree with her position, and intend to rebut her piece on BTT, but want to compliment her for at least joining the debate constructively.

But first, let me talk about the reason I am dismayed. The current taxation system is like “death-by-thousand-cuts”! The Middle Class and Corporate India are dying under the yoke of this exploitative and usurious system. The current tax collection machinery is nothing but a hydra-headed ‘rent-seeking’ bureaucracy, ostensibly to ensure compliance. It has also engendered a ‘rent-paying’ ecosystem which is an intermediary between the tax-payer and the government. My blood boils when I receive a “sanctimonious” nod along with an argument saying “trust me, I have been a tax consultant for 25 years, and I say with a sense of responsibility that BTT cannot work”! I am extremely sorry Sir, but the system of which you are a part is broken, and you have no credibility left!

There are three popular types of arguments that I have come across, to convince me why BTT won’t work, as follows:

1. It won’t work because I say it won’t work (I know the current system or don’t you know who I am).
2. It won’t work because a “Baba” is saying it will work (I mean, what does a Yoga Guru know about taxation right).
3. It won’t work because I can use some fancy words to describe what will happen if you implement it (like distortionary‎, defying “canons of taxation”, hare-brained scheme, regressive, etc.)

Any reasonable person who wants to have a debate will see that these are disingenuous tactics to avoid the debate, and indicative of resistance couched in high-sounding verbiage (two can play at this game right).

Before I get into the specifics and valid argumentation put forward by Ila Pattnaik, let me get the criticism out of the way. The title of her article “Not by Babanomics” is unfair and almost displaying a “classist” bias. It literally invites the reader to deride the proposal because it is being championed by a “Baba”. To be fair to her, not once in her article has she used the argument that we should dismiss it because Baba Ramdev is talking about it, but then Ms. Pattnaik, why the misleading and derisive title? Unfair, unfair and unfair!

Now let’s come to the core of her argumentation. I will put forward her posit, and then proceed to rebut it.

Posit 1:

These kinds of taxes are called “sands in the wheel”, like say the Tobin Tax, where the objective is to control certain types of transactions. The Tobin Tax on currency trading was intended to reduce the magnitude of currency trading turnover. The BTT is like this tax, and will hence force people to move away from such transactions.

Rebut:

This is a wrong comparison and equation of one with the other with a sleight of the hand. The correct comparison in the Indian context is with the Securities Transaction Tax (STT) or that disastrous idea of Chidambaram, the Banking Cash Transaction Tax (BCTT). However, this argument goes against her, as the STT has not curbed securities transactions and neither did the BCTT curb cash withdrawals, although it did change behaviour in people while withdrawing cash. BCTT has since been withdrawn, and STT continues, without causing any serious distortions in the system (because it is at a very low rate?), although the brokers hate it (and rightly so). The BTT, is different, as it will replace all other taxes in the system, and hence except by committing serious fraud, people will have no option but to move towards it (like the STT).

Posit 2:

Since people will inherently move away from the banking system due to BTT (contestable claim, as above), there will be serious misuse of the system, and people will move into other “stores of value”, like gold, bitcoins, and other currencies!

Rebut:

I have argued against the possibility of this happening in my earlier posts, but I reiterate here again. This is a bizarre argument, as apparently people will also move to using Tide Detergent bars (I am not disputing the veracity of these stories, read Here and Here), but the hypothesis that all of us will become underworld dons, drug dealers or shop-lifters, in order to avoid paying a 2% BTT tax is fear-mongering of the worst kind! I am not saying that since cash-transactions will be discouraged in a BTT regime, people will not resort to alternative forms (if possible), but this will be a minority and not the vast majority.

What one must appreciate is that under BTT, cash transactions (of over INR 2000) are not illegal or to be criminalized, but merely will not have legal protection or enforceability (explained in my earlier post). If people are willing to go to the inordinate inconvenience of transacting in cash (or its surrogates, like barter systems, or Tide Detergents), then so be it! The reason why this system will deliver is that 2% is a low rate of tax, and people will not go beyond reasonable limits to try and save on it.

There is also a design philosophy answer to this. For any system, one can design it keeping in mind the vast compliant majority or the rule-breaking (at any cost) minority. The Western construct (and the current taxation system in India) is that it doesn’t matter if the majority of people are excruciatingly inconvenienced, we should ostensibly not allow even one defaulter to get away. The Indic philosophy towards a system is that people will largely comply when the system is transparent, convenient, fair and equally applied (this is very important). BTT is designed around an Indic compliance model, and will work, if honestly implemented.

Posit 3:

Stamp duty is a tax on transactions and does not work as people pay part of the amount in cash to avoid having to pay the full duty. Ergo, they will avoid paying all kinds of taxes, and ergo ergo, BTT will not work.

Rebut:

Again, this is a very disingenuous argument, and extremely unfair to the honest taxpayer. Firstly, yes I agree that Stamp duty, like all indirect taxes, is a tax on transactions. However, the cash component required for buying houses was not innovated by the house-buyer, but by the real estate industry, as it needed to bribe the establishment in countless ways, in order to develop a project. Where would this cash component come from, obviously, the buyer! I don’t deny that there is a benefit that the buyer gets in the form of lower stamp duties in this, but the ready reckoner rates, etc., have curbed this. Also, 5% on a high-value transaction is a lot of money, which the buyer wants to avoid having to pay. A 2% tax, is much lower, and the buyer doesn’t mind paying it, as is seen in the brokerage that the buyer pays, or the1% “processing fee” that is paid for housing loans.

Also, please note that in a BTT regime, the load on the real estate developer would come down significantly, and prices would hence tend to move downwards. Also, recent history has shown that some of the “newer” developers (large professionally managed listed companies) are increasingly doing “100% Cheque” deals, and guess what; the buyers are flocking to them. Shifting the entire blame of the cash-driven nature of the real estate industry from the builders and politicians to the poor, harrowed tax-payer, who also wants to take advantage of a slightly lower stamp duty, is extremely unfair.

Incidentally, GST is also a tax on transactions, which she does not oppose. Additionally, since people will try and avoid GST also, and practices like under-invoicing and over-invoicing are known misuses, should we throw GST out also? If not for GST, then why should potential for misuse (which is possible everywhere) be used to damn BTT?

Posit 4:

BTT will require constitutional amendments, which will take a lot of time, as our experience with GST has shown. Why start something new all over again.

Rebut:

I disagree that BTT requires a constitutional amendment. GST required it, because under GST, the states are being given the right to levy tax on services, which they do not have earlier. The reason for the delay in GST is not because the states did not want it, but they wanted to know the mechanics of how they would be compensated for potential revenue-loss. Their experience with the Centre not compensating them  adequately for reduction in Central Sales tax did not give them confidence. The lack of credibility of the Central government also had a big role to play in this.

In a BTT regime, the rights of the states and the centre to levy taxes are not being taken away (this is a very important point). The centre and the states are merely suspending all the existing myriad taxes, albeit retaining the right to levy them, if required. Assume that the BTT regime is a total disaster (for arguments sake) and needs to be junked say two years down the line, the states and the centre will still have the right to go back to the old (i.e. existing regime). In order to bring BTT into effect, the centre merely needs to introduce this new tax, define its distribution process, suspend all its other taxes and make the states also agree to do the same. Like VAT, states withdrawing their other taxes can also be done differentially, as they see the revenues coming to them, and due to competitive reasons (with other states).

Having said that, I agree that there is a roadmap required for a planned transition into the BTT regime (which I will propose in a final post on this topic).

Posit 5:

No country in the world has eliminated all taxes and hence we should not do so. Also, international experience with transaction taxes has shown that one cannot collect more than 2% of GDP in taxes and Modi would need around 10% of GDP (Sic, as this is not a Modi-issue).

Rebut:

The good economist is unable to see the obvious contradiction in her argument. If no country has eliminated all taxes in favour of a BTT-type regime, what is this “international experience” that has shown that one cannot collect more than 2% through it?

In any case, let me tell you what this “international experience” with BTT is. Sweden, Argentina and Brazil introduced something similar to the BTT in their economies at various points in time, over the past 2 decades. All three withdrew it, as it was a failure. Ergo, it will be a failure everywhere, and hence we shouldn’t do it. I would have expected some better research from the good economist. While it is true that these countries implemented this, but they introduced this as an additional tax and not as a replacement for all existing taxes. They also did not demonetize high-value currencies, hence it was very easy for people to move transactions away from the Banking system. In the case of Brazil and Argentina, it was introduced during times of hyper-inflation (more than 50%), wherein people were struggling for survival, and willing to go to any length to beat the system (justifiably).

The BTT regime, the form in which it is being proposed, I REITERATE, has not been tried anywhere in the world. Hence we will be pioneering it, if at all we decide to implement it. The number crunching that Arthakranti has done shows that the current and future fund requirements of the government can be met through this. In any case, we will make our share of mistakes, and learn from it. If someone is trying to make a case for us not to adopt it, they better look for better reasons than “no one has tried it before”!

Posit 6:

Why make such radical changes when there is a better way forward. Remove the myriad taxes that we have in our system today, and converge on two simple taxes, Personal Income Tax and GST, with few liberalisations on rates, etc., and let life go on as normal.

Rebut:

Now this is a rational argument, and I anyway see this convergence towards two taxes as an interim step towards BTT (except that we may not need to go in for GST). Some people like Ajit Ranade have grudgingly acknowledged that this proposal has brought the issue of tax reform into public debate (which is true). The reasons I do not agree with this idea of hers is that I do not want to give up the benefits of doing away with the current tax collection machinery, and allowing Banks to collect taxes. The reasons are as follows:

1. The current establishment is a needless cost on the economy and does not add any value to the tax collection process. Doing away with this will be a huge cost saving to the government, as well as corporates.
2. The rent-seeking and rent-paying activities will continue unabated, which is unacceptable.
3. Even if on average, an individual income tax payer can save say 50 hours in a year, in not having to bother about tax compliance (as the Banks will take care of it), there will be a huge productivity boost in the economy.

Somebody needs to make a much stronger case for why the current rotten system needs to be sustained.

She ends her piece on a rather pompous note that tax reform should be based on “rigorous economic theory”, and is an “important and serious” issue, the implication of which seems to be that random “Babas” should not be allowed to comment on this. Sorry Mam, but you have not convinced me (for all that it matters)!

I also want to rebut some of the points made by Kalpesh Chavda in his piece.

1. Do we have sufficient Banks in India?
   Well, obviously, as of now, we don’t and I have answered this point in my earlier post. However, as Banks realize that there is money to be made in the process of being an intermediary in the BTT regime, they will make the necessary investments. Additionally, as mobile-banking and NFC-based (Near Field Communication) based systems become more secure, this will explode, and make it much simpler. In the interim, some people in rural India will get left out, but they can continue transacting in cash. The poor amongst them will not have a problem because of the missing high-value currency notes, while the richer ones will need to figure out how to get into the banking system, or use gold nuggets (as suggested by Ms. Pattnaik), or Tide Detergent Bars!
2. 2.       Isn’t BTT representing socialism?
   Kalpesh seems to be over-focussing on a word used in the Arthakranti proposal and nothing really material in the design. The fact is that the incidence of BTT will be progressively higher on richer people, has been discussed adequately, and hence this is not “socialistic” in nature. Incidentally, the constitution of India also carries the word “socialist”, but that is a separate debate.
3. BTT is cascading in nature?
   This is true that BTT is cascading in nature, unlike say VAT or GST. However, since the rate is so low, even after 20 sequential transactions, the total tax component under BTT will be around 16%, much lower than the total tax component today (which is 30-50%), not just as per GST rates. This will also trigger efficiency improvement in supply chains, as needlessly long chains are inefficient. I do not see anything wrong in it. Having said that, if price distortions are observed, rates can be lowered in future. This is not a show-stopper for this large an exercise.
4. Does BTT comply with the various “canons” of taxation?
   I have replied to each of the “canons” in my earlier post, except one, that is elasticity. Obviously, the BTT rate can be revised upwards or downwards, depending on economic conditions and the total tax collections. BTT does comply with all the other “canons”.
5. Is INR 2000 too low a threshold for India?
   This has been said by quite a few people to me. Of course, the threshold can be debated, depending on the purchasing power of the rupee. The biggest point why distortions won’t happen is that there is no criminality attached with performing transactions of a greater value in cash. There is only a legal compliance and enforceability angle. This also raises an issue of corruption. Corruption will still be illegal, and there are enough laws in place for that. This proposal only talks about decriminalizing tax-avoidance, so that extreme behaviour for tax-avoidance is eliminated (like tax havens, hawala transactions, etc.).

I once again reiterate that I am sure there are unresolved issues with BTT which need to be discussed, debated and solutions found. For example, I have myself proposed that SB account to SB account transactions be made tax-free. We need to find a solution for the impact BTT will have on brokerage businesses. All of this and more needs to be done, and can be done.

I had conducted a session in Mumbai on 19^th January, which was not only well-received, but also made me realise that despite the fear-mongering going on, simple honest tax-paying citizens want relief, and see some hope in the BTT. I am confident that there are solutions that will be found for all “doubts and concerns”. However, there are no solutions that can be found for disingenuous fear-mongering!

I was disheartened to hear that at least two senior BJP leaders are still unconvinced about this and are keen on spiking this proposal, even without as much as a debate. This is unacceptable! The Middle Class and Corporate India must take the lead in discussing and debating this idea, and even if we eventually reject it, let it be done after a rigorous debate and getting convinced that it is unviable, and not because “it won’t work because I told you so”!