The Hindu Business Line : Cash transaction tax

THE Finance Minister has imposed a tax of 0.1 per cent on withdrawal of cash from banks in excess of Rs 10,000 per day. This excludes savings bank and small current account transactions. Such taxes are not new. Zee Howell of the IMF writes that in 1936 Keynes had suggested "a tax on financial transactions to discourage speculative activities which are not in line with economic fundamentals. Keynes' proposal was directed narrowly at the US stock market, which is likened to a casino where speculative activities were allowed to be carried out with little transaction costs. A financial transaction tax would have increased such costs and, according to Keynes, directed investments away from the speculative and towards the enterprise (that is, productive) objective".

This idea was revived in the 1970s by James Tobin, who suggested that cross-border currency transactions be taxed to discourage speculative activities and a run on currencies.

In the last Budget, the Finance Minister had imposed such a tax on sale and purchase of shares.

At that time there was much hue and cry about the negative impact on the stock market. But the market has continued to scale new heights. In this Budget, this tax is sought to be expanded to cash withdrawals. Such Financial Transaction Taxes (FTT) are equitable.

The New Zealand Alliance of political parties supports such a tax. It explains on its web site: "FTT is a tax on virtually all transactions that take place within a society. It is thus much more broadly based than the Sales Tax which only taxes a person's spending on goods and services and which, therefore, means that the overwhelming majority of transactions go completely untaxed. Because Sales Tax is not charged on purchases of assets like company shares two people with the same income and same consumption may pay different levels of sales tax, depending on how much each spends on assets...The introduction of FTT will materially assist lower income families and individuals."

A Resolution by the Town Council of Genoa in Italy says: "The Town Council, considering that since financial globalisation increases economic insecurity and social inequality, duping and humiliating the decisions of the people, of the democratic institutions and of the sovereign States responsible for the general interest, it is necessary and possible for the citizens to make public interest prevail over the interest of the financial markets and multinational enterprises; engages the Mayor and the council to obtain that the Italian government and members of the European Parliament uphold and endorse the following proposals: that a tax be levied on all financial transactions, particularly those based on speculation, and that the revenue from this be directed to the fight against inequality and unemployment."

Thus, it would be good to replace sales tax with FTT. But the Finance Minister has imposed an FTT additionally on cash withdrawals.

This can be doubly harmful. It will neither provide relief to the poor not improve financial activity. One way of removing the negative effect of the FTT is to allow it to be set-off against income or sales tax. Peru has imposed a temporary tax that levies a 0.08 per cent tax on all banking operations in national or foreign currency (both debits and credits) which will be deductible for income-tax purposes.

Dean Baker of the Center for Economic and Policy Research, Washington, says that mere taxing of a few financial transactions — such as the Cash Transaction Tax imposed by the Finance Minister — is not useful. The tax should be imposed on a wide range of transactions to make evasion difficult: The motivation for imposing currency transactions taxes (CTT) has been two-fold: (1) to raise money for important social purposes, such as reducing poverty in developing nations; and (2) reducing instability in currency markets by reducing the volume of trading. A well-designed CTT can serve both ends.

Simple arithmetic shows that a CTT set at even a very modest rate (0.1 per cent), could raise an enormous amount of revenue. With daily trading volume now exceeding $1 trillion, a 0.1 per cent tax could raise over $100 billion annually, even with very large decline in trading volumes.

Similarly, by reducing the volume of trading, it is possible that a CTT will increase the stability of the currency markets. However, a CTT that applies to the spot market for currency cannot possibly achieve these objectives because such a tax will be readily evaded by speculators acting in secondary markets. To be effective, any CTT will have to be applied to a wide range of financial instruments. Baker points out that the FTT is not a new idea: "Every industrialised nation imposed taxes on trades in its stock markets until recently, and several still do. For example, until 1989 Japan had a tax of 0.3 per cent on stock trades. Until 1966 the United States placed a tax of 0.1 per cent on shares of stock when they were first issued, and a tax of 0.04 per cent when they were traded.

"While most developed nations have reduced or eliminated their taxes on financial transactions in recent years some developing countries have gone in the opposite direction, most notably Brazil and Argentina.

In 1998 Brazil imposed a broad based financial transactions tax which applies to a wide range of assets from stocks to checks. Argentina has imposed a financial transactions tax in 2001. In both cases, the main purpose of these taxes was to raise revenue."

But mainstream financial markets do not like the FTT. Kurt Schuler of Cato Institute writes that Ecuador eliminated a "widely despised" financial transaction tax of 0.8 per cent that generated about 20 per cent of all non-oil tax revenue in 2000.

Vladimir Chelminski writes about Venezuela in The Wall Street Journal: "The financial transaction tax of 0.5 per cent is particularly damaging. Because most of the population is poor and does not use checks, the government says the tax won't affect them. This ignores the fact that business passes its cost onto consumers. Tax rules now stipulate that even the purchase of a cup of coffee requires the consumer to tell the vendor his tax identification number and address."

A report by Reuters says that Serbia is planning to abolish the FTT.

This history of the FTT is not encouraging but that does not vitiate its logic because it has mostly been used as a revenue-generating effort rather than a replacement of sales or income tax as it should have been.

The Finance Minister is moving in the right direction by bringing financial transactions in the tax net. It helps establish financial stability. This tax would be is equitous if it replaces the sales tax. It encourages investment if it replaces income tax. But it acquires a negative implication when imposed in addition to sales- and income taxes.

(The author is a New Delhi-based freelance writer and can be contacted at bharatj@nda.vsnl.net.in)

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