Is India considering a financial transactions tax?

India can impose taxes on international capital flows but only after there is a ‘global' consensus on them.

This is the considered view of Dr Parthasarathi Shome who is currently the Director of ICRIER. He has also been Advisor to the Indian Finance Minister, and subsequently the British Treasury.

ICRIER is currently engaged in a large research project on G-20 for the Finance Ministry.

India has so far resisted imposing such taxes. But are they completely ruled out? Maybe not.

The problem

The Indian economy is growing at well over 8 per cent. In spite or because of this, it does not produce enough of what it needs. So it needs to import a lot of things. But it doesn't export enough to pay fully for these imports.

The gap in what it owes to foreigners is called the current account deficit. It is made up by large inflows of foreign money. Most of it comes into the capital market. Small amounts of direct foreign investment in building factories also help.

While foreign direct investment (FDI) is here to stay, the capital market inflows come and go at will. This coming and going is called volatility.

Volatility causes serious problems for the management of the economy because of its unpredictable nature. To tackle it, governments impose what are called financial transactions taxes (FTTs).

India and FTT

In ICRIER Working Paper No. 254, Dr Shome has spelt out the pros and cons of FTTs.

Using cross-country data, Dr Shome has concluded: “We still lack convincing evidence concerning the effects of FTTs, in particular what impact they have on volatility of financial markets, or what long run revenue potential these taxes have.”

He then goes on to say that while FTTs meet momentary objectives, “they seem to be disliked even by the policymakers that use them for their deleterious efficiency ramifications.”

If not FTT, what?

So how does a country combat volatility? Dr Shome has this advice to offer.

“Non-tax structural institutions, rather than a tax, are needed to seek and support the trajectory out of deep recession... between the two, the non-tax regulatory route has greater advantages than does FTT.

“If both instruments are to be used, a very small, temporary, global FTT with clearly earmarked equity goals may be envisaged.”

In short no unilateral action should be taken by India.

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