The principal motive behind the proposal prepared by a Pune-based research organisation, Arthakranti Pratishthan, is the urge to simplify the hugely complicated extant tax structure. The tax system has substantial inbuilt discretion and, hence, the possibility of corruption and harassment and outright persecution of the taxpayers is high. There is no doubt that the high-handedness and utter viciousness of the tax officials has generated a very strong public reaction against the system, especially among the small and medium entrepreneurs. Moreover, being declaratory in nature, the present tax system allows significant evasion and low compliance. The cost of administering it is also appreciably high. So, should BTT be seriously considered
Admittedly, being a flat, single-point tax to be collected automatically by commercial banks from recipients of bank transactions, BTT is simple and has practically zero compliance cost. Its simplicity and the prospect of liberation from legions of corrupt officials is hugely seductive. BTT will generate the required tax revenue and has buoyancy. And if implemented with due care, in phases, as is being contemplated by the BJP, it is worth considering.
The proposal cites the case of 17 countries where the securities transaction tax, and not BTT, is in placeas an additional and not an exclusive tax. It was tried in Brazil between 1998 and 2004 but again as an additional tax. There is, at present, no other country that has a BTT in place. India is structurally a fiscally deficit economy with a huge population and high levels of income inequality and poverty. These features exaggerate the regressive impact of such a flat transactions tax. BTT will be seen as regressivelike any indirect or transactions tax; 2% of tax on a small income has greater impact on the welfare of the poorer people than 2% imposed on a large income.
The revenue from BTT will be pro-cyclical as the volumes of bank transactions will decline in an economic downturn. In the current tax system, the cyclical impact is somewhat mitigated because there are a variety of taxes and some components (personal income, property taxes, etc) are not as strongly impacted by the economic cycle as BTT would be.
It will hurt India's meagre exports because even Marcos Cintra (the chief proponent of a single tax in Brazil) believes it is difficult to exempt exports from this tax which will become uncompetitive. Moreover, BTT is an input tax and all such taxes will have a cascading impact on costs of production. In these days of distributed production, the cumulative impact could be significant. This will discourage ancillarisation with an adverse impact on employment generation.
Arthakranti suggests that all 32 taxes currently imposed should be done away with once BTT is introduced. This will require constitutional amendments as some of these taxes are levied by the states, who may see it as threatening their fiscal space and federalism, as in the case of GST. Getting the states on board will be difficult and time-consuming and could result in a significant confusion
BTT has strong revenue collection capability. The current volume of RTGS transactions are R80 lakh crore per month or R960 lakh crore annually. BTT at 2% will yield a revenue of approximately R19.20 lakh crore. This is excellent for a single-point tax and increases its attraction. But it is still about 15% short of the total present combined revenue receipts of the Centre and the states, which stood at R22.53 lakh crore in 2012-13. But, in nearly 30% of the RTGS transactions, the governments will be actual recipients. These transactions will have to be excluded and the revenue shortfall will be correspondingly higher. The BTT rate will have to be nearly 5% to be revenue-neutral, not 2% as has been suggested. This will create substantial incentive for evasion and add to the growth of the parallel economy.
BTT will, thus, encourage those already in the formal economy to transfer to the parallel or the black economy, expanding it further with all its attendant ills. This is a serious lacunae. Further expansion of the black economy could result in a dollarisation of the economy and an increase in gold smuggling for financing transactions outside the banking system. Sufficiently robust and foolproof measures will have to be put in place in advance of introducing BTT to curb the parallel economy, which if successfully done, as included in successive election manifestoes of the BJP, would remove the pressure to introduce BTT in a hurry.
To overcome this major lacunae, Arthkranti proposes the demonetisation of the higher currency notes, which are used in the parallel/cash economy. Demonetisation is surely desirable in India at this stage to strike a huge blow on all the ill-gotten wealth. But demonetisation is also a huge and very complicated undertaking. Therefore, if it is to be done, it should be done well in advance of the introduction of BTT, with careful planning and water-tight implementation. Any rumour or loose talk in this regard can have a huge negative impact with black money operators rushing to buy gold or assets abroad. This could result in a massive flight of capital.
As an aside, Arthakranti makes the argument that India has exceptionally large denomination currency notes when compared to advanced economies normalised by the respective per capita incomes. This does not hold at all. The $100 note was introduced in the US in 1862. Then, its per capita income was $600. In the UK, the 50 note was introduced in 1725 when its per capita income was a mere 85 This yields ratios of 6.0 and 1.6, respectively, which are far lower than the ratio of 70 between our highest denomination note of R1,000 and the current per capita income of R70, 000. This cannot be a reason for demonetisation.
The other proposal to curb the cash economy is to make all cash transactions above R2,000 illegal. This assumes that India has or will soon have universal formal banking coverage. The BTT proposal itself states that financial inclusion is very poor in India. All banking sector data point strongly to the under-banked state of the Indian economy. Domestic credit is only 76% of the GDP in India while it is 229% in the US. There were only 121 million borrowing accounts in India in 2010, which is less than half of the number of total households. Data from the recent census of India indicates that only 58.7% of households in India avail of banking services with the figure being 54.4% for rural areas and 67.8% for urban areas. So, BTT will leave out nearly 40% of the population from its coverage while it is not necessary that all them will be non-taxpayers. Deeming cash transactions above R2,000 illegal could cause massive confusion, especially in agriculture and construction sectors where these are pervasive.
Therefore, while the BJP needs to be complimented for at least considering out-of-the-box options to eliminate tax-related corruption and black money, something which can hardly be said about the present government, it should insist on three necessary conditions for implementing the BTTfirst, the creation of a consensus across states to pass the necessary constitutional amendments; second, the introduction of strong steps to curb the black economy and ensuring their successful implementation; and third, ensuring universal coverage by the formal banking system.
The following steps could be a way forward:
* Exempt all incomes below R10 lakh from personal income tax and reduce taxes on petroleum products by 30% to begin with. This will make the BJP the darling of the middle class and the SME sector.
* Introduce a very nominal (0.2-0.5%) bank transaction tax as an additional tax to introduce the instrument, examine the impact and compensate for the loss of revenues from the previous step.
* Implement measures to eliminate the black/parallel economy, including demonetisation. The BJP has all along promised this and should now spell out the measures to achieve this.
* Bring in measures to bring back the ill-earned wealth of Indians stashed abroad. These could be on the same lines as Germany and the UK, in their agreements with the Swiss authorities. This was suggested to the present government but it has failed to act on it.
* Promote and hasten universal access to and coverage by commercial banking in the economy, and bring all agriculture and construction industry transactions within the ambit of formal banking.
* Create political consensus for the abolition of state taxes and a new revenue-sharing mechanism by passing the GST, which will demonstrate BJP's ability to achieve this.
* Do away with a host of petty, corruption-prone and vindictive taxes like the wealth tax, sales tax and octroi apart from reducing tax charge on petroleum products. This in itself will greatly simplify the system.
* Finally, if still seen as desirable, shift to a BTT, exempting all pensions below a specified level and subsidy payments to those below the poverty line and prevent leakages by not specifying any lower limits for BTT. Abolish other taxes in a phased manner as revenues increase from BTT and wrinkles are smoothed out .
The BJP, whose declared intention to rationalise the tax structure is to be lauded, could, for the present, focus attention on measures for stricter implementation and simplification of the present system, which would achieve the desired objectives.
The author is Senior Fellow, Centre for Policy Research, New Delhi