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Column : Reform, then remove STT

Jan 28 2013, 03:12 IST
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SummaryRealistic discussions about whether the Union Budget should propose to remove the securities transaction tax or introduce a commodities transaction tax need to be more balanced than simply saying a complete no or yes to either.

The rate must be lowered, foreign participants should be reimbursed, and finally the tax must be removed over 4-5 years

Realistic discussions about whether the Union Budget should propose to remove the securities transaction tax (STT) or introduce a commodities transaction tax need to be more balanced than simply saying a complete no or yes to either. The first principles of public finance teach us that we should not tax transactions. Taxes like customs, octroi or excise—which tax transactions—have to be removed. All the tax revenue of the government must come from three sources: income tax on individuals, the goods and services tax, and property tax. This is the long-term direction of tax policy.

In this setting, STT was clearly a move in the wrong direction. But, in 2012-13, it was estimated that it would raise R5,920 in tax collection. This is a sizeable amount of money. To be pragmatic, it is unlikely that at a time of fiscal crunch, the tax would be removed completely. It can, however, be reformed slowly, in the following three stages. The first stage is to lower the rate by increasing the tax base. This would be revenue-neutral and reduce the visible distortions associated with the tax. The second stage would be to reimburse foreign participants, as is done with zero-rating of VAT. The third stage would be to set a timetable for removing the tax over a four or five year period. These steps add up to a feasible strategy for the reform of STT.

The introduction of STT in the equity market has given distortions in the financial system. There are four components of the financial system: currency, fixed income, commodities and equities. The imposition of STT upon only one—the equity market—has given incentives for market participants to focus on the other three. There is an artificial avoidance of equity market activity, with employees, public participants and capital shunning the equity market in favour of the other three markets.

All taxes are distortionary, and a basic principle of public finance is that we should have a low rate that is spread across a large tax base. It would hence make sense to cut the magnitude of STT and apply it across all organised financial trading—i.e. equities, currencies, commodities, and fixed income. This would generate no adverse impact in the short run while reducing the distortions in the economy where market participants are avoiding activity on the

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