Chipping away

The government proposes to reduce the rate of Security Transaction Tax (STT),and reduce and enforce uniform stamp duties across the country. This is a step in the right direction. This should pave the way for removing these taxes altogether. Both are transaction taxes that are essentially distortionary and proposed not on grounds of equity or efficiency — they do not tax income or value added,but are imposed on grounds of ease of collection. In addition,the stamp duty differs from state to state.

Taxing transactions is attractive for governments. It is all too easy for a government to look at the big numbers for trading volumes and wonder how to grab a few percentage points out of that. But taxing transactions creates economic distortions. When a truck carries goods from one place to another,it’s fair to impose user charges or tolls for the use of the facility of the road,but it’s wrong to impose a tax on this movement as it moves from one state to another. In that same fashion,when securities change hands,it’s fair to impose a user charge which reflects the cost of the exchange infrastructure,but it’s wrong to impose a tax on this movement. Taxing securities transactions is wrong,for exactly the same reasons that the octroi is.

The very purpose of economic reforms is to make transactions frictionless. We build roads so that trucks can move at the lowest possible cost; we should not then subvert this gain by introducing octroi or entry tax. We design financial sector reforms so as to drive down transactions costs; we should not then subvert this gain by introducing transaction taxes. Successive governments attacked the non-transparent and monopolistic BSE,because it had high costs of transactions. The reforms to the equity market have been a great success — transaction costs have come down sharply. But the beneficiary of this should be the Indian economy. A tax captured by the government is exactly as wrong as a rent captured by a BSE broker. Taxation of transactions should be removed and tax policy should refocus the task of taxation on the VAT and the income tax.