By Chaahat Khattar

April 2014, will probably be the most politically happening month our generation has seen so far with close to 1 billion eligible voters deciding fate of thousands of politicians (or aspiring) and probably leading to new political relations across the globe. India being the largest democracy in the world, will have many stories to tell but before that it is the election manifestos of political parties in India and their fuelled (controversial as well) speeches that steal the show.

India is not only home to good number of Forbes and Fortune headlines, it is also known for one of the most stringent tax regime. The Income Tax Act, 1961 (edited and revised hundreds of times thereafter) is the bible for every tax payer in the country and concepts like Goods and Service Tax and Direct Tax Code are poised to revolutionize it. Governments after governments, targeting a common man or known industries with lucrative tax relaxations is in fashion and easy way out to get onto national newspapers for good.

Known Indian Yoga guru- Swami Ramdev also found out an interesting way (initially layered and put forth by Arthakranti Prathishthan and Maharashtra Knowledge Corporation Limited) to not only enter into politics indirectly but also to challenge the economics of taxation. He went ahead to term Income Tax and other taxes such as Sales and Excise Taxes as burdens and abolishing them is the need of the hour. Initially, the Bharatiya Janata Party (BJP, a national level political party in India and a frontrunner for the Lok Sabha Elections 2014) initially backed the idea of Ramdev but later made a U-turn and since then has not really even talked about it. Looks like BJP visited the drawing board with their economists before promising something that definitely needs a good bird’s eye view.

Before we go down to discuss what Ramdev initiated and how a country with just one single tax (Banking Transaction Tax as Ramdev mentioned) would function, let us know a bit about taxes.

The Great Depression of 1929, saw the epic fall of Classical Economics and birth and rise of Keynesian Economics which stated that government always has a monumental role to play in the economics of a country as against the fundamentals of Classical Economics which strongly advocated Laissez Faire (free economy without any government interference). Fiscal Policies (policies related to revenue and expenditure of the government) is one tool in hands of federal government with which it can both directly and indirectly impact not just its vote bank but more importantly the purchasing power of a citizen (natural or artificial) thereby directing the growth of the nation. Taxation is certainly the most common source of revenue in mixed economies. Taxes are compulsory in nature and there is no quid pro quo (meaning you cannot expect what for what in that). Taxes are sacrifice by taxpayers and not something they should see as a payment for some facility from the government.

Governments also use taxation to encourage or discourage certain economic decisions. For example, reduction in income tax by the amount paid as interest on home loans results in greater construction activity leading to more employment. Tax rates across the nations promote or restrict (regulate) trade and transactions which are the essence of any economy.

There are many uses of collecting taxes and let us know some really common to all. The most obvious usage of tax is to pay for the operation of central and state governments. The main use for the money governments collect in taxes is to provide goods and services to the public. Taxes pay for education, infrastructure and public transportation, public welfare programs such as housing and shelter programs or what we know as “yojanas”, unemployment benefits, and health, police, and fire protection. Tax money also pays for the daily operating expenses of government, such as the salaries of government employees and interest owed on government debt.

With progressive taxes, such as the income tax, the more one makes, the greater the percentage of tax one pays. When wealthier taxpayers are taxed at a greater rate than the poor, there is actually a redistribution of wealth. Many people feel that redistribution is required to maintain a desired level of economic health, as well as being a so­cially beneficial thing to do.

Another major objective of the tax system is to give incentives to activities that government believes are good for the nation and to discourage activities that are not. For example, a tax waiver for industries promoting exports of the nation. Similarly, higher taxes for high pollution emitting automobiles.  So, tax is the backbone of any economy especially developing ones which cannot really do without having huge public spending bills or even for developed nations which continue to face mammoth business cycles (coexistence of tremendous growth and steep downfall).

In a modern economy like India, what would happen if we replace all prevalent taxes (and doing away with all deductions or exemptions) with one single tax such Banking Transaction Tax (“BTT”)? People proposing and backing this idea on paper has estimated close to INR 15 lakh crore in tax collection annually through BTT as against the current combined current earnings of INR 10 lakh crore. BTT is very simple to understand by virtue of its name itself. There will be a flat tax rate for all bank transactions and one would pay no other tax. If BTT is say 2%, someone transacting INR 20,000 will pay INR 400 as BTT or someone transacting INR 20 crore will end up paying INR 40 lakh as BTT. This looks and sounds very simple. It is even feasible as countries like Estonia, Lithuania and Latvia are following BTT as its sole taxation based revenue system. Interestingly, these countries have also experienced positive economic growth adopting flat tax rate policies.

Coming back to India, there are two stark sides of having a single taxation system. On the positive front, a simple BTT will significantly bring down the operational costs of administration and tax compliance. Also, zero income tax will benefit the taxpaying classes directly, the demand will significantly sprout which will flow directly to manufacturing and service sectors that have inflation lower than food. Another major benefit for the economy would be that government can cut down its subsidy bill significantly. As people will be pocketing more and may have higher disposable income, the purchasing power will be high. There are chances that the black money stacked abroad (trillions of dollars) may find its way back home as multiple taxation is abolished.

On the other side of the coin, the story is different. India is a country where only 3% of its population pays income tax and indirect taxes contribute maximum to the tax revenue. As far as banking transactions are concerned, 60% of the population of the country has no bank account and mere 20% of all the transactions in the economy is through bank and rest is in the form of cash. Opening banks and promoting more non-cash based transactions (doing away with notes of higher denominations such as 500 and 1,000) might influence people to opt for transactions through banks but that will need both extensive capital and good time.

A flat tax system imposes similar tax rate on all taxpayers regardless of the income. It looks to be fairer but the catch is that it has its own dark side. A person earning INR 2,000 a month will be taxed at the same rate as the person earning INR 2 lakh a month. The former spends more of his/her income on necessities against the later, hence it might be too much for him to pay BTT and maybe too little for the later. A farmer getting subsidy to a senior citizen getting a small pension, everything will be slapped with BTT.  From a broader perspective, it is extremely regressive and can lead to income inequality on a large scale.

As far as black money is concerned, when government introduced Voluntary Disclosure of Income Scheme (VDIS), it managed to get INR 33,000 crore of undisclosed wealth into the white economy which further provided INR 10,000 crore in taxes in that respective year. The catch is that majority of that undisclosed income was in the form of jewelry and gold (37%), cash (50%) and property (5%) and not in bank accounts. So the applicability and ambit of BTT seems questionable.

All in all, on paper the idea is definitely aimed at the right direction but a country where there is dispute on sharing revenues amongst the Center and the State on something like Goods and Service Tax (GST) will a centralized single taxation system work? It could also be a case where India would also be seen as a tax haven which may lead to illusionistic but unrealistic economic growth. Industry leaders have varied opinions but implementation seems to be the common buzzword amongst all. Reforming taxation system, paving way for GST and Direct Taxes Code (DTC) and eventually moving to something like BTT or a more applicable and feasible taxation system can well be the way forward keeping in mind the enveloping principles of India’s fiscal federalism.


Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at ckhattar@gmail.com

Posted by The Indian Economist | For the Curious Mind