The Next Bug: "Transaction Tax"

Those who have little or no grounding in theory and practice of public finance are busy advising government on taxation.They are now busy lobbying the goverment for replacement of "the complex income tax" with "a simple transaction tax". Those very self-styled “experts” who have little understanding of how a real economy works have succeeded in advising the government on vital monetary policy and created a mess which is dragging the economy to a totally avoidable low, not to speak of the inherent injustice and misery that it has heaped on the poorer sections of the people in whose interest the measures were advertised to be taken.

A lot has been written about the latter and a lot more can be said. The purpose of this article is to analyse the former before events overtake us and land us in another and even more permanent economic mess.

Much will depend on how one defines a transaction. If one defines it to eschew multiple- point incidence inflating the tax burden and relate it to a rational economic base, it will tend to become income or value- added tax i.e. you go back where you started to look for a “radical” alternative.

On the other hand, if, in paramount pursuit of “recording” the trajectory of money-flows and taking a cut at every turn, the definition is left too wide, it will introduce arbitrariness or unintended distortions in efficient use of resources. Businesses characterised by multiplicity of transactions will attract more tax than others.

Wholesalers may attract lesser tax burden than retailers; vertically integrated industries may be taxed less than those not so integrated; monopolies may fare better than units characterised by a competitive structure; automated industries too may fare better than the labour intensive units.

Paradoxically, a transaction tax may result in greater resort to cash to aggregate bank transactions, large cash being drawn in one transaction and used for subsequent disaggregated,smaller cash transactions which will not attract transaction tax.

Arbitrage business may develop to aggregate and disaggregate transactions through “netting” of cross-transactions and using cash for residual settlement. For example, A owing to B and B owing to C : A can net the transaction by directly paying to C, thereby reducing two transactions to one and even avoiding the last one by residual cash payment. Netting will tend to reduce the total value of transactions. It will also tend to reduce the number of transactions.

Both these tendencies will tend to reduce the tax potential. Which will provide a fertile ground for businesses to sprig up to share the benefit of reduction in tax burden. When payment-receipt chains are long and complex and “netting” is not obvious, software applications solutions will be developed to promote such businesses which will serve no useful purposes except enabling avoidance of tax!

Such businesses would be kind of non-banking clearing houses. They will effectively erase the potential footprints of real trajectory of money-flows by creating a parallel and abridged trajectory. Access to information underlying the abridged trajectory being under private players’ control, the data will not be easily available to public authorities except through laying down appropriate regulations. Which brings one back where one started in the hope of a simplified, automatic and radical alternative!

More important, a flat, indiscriminate and simple transaction tax is, by definition, regressive. It would cast the same burden of taxation on transactions, irrespective of the capacity to pay of the economic agent undertaking the transaction. Like all indirect taxes it would distort consumer preferences and lead to misallocation of resources. It is also irrational.

It conflates, for taxation purpose , distinct economic activities serving different economic objectives, without considering the adverse or unintended economic effect of such conflation. Such a tax conflates income and expenditure; saving and dissaving; current expenditures and provisioning for future; consumption and investment. In other words, it wishes away all legitimate, economically and socially desirable criteria relevant for taxation, in its misguided pursuit of “simplicity”, “footprint record”, “automaticity” and “ ease of payment and realisation.”

Incidentally these last requirements, can be largely taken care of without wholesale replacement of existing tax structure ,with a number of reforms such as inter-bank linking of transaction data, pertaining to individuals and corporate entities; removal of exemptions; keeping a close watch on heavy cash withdrawals; simple and automatic assessment rules for a large number of low and middle incomes; making corporate access to subsidies, incentives and facilities contingent on their tax payment records.

The ham-handed and disruptive demonetisation of 86 % percent of value of currency was not and cannot be a remedy to the ills of black economy whose eradication requires a persistent painstaking work to be carried on by investigative and enforcement machinery sans the razzle-dazzle of publicity. Similarly, replacement of income tax by a transaction tax will turn out to be a remedy worse than the disease of complexities, loopholes and harassment potential of the present tax system.

Why then is this irrational and ill-thought proposal receiving attention of powers -that- be and is even producing appreciative vibes in the media and better off sections of our people?

To understand this, we have to look for the answer to the classic Leninist poser “ Who-Whom ?”. Who is proposing this and Whom will it benefit? The regressive and irrational character of the measure speaks volumes in answer. Those who cannot tolerate even the present, highly diluted progressive character of income taxation are advocating it.

The likely adverse effects on the efficient use of resources do not worry them much because they are not interested in enhancing social productivity but only in opening avenues for larger private profit.

And they are trying to substitute their ignorance of political economy by out -of- context references to Kautilya, who, incidentally, lived eons before the advent of the present stage of capitalist economy in which we are living. But it is not surprising to see such referencing in these times when the head of the government did not hesitate to refer to puranic myths to “prove” the existence of high- degree surgical skills achieved by “us” in the imaginary past.

(S.P.Shukla, retired from the IAS, is a former Commerce Secretary, Finance Secretary and Ambassador to GATT in Geneva).