Straight from Fantasia: BJP's Bank Transactions Tax

I should have seen this coming. A political party feeling encouraged to show its true colours, actually does. I have long believed that the BJP is a khaas aadmi party. This belief became stronger when the BJP announced it was considering a “banking transactions tax” or BTT to replace all taxes barring import duties. The “simplicity” of this uniform BTT, which is being promoted by an NGO, would increase tax revenues, eliminate black money and provide cheap access to finance for all Indians. Miraculous! Why don’t I ever think of such brilliant ideas?

A revolutionary win-win-win situation?
So, what is the banking transactions tax and why has it got everybody in the BJP and some in the chattering classes in a tizzy? Simply put, the BJP wants to dump the current tax system (income, sales, excise etc.) and institute a tax of 2% (or thereabouts) on banking transactions. Why? According to Narendra Modi, the BJP’s prime ministerial candidate, “the present taxation system is a burden on the common man. There is a need to introduce a new system.”

What Modi wants, Modi gets. So, Pune-based organisation Arthakranti made a presentation to the BJP’s top brass, including president Rajnath Singh, LK Advani, Sushma Swaraj, Arun Jaitley, Yashwant Sinha and Nitin Gadkari, briefing them about their concept of simplifying taxation by a universal, flat banking transaction tax. Essentially, everybody would get credit and debit cards, and transactions would be taxed at 2%. The receiving party would be taxed and the revenue would be sent to the government with the banking intermediary keeping about 17.5% of the collected tax given that it has a “key role to perform” in the transaction. To eliminate black money, high denomination notes (say Rs 100 and above) would be eliminated. Cash transactions will not attract any tax but would be illegal beyond a certain level, say Rs 2,000 according to Arthakranti’s website.

At the meeting of the BJP’s brain trust, participants were informed that banking transactions are “merely a fraction of total financial transactions in the country with about 80% being in cash.” According to Mukesh Sharma of the Delhi chapter of Arthakranti, “if we account majority of these cash transactions into banking, this will amount to about Rs 40 lakh crore of annual revenue from this tax.” With some nice, easy-to-understand examples, Arthakranti and its main supporters in the BJP conveyed how a 2% tax is really so much better than a 30%, 20% or even a 10% tax.

So let me get this straight: the BJP wants to eliminate pretty much all taxes (win), eliminate black money (win), and bring in revenues for the government far greater than what it gets now (win)? And, I don’t even have to file tax returns? This proposal also has the credible backing of legal luminary Subramanian Swamy and yogi turned economist Baba Ramdev? Sign me up! I am a convert to Modinomics and this triple win (and then some) idea. I am... hey, wait a minute! How did these guys come up with this genius trick?

A slight of hand, warm and fuzzy assumptions, and zero research
Quite simply, the BJP and Arthakranti broadened the tax base to include more middle and low income families and tax them at the same rate as the BJP’s khaas aadmi friends like those flying in private jets. In addition, they made some comforting assumptions about high banking sector participation and difficulties in carrying cash in suitcases. They also avoided research. This approach always helps people come up with ideas that “no one else has ever come up with”. So, shall we dig a little deeper? Yes, we shall.

On its website, Arthakranti states that “the ‘Arthakranti’ (Transaction Tax) concept has been designed for India, in India, by an Indian. Nevertheless, looking at the superlative merits of this proposal over all existing tax systems, it is likely that most countries of the world may adopt Transaction Tax system.”

How wonderful! We would be exporting our home grown, ideal tax system to the rest of the world. Except that a simple Google search of the term “Transaction Tax System” would have revealed to the proponents of the BJP’s proposal that this idea and its variants have been in existence for a really long time. In fact, the BTT has been implemented in various forms in many countries, notably in Latin America.

Perhaps the BJP’s BTT isn’t original, but surely it has its merits? How about the idea that it increases government revenues? Research by OECD economists Jorge Baca-Campodónico and Luiz de Mello and IMF economist Andrei Kirilenko, as well as a research paper for the World Bank by Patrick Honohan and Sean Yoder have debunked the claim that BTTs deliver the promised revenues. In a study of six Latin American countries (Argentina, Brazil, Colombia, Ecuador, Peru and Venezuela), the OECD/IMF team concluded that “for a given tax rate, revenue declines over time. Therefore, in order to meet a fixed revenue target in real terms, the tax rate needs to be raised repeatedly. However, we also find that successive increases in the tax rate erode the tax base by more than they raise revenue, and that the higher the increase in the tax rate, the more and faster the tax base is eroded. We conclude that bank transaction taxes do not provide a reliable source of revenue, especially over the medium term” (emphasis is mine).

So, my reading of what the economists are saying is that the BJP’s proposal would not only bankrupt the government by bringing in far lower revenues, it would also increase the tax rates which would drive people to avoiding taxes. So, fewer revenues and no elimination of black money despite getting more middle and low income people into the tax dragnet.

But how bad can it be? Can’t we give up a little revenue in exchange for all the ease of not having to file tax returns? Well, it turns out that the Latin American countries imposed these BTTs in addition to existing taxes! They were going through financial distress and had to raise additional money. So, how much did they collect? Not much, is the short answer. In Argentina (2004), a BTT rate of 1.2% yielded revenues of 1.72% of the GDP. In Peru (1990), a 1.42% BTT rate yielded revenues of 0.89% of the GDP.  In Ecuador (1999), a BTT rate of 2.0% yielded revenues of 2.51% of the GDP. By way of comparison, the dreamers in the BJP and Arthakranti feel we can generate 40 lakh crore by imposing a 2% tax on bank transactions. In case you are wondering, that is 40% of the GDP!

Of course, these pesky economists with thick rimmed glasses have come up with other uncomfortable findings. A study by Kirilenko in 2004 indicated that there was disintermediation (aka reduction in tax base) if BTTs are levied. And, remember, the longer you keep these taxes in place, the higher the rates have to be to generate a certain tax revenue. That means the tax base gets worse over time. So, we would have double digit fiscal deficits and an increase in black money within no time if the BJP’s proposal were to ever see the light of day. No wonder these taxes were abandoned time after time in country after country. But, history isn’t important. The BJP can write a new history, as it has attempted in the case of, well, history.

But... isn’t this revolution for the aam aadmi? No it isn’t!
But, who cares about facts and numbers and all this mumbo jumbo about increasing tax rates, a shrinking tax base and a disappearing revenue stream. Won’t the “common man” be happy with zero taxes and no tax returns to file and better access to low interest finance? Yes, the fabled aam aadmi will be super excited by what dream merchants have to offer until they find out that the “experts” at Arthakranti, in their revolutionary zeal, forgot all about the concept of disposable income and marginal utility of money. What is that now, disposable and marginal?

You see, the Arthakrantikaris thought they had disposed off the “marginals” by making them think they would get all the goodies and still be taxed by that oh-so-low 2% on their bank transactions. The problem is that the khaas aadmis would pay the same 2% on their transactions. But, as some of us learnt in basic economics, the value of Rs 100 is not the same for everybody. Someone with Rs 5,000 values it highly, while someone earning millions sees it as an annoyance. So, a tax that may be levied at the same rate on the receipts of aam and khaas aadmis may be a way for revolutionaries to make everyone feel equal, it is what economists call regressive, as in not progressive. Even if a low income family conducts most of its transactions in cash, any time it receives credit through a bank, it will get taxed. So, low income families are likely to skip banks and not benefit from the easy access to low interest finance that the BJP and Arthakranti offer. Oh, sorry, I forgot a minor detail. Typically, you can’t have low interest rates (and low inflation) in a high deficit economy unless, of course, the economy is Modi-fied.

With a tip of the hat to a few sane voices that expressed queasiness with this proposal, let me say to the BJP that they are welcome to put this proposal in their “vision” document. But let the rest of us at least have what your experts are smoking. We are going to need it if the BTT ever becomes law.

The author is a member of the Indian National Congress. Views expressed are personal.

Salman Anees Soz describes himself as a former World Banker hoping to help find a way forward in Jammu & Kashmir. He tweets @SalmanSoz.