Some of the most outlandish suggestions are made ahead of elections.
But perhaps nothing in recent times approaches the suggestions of some
in the Bharatiya Janata Party (BJP) to do away with all existing taxes
other than customs duty and in their stead introduce a single tax on all
bank transactions. This proposal has not yet been formally articulated.
But the former BJP president, Nitin Gadkari, who is supposed to be
preparing a “vision document” for the 2014 elections has spoken about
it. And the party’s prime ministerial candidate, Narendra Modi, has as
the price of support from yoga-teacher-turned-politician Ramdev agreed
to a similar proposal to replace income tax with a bank transaction tax.
The BJP whose original core support base consisted of urban traders
and the salaried has always espoused one concern dear to these groups:
the burden of personal income tax. But India now has one of the lowest
incidences of income tax among countries of comparable size and at a
similar stage of development. The tax kicks in at an income of Rs 2 lakh
a year, or as high as 34 times per capita annual income and if one
assumes a family size of five then at almost seven times the average
family income. There are now as few as three slabs of rates, easing the
burden over large ranges of income. A number of exemptions further
lighten the burden of income tax. Of course, all this has not prevented
large-scale tax evasion. As is well known, only 2% of Indians now pay
personal income tax, while it is 20% in China and 8% in South Africa.
None of this has prevented the BJP from continuing to think of how to
further reduce the incidence of personal income tax.
The proposal on the party’s drawing board is to abolish all direct
taxes (personal income tax, corporate tax and wealth tax) and all
indirect levies other than customs duty (excise duty, value-added tax,
sales tax and cesses) and have a single tax of 2% on all bank
transactions. Simultaneously, high denomination notes will be
demonetised and it will be illegal to have any cash transaction larger
than Rs 2,000. In the BJP’s internal estimate, a 2% bank transaction tax
will yield as much as the central government’s current gross tax
receipts of Rs 14 lakh crore though Gadkari has claimed that the
receipts could even go up to Rs 40 lakh crore a year.
However, there are many basic problems in this poorly thought-out
proposal. First of all, like the sales taxes and excise duties before
the era of value-added tax (VAT), a single bank transaction tax would be
a cascading tax that would have distortionary effects on the economy.
An additional fallout could be the generation of a parallel currency or a
series of IOU notes between businesses that can be used to avoid the
bank tax. The non-business entities in the economy like households and
other non-business institutions will also move away from the banking
sector.
If so much of the economy now revolves around the cash (illegal)
economy and evasion, how will a ban on cash transactions of more than Rs
2,000 possibly persuade the entire economy to route most transactions
through the organised financial sector? Indeed the opposite may happen.
What the central government will then find to its horror is that an even
larger part of the economy will have shifted to cash to avoid the new
tax and with that tax revenues will plunge.
Second, the proposed levy will also be regressive. Since it will be a
cascading tax, its actual incidence on any good or service would depend
on the number of stages of production the good passes through. If the
poor make their purchases from small outlets that cannot afford to
vertically integrate, the tax would be even more regressive. Such a
regressive tax may appeal to the likes of the business-politician groups
pushing the BJP and that may indeed be why they are thinking of it, but
it goes against the basic tenets of taxation and is not in the
interests of the majority.
A third major problem with the BJP proposal is that it will play
havoc with centre-state financial relations. The party should surely be
aware that there is a constitutional division of responsibilities
between the centre and the states and so also a division of powers of
taxation. The proposal to abolish all taxes, including sales tax, means
that the one major independent source of revenue for the states will be
taken away. One must also note that, side by side, the transition to the
goods and services tax, on the introduction of which so much hope has
been placed, will have to be abandoned.
There is, in short, nothing at all going for what can only be called a
hare-brained idea. No country anywhere in the world has chosen such a
course of action. Some countries have attempted to introduce a bank
transaction tax but mostly as a substitute for VAT on financial
services. A couple of South American countries, which introduced a
variant in periods of fiscal stress to augment their revenues and not to
replace existing sources of revenue, withdrew it later.
There is indeed much that is wrong with the existing tax system of
both direct and indirect taxes. In spite of many years of tax reform,
the system remains extremely complicated, opaque and discretionary. The
tax bureaucracy uses its powers of discretion and the only groups to
benefit are the lawyers and accountants. But the solution lies in doing
the hard work required to reform the tax code and administration, and
not in pursuing an idea whose only appeal is its supposed “simplicity”.
