Is banking tax a solution to India's fiscal woes? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is banking tax a solution to India's fiscal woes? 

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In this issue:
» Financial inclusion dream to be a reality in 2016
» Loan recast requests reach all time high
» QE to end by 2014
» Absorption rates drop by 25% in 2013
» ...and more!

Taxes are the main source of income for government. Any shortfall and the government may run a deficit. Hence, the goal of any government is to have a balanced taxation structure that can meet its social spending requirement.

India has a very complex tax structure with total number of taxes amounting to sixty. The tax revenues roughly stand at Rs 14 trillion. However, due to tax evasion and higher subsidy burden, the government runs a deficit. Also, a complex tax structure with higher number of taxes creates loopholes for evasion which are exploited by many. Thus, there is a strong need to revamp the tax structure of the country.

In a radical proposal, one research group, named Arthkranti Pratisthan has suggested that all direct and indirect taxes should be abolished. Instead, there should be a single banking transaction tax on both individuals and corporates. If levied at 2%, it can increase the tax revenues of the government to Rs 40 trillion!

If implemented, India will have a single tax rate on both individuals and corporates. This will greatly simplify the taxation structure. It shall reduce paperwork related to taxation. Instances of tax evasion will also reduce to a large extent. Revenue of the government will increase and it will be able to spend more on creating infrastructure. At the same time, disposable income in the hands of an average Indian will increase which shall boost spending. All in all, the proposal has all the populist and fiscal ingredients in it.

Hence, the main opposition party is trying to capitalize on the same by lending an outside support to it. Currently, it has undertaken a feasibility study on the matter. Though it appears that new tax proposal may indeed benefit the society and simplify the tax structure, there are certain issues which need to be addressed.

For example, a banking transaction tax will induce citizens to transact in cash. We are already living in a cash economy and this shall further increase the black money menace. There are also various technical issues that need to be addressed. Also, India has still not achieved financial inclusion. This means not all citizens will be brought under the transaction tax net.

Further, banking transaction tax may also increase the end price of essential goods. Since corporations make payments, right from procurement to sale of the product, via banking channels, they shall be liable to taxes at multiple points. This burden will be eventually passed to the consumer.

In short, the objective of the government should be to balance the tax structure, and at the same time minimize evasion. Eliminating taxes all together is not a solution, neither having a multiple pyramid structure. A balanced approach is needed which has to be fiscally prudent and commercially viable.

Should the current tax structure be abolished and replaced with banking transaction tax? Let us know your comments or share your views in the Equitymaster Club.

01:50  Chart of the day
Not just equity but debt markets too were witnessing lack of money flow from foreign shores until now. However, the tide seems to be turning as far as inflow into the debt markets is concerned. Since May 2013, the Indian debt markets have witnessed FII inflow for the first time in December 2013. Volatile rupee and hawkish stance by the RBI led to a massive outflow of money from Indian bond markets in the last 6 months or so. Depreciating rupee reduces dollar return for foreign investors. This led to massive sell off in debt markets as investors feared further exchange losses on their investments. Further, a hawkish stance is also negative for bond prices since interest rates and bond prices move in opposite direction. As RBI continued with its tight monetary policy to curb inflation, bond prices fell. As a result, investors turned bearish and reduced their exposure towards Indian debt. This led to significant outflow of money from Indian debt markets as can be seen in today's chart.

However, an inflow of Rs 52.6 bn in December 2013 is a sign that foreign investors do not expect rupee to depreciate further. Also, they believe that interest rates have stabilized. However, considering that inflation is above comfort zone, RBI may surprise the street in the next policy review. Thus, one should not try and read too much regarding the inflow number of just one month. If the trend continues for a longer period we can infer that both interest rates and currency markets have stabilized.

Net debt FII inflow/outflow

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This may seem unreal to residents of metro cities. But the fact is that even basic bank accounts are yet inaccessible to those in semi urban and rural areas of the country. No wonder, the biggest challenge for the banking regulator is to make banking services available to everyone. As per demographic statistics, just 50% of India's adult population has a savings bank account. Further, more than 80% of small businesses do not avail formal banking services. Hence, the special RBI panel has recommended setting up of specialized banks. This is to ensure that all citizens have bank accounts by 2016. It essentially means that the new banks should cater to low income households across the length and breadth of the country. Not just that it has recommended facilities for deposit and withdrawal of funds to be readily accessible. A gradual abolition of the SLR (statutory liquidity ratio), which makes it mandatory for banks to invest in government bonds etc, has also been recommended. This could prompt more NBFCs to apply for bank licenses. While the 2016 target seems rather ambitious it could give a massive boost to Indian economy and curtail the parallel economy. However, the new banks need to be prepared to commit to social causes rather than just profiteering.

We sort of admire the confidence that investment strategists and money managers often portray. As per them, the economy is a perfectly oiled machine that will do exactly as desired by its operators. If the economy is down and liquidity absent, all one has to do is pull down the levers of interest rates and money printing. And voila, within a couple of years the economy is back on track. And now that the mission is accomplished, pull back the money printing and once again, all will be good. Sadly, this is not how economies in real life work. Simply because each participant in an economy has its own thought process and it's absolutely impossible to tell in advance how these people are going to react collectively. Therefore, a news article on CNNMoney that argues for a smooth ending to the US Fed's QE taper has got its conclusion totally wrong we believe. Much of the growth that has happened in US and worldwide is on account of this very policy and once the liquidity starts drying up, there could be dislocations beyond what anyone could comprehend. As a result, one should be braced for a significant volatility ahead. It may not be a bad idea to load up on some gold in case things really turn for worse.

Debt is a double-edged sword. It is vital for economic growth. But when the economic tide turns adverse, debt can be dangerous. The problem is that interest expenses are a fixed cost. You have to pay them irrespective of how the sales and profits are performing. This is the reason why too much debt in an adverse economic scenario can wreak havoc with a company's finances. And when there are many of businesses that have troubled finances, it means trouble for the country's banking system and the economy at large.

Such a situation is currently brewing in India. The woes of debt-laden Indian companies are getting worse. The quantum of debt for restructuring in India Inc has been growing at an alarming rate. Here are some worrying figures reported by Indian Express. On the 31st of December 2013 alone, there were requests for debt restructuring worth Rs 140 bn. With this, the value of referrals to the corporate debt restructuring (CDR) cell hit an all-time high in the October-December quarter at nearly Rs 450 bn. With a quarter yet to go, debt restructuring requests before the CDR cell in the fiscal so far has already crossed the Rs 1 trillion mark.

The slowdown in the economy has severely crippled the financial health of several Indian firms. While speculators in the stock market are pinning hopes on a new government post elections, the outlook for the Indian economy continues to remain bleak at least over the medium term.

It is a well known fact that recent times have not been particularly good for the real estate sector. As far as housing goes, most buyers have chosen to stay on the sidelines because house prices refuse to confirm with simple economics of demand and supply. Thus, logic suggests that at some point, house prices need to cool off. So what about commercial real estate? Here too the scenario does not look too optimistic for investors and real estate players alike. Indeed, as reported in Mint, net office absorption rate declined 25% across the top 8 markets. This is because at a time when the Indian economy has slowed down, Indian corporates have been focusing on rationalizing costs. Most of the companies are either relocating or consolidating so as to derive greater value from operations in the country. Thus, the real estate sector will have no choice but to grapple with a few more quarters of low demand. Whether that will lead to prices coming down remains to be seen.

In the meanwhile Indian stock markets are trading firm. At the time of writing, the benchmark BSE Sensex was up by 34 points (0.17%). Pharma and Metal stocks were the biggest gainers. Most of the Asian stock markets were trading higher led by Hong Kong and Japan. The European markets opened on a negative note.

04:50  Today's investing mantra
"When forced to choose, I will not trade even a night's sleep for the chance of extra profits." - Warren Buffett
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45 Responses to "Is banking tax a solution to India's fiscal woes?"

sanjay jain

Jan 15, 2014

banking transaction tax is a great idea and revolutionary step for economy, there are many doubts about it. as of multiple charges tax will be deducted only on deposits and not on any kind of withdraws.
more over saying that people will start deals in cash is not true, please think positively, ie by paying only 2% tax your all money will be white and u need not have to keep large amount at home,or carry amount with u any where
so its not bad deal. every one prefer to deposit money in banks instesd of keeping at home just to save 2%. even hawala charges or difference between buying or selling gold are more than 2%

by removing all direct n indirect taxes prices of all things (all items of daily use)even petrol will come down.
when we talk about same tax rate for all rich or poor, so even today except income tax or wealth tax all indirect taxes ( excise or service tax etc) are same for all. so many more things are there to discuss so we should discuss different aspects of this thought so there may come some good idea.
today every one wants simple tax structure. people are ready to pay taxes only but they afraid of todays complex paper works n structure.



Jan 14, 2014

Dr. Atul Tiwari has raised a very pertinent issue about this idea.
I believe the idea of doing away with such a complex structure is in the right direction but this is not the way to do it. I believe we should do away with tax on income and only have tax on consumption by way of VAT.
While the current slab-wise income tax appears to serve social justice, in practice this is hardly so because those with the maximum income get away with evasion. Tax on consumption will server social justice far better.


Dipankar Mitra

Jan 13, 2014

Abolition of all direct and indirect taxes and imposing a transaction tax on banking is one of the most hare brained ideas I have heard in recent time. It will push significant financial transactions in cash mode, generating more black money. As it is, significant segment of our population do not have a bank account. This will be a further discouragement. We badly need streamlining of our tax structure, not total abolition.


Chandra Prakash

Jan 12, 2014

One point Tax is a good idea .... but Bank Transaction Tax is not the only option.

Why not have One Point Tax at Production point.



Jan 11, 2014

First question to be asked is why does the govt need such huge amount of tax. Govt needs all this money not for any noble causes, just to stay in power, have complete control over every aspect of a citizens' life, dole out money for all sorts of vote banks. Lets remember Thomas Jefferson 'least governance is best goveranance'.
The first thing is to have a small govt, the business of govt is not business and they should get out of all economic activities. Running BSNL, Airindia, NMDC, SAIl, NTPC, hopcoms, tansi, scooters india is ridiculous besides being illegal, immoral and evil.
Once the govt gets out of business it need not fleece the citizens with a plethora of confounding and perplexing taxes concocted by devious and flagitious minds.
This is the only sure way to bring down corruption by a great extent. Of course we shall still have corruption in defense, police and wherever we cannot do away with the government, but that could be tackled with more pay and less people to go after.
And also we shall do well if 10% of laws are removed from our law books every year.



Jan 10, 2014

Dear sir,
First,we thank to the research group,because their thinking
is very different.i think,if we implemented we may be the first in the world.presently we collect the tax,we spend more like income tax deprt,sale tax depart,and service tax,etc..but in this new system implemented all are not need.

Any way deep discussion still need,Opposition party is thinking to implement.




Dr. Arun Draviam

Jan 10, 2014

No. The proposal will have disastrous consequences. People will not come forward to open bank accounts and thus the object of financial inclusion may be defeated. More than black cash, people may settle transactions through 'parchi' used by marwaris. Some may resort to use gold to settle high value transactions. The intended tax collection may not be achieved. Rather the black economy will flourish.



Jan 9, 2014

In the matter Warren Buffet type of stocks screen
Is Dividend payout expressed in percentage or Rupees.


Dr Atul Tiwari

Jan 9, 2014

Funny suggestion-(Banking transaction tax)
If I borrow Rs 1 Lack from my father to pay a course fees than my dad would be chargs 2000/ & I will also be 2000/ (Making total 4000/)
Than I transfer this money (By adding 4000. to make it 1 lack again) I will be again charged 2000/ & Institue will also be *Which they will charge from me) making total tax till date- 8000/
Now if refund fees to me back (By finding me non eligible for course or scheme (Happnes many time with insurance houses) I will be again charged 4000/ (2000/+2000/)
Now I will return back it my dad (Because purpose is not solved) this money will be charged again by 4000/ (2000/+2000/
Nothing is done, money (Rs 1 lack) was returned back to dad with loss of Rs 16000/ (as RS 84000/.
lost 16000/ for nothing- What an idea Sir Ji !!!
Please let us know where this genius lives?



Jan 9, 2014

interesting! how will the political class and buerocracy will accept such a change, which is beneficial to people!

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