Swap Income-tax, GST for a Banking Transactions Tax To Trigger Growth with Justice
These are unprecedented times as an extremely severe health and economic crisis is impacting our lives to a major extent, courtesy the novel coronavirus (COVID-19). Many distinctive features make COVID-19 a very eclectic crisis. First, it is a highly chaotic and unusual fusion of a deadly disease with an economic calamity. Second, its escalating growth has seen it become a global phenomenon in a very, very short period. Third, as economists would call it, it is an unparalleled supply and demand side (macro-economic) shock with great uncertainty in magnitude and duration. Fourth, its impact is many-sided and includes infection, death and loss of loved ones, severe human suffering in several forms (such as job losses, lack of food and nutrition, loss of education, even if it may be temporary, lack of cash flow for sustenance and livelihoods), greater indebtedness, severe global recession caused by a prolonged (uncertain) contraction in economic activities, brutal individual and corporate (financial) distress, huge stress on the financial systems (thereby exacerbating the supply of credit to the real economy), stoppage of flow of capital due to risk aversion by investors and other stakeholders and so on. Clearly, COVID-19, is a once-in-a-lifetime situation, whose multi-faceted impact will render the world into pre- and post-COVID-19 era’s.
But there is a silver lining to it: countries that are best prepared to assimilate digitisation are likely to recover quickly (in an economic sense) and India appears to be one of them. In a brilliant recent article titled, “Life in the era of COVID-19
”, prime minister Narendra Modi has talked of how the COVID-19 situation can be used as an opportunity to change things for the benefit of the poor and humankind and one theme that he repeatedly emphasises here is the need for and use of increased digitisation. As he so very succinctly argues, one thing becomes clear—COVID-19 has given us a rare opportunity to revolutionise our way of life, especially using digitisation and for the larger benefit of all humankind.
One direct result of this could be an even greater use of the Reserve Bank of India (RBI) payments system than in the previous years and this precisely provides us with a wonderful opportunity to bring the kind of reform suggested by the PM. Indeed, the present situation provides us with a unique opportunity to reverse what has been happening for the last 72 years and bring in major progressive reforms in taxation.
Direct and indirect tax proposals have that kind of power over an economy, the power to make or break it. And this is the time to rationalise income and other direct and indirect taxes to usher in a total revolution, whereby it will be easier for the government to maximise revenue while simultaneously reducing the burden on citizens. I think that is a pareto optimal goal.
Let me quote from the great Indian epic Mahabharata, which offers advice on taxation to the ruler of the day:
“The king should take wealth from his subjects at the proper time... Like an intelligent man milking his cow every day, the king should milk his kingdom every day. As the bee collects honey from flowers gradually, without causing harm to the tree; the king should draw wealth gradually from his kingdom for storing it.” — Bhishma’s counsel to Yudhishthira. (Mahabharata, Book 12: Santi Parva: Rajadharmanusasana Parva)
So, let us move on to the question of how to rationalize the direct and indirect tax regime and enhance revenue generation for the government while at the same time making it less burdensome for the citizens? We also need to simultaneously ask how India’s tax system be rationalized to eliminate black money generation?
An answer lies in moving away from the existing complex income-tax system to one that is simple, cost effective and transparent, with lower transaction costs and greater ease of operation for the government and the taxpayer.
In the long term, taxation laws need to be simplified. Wherever and whenever possible, positive reinforcement rather than the threat of punitive action must be used to influence attitudes and bring about long lasting behavioural changes.
A transparent and simple tax system can go a long way in helping people negotiate their way through it.
Taxation should be pareto optimal—it should neither diminish the drive for enterprise nor should it result in huge inequities due to the hoarding of money by a select few. An unduly high tax rate and low exemption limits are constraining factors on consumption and enterprise. That is why having a transparent and forward looking tax system is critical for any economy.
What are the criteria that enable a system to be a forward looking transparent tax system?
• Transaction Cost.
• Ease Of Implementation.
In fact, the Nagpur-based economic think-tank Arthakranti,
which has reportedly claimed credit for proposing the idea of demonetisation, has proposed a complete abolition of all direct and indirect taxes levied by the Union government, the various state governments and all local bodies across the country, with the exception of customs and import duties that function as international trade balancers. Instead, they propose a banking transactions tax (BTT) at the rate of 2% on all banking transactions, with the exception of cash withdrawals.
Given that BTT would be a flat, single-point tax to be levied by commercial banks on all bank transactions, it would be simple to implement and have practically zero compliance cost. With the numbers of those within the fold of the banking system expected to increase even more significantly (given the drive for 100% sustained financial inclusion), BTT is likely to generate the required tax revenue and have buoyancy too.
The negative fallout might be an attempt at bypassing the banking system, but certain additional measures (discussed in in detail in my above cited book) need to be undertaken to ensure that people prefer not to transact in cash, wherever and whenever possible. However, there exists the challenge of ensuring that the people newly entering the banking system remain within its fold. Simplifying banking procedures and improving the quality of and access to other support services should help achieve that.
Coming back to the BTT, let us look at transaction numbers to understand how beneficial the BTT could be if and when it is implemented. For example, for the FY18-19 alone, the total value of RBI payment system transactions
(Table IX.1: Payment System Indicators – Annual Turnover) stood at Rs28,86,465 billion, or Rs28,86,46,500 crore. If we compute a BTT of Re1 per Rs100 (or 1%) across this 28,86,46,500 crore that flowed through the RBI payment system in FY18-19, we get a BTT collection of Rs28,86,465 crore.
Thus, if one were to try to make a projection based on the total BTT estimated to have been collected using the RBI payment system data for FY18-19, the annual total yield from BTT would have been able to easily compensate for the loss of revenue from all direct and indirect taxes which stood at Rs20,80,000 crore as per the data available and cited in “Union Budget 2019-20: An Assessment, RBI Bulletin September 2019” as under column 4, Table 2
In fact, there would have even been surplus revenue of Rs806,465 crore, which is huge by any standards. And more importantly, it would have been far easier and less costly to implement and ensure compliance.
The same principle should hold good for 2019-2020 and I have taken a look at the provisional RBI payment system numbers for 2019-2020 (which is available until February, 2020) and it suggests that a BTT of Re1 per Rs100 transacted through the RBI payment system, should be more than good enough to take care of the total of direct and indirect taxes—budget estimates put it at Rs24,61,000 crore (see column 5, Table 2).
Using the provisional RBI payment system data until February 2020
and also extrapolating it for March 2020, the total estimated revenue from a BTT of 1% would have yielded Rs25,00,901 crore, which as you see is higher than the Budget estimates of direct and indirect taxes of Rs24,61,000 crore (see column 5, Table 2
). And going forward, post COVID-19, with increased digitization and further stabilization of the economy, the transactions through the RBI payment system should only further increase.
Accordingly, the following changes to the present tax system are suggested.
A crucial first step here is to abolish all direct and indirect taxes—i.e. personal income tax and corporate tax including all kinds of capital gains tax (both short and long term). Corporate tax will also have to be abolished for all body corporates.
GST must also be completely eliminated. The same has to be immediately and seamlessly simultaneously substituted with a banking transaction tax (BTT of 1%) of Re1 per Rs100 transacted through RBI’s payment system.
As the velocity of the payment system and banking transactions increase, the BTT would also be good enough to provide a huge surplus as well. I believe, that, post COVID-19, after the economy stabilises, BTT should ultimately settle down at 75 paise per Rs100 (or 0.75%).
After a few years, with inclusive and further digitization, it could even come down to 50 paise per Rs100 (0.50%) The BTT is what I see as a fair system to taxation, without burdening the common person—it will bring into its fold, almost everyone in the country from a tax perspective (currently, less than 10% of India is part of the direct tax system) and give huge tax revenues to the government and most importantly, without inconvenience to the common man. A forthcoming article dwells on the specific steps and actions that would need to be undertaken to operationalise this idea in real time.
The country has been through testing times. Even in the face of adversity, the people have stoically borne inconveniences/losses in the hope of a liberalised economy in the future that will yield benefit to all. Taken together, the abolition of direct and indirect taxes and their substitution with a BTT, as outlined above, should start to yield significant results.
Once the above is done, it is expected that the various pillars of economic growth will automatically start to move and move at an increased pace. Over time, the shift to a BTT should greatly enhance domestic consumption, increase domestic savings, further reduce interest rates for lending and make exports competitive, apart from helping to generate surplus funds for development (including infrastructure), enhance investment, eliminate poverty and transform India into a rapidly growing, stable and inclusive economy.
Together, the abolition of direct taxes and indirect taxes and introduction of a simple BTT should also help in building a more competitive industrial base in India, especially among the micro, small and medium enterprises (MSMEs) and also in manufacturing in general. Various manufacturing clusters that are doing badly should now be able to do better and without a doubt, exports will pick up.
The move to BTT (with additional reforms in the real estate and other sectors) should also enhance the overall size of the economy, especially given that the informal sector and the parallel (black) economy in the real estate sector would have been fully absorbed into the mainstream.
One last point is in order. Much has been tried for the past 72 years (with varying degrees of success) with regard to building a vibrant economy and I strongly believe that it is a now or never situation for the Indian economy today.
What we do now will determine the quality of life for our children and grand-children (much into the future) and India is clearly at the cross-roads.
Here is a great opportunity to create a vibrant and dynamic economy and that should be utilised. That is what India needs today and that is what will cure our ailing age old system of economic governance and push us into an era of dynamic and vibrant entrepreneurship based on sound fundamentals into a period of long-lasting (hopefully, double digit) growth.
(Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years