Stamp them out

The recent ruckus in Maharashtra, where the state government imposed a tax on securities transactions and derailed the entire country8217;s securities markets, is eerily familiar. It shows that bad economics is not the exclusive preserve of the ministry of finance; other entities also do it. It also shows the vulnerability of India8217;s financial sector to transaction taxes. We have seen the repeated collapse of financial market liquidity owing to bad policy announcements by the government.

Taxing transactions is alluring. It is all too easy for a government to look at the big numbers for trading volumes and wonder how to grab a few percentage points out of that. But taxing transactions is wrong. When a truck carries goods from one place to another, it is fair to impose user charges toll for the use of the facility of the road, but it is wrong to impose a tax on this movement eg, octroi. In that same fashion, when securities change hands, it is fair to impose a user charge which reflects the cost of the exchange infrastructure, but it is wrong to impose a tax on this movement. Most people in India now understand that octroi is wrong. Taxing securities transactions is equally wrong, for exactly the same reasons.

The very purpose of economic reforms is to make transactions frictionless. We build roads so that trucks can move at the lowest possible cost; we should not then subvert this gain by introducing octroi or entry tax. We do financial sector reforms so as to drive down transactions costs; we should not then subvert this gain by introducing transaction taxes. Successive governments attacked the non-transparent and monopolistic BSE, because it had high costs of transactions. The reforms to the equity market have been a great success 8212; transaction costs have come down sharply. But the beneficiary of this should be the economy. A tax captured by the government is exactly as wrong as a rent captured by a BSE broker. The ministry of finance showed the path to bad economic policy with the securities transaction tax and the cash transaction tax. The Maharashtra government has followed in its footsteps, by demonstrating an equal ignorance of economics. It is important to stop this rot from spreading, by putting an end to all taxation of transactions, and by refocusing the task of taxation upon the VAT and the income tax.