The Hindu : Business : Poor Budget exercise

Online edition of India's National Newspaper
Monday, Jul 19, 2004

Business

Business

Poor Budget exercise

The transaction tax, as introduced, is symbolic of all that is wrong with the budget preparation. It also proves once again how little the policy makers understand the capital market and its practices, says C. R. L. Narasimhan.

THE TURNOVER tax on share market transactions, actually a purchase tax on listed securities has been the most controversial proposal of the recent budget, not necessarily because it brought segments of the share market to a standstill. In several ways the tax proposal has come to symbolise all that went wrong in the preparation of the UPA (United Progressive Alliance) Government's first budget.

Even conceding the Finance Minister's point that the time available for the preparatory work was short, there was absolutely nothing to be gained by imposing a tax such as this one without first discussing and debating it in detail. It is pertinent to note here that the Kelkar reports continue to be studied in depth, now by a task force too. Obviously laying down rules for such a massive transformation of the tax structure takes time.

Another analogy is the delayed move to introduce VAT (Value Added Tax) from April 1, 2005. The postponement of the VAT system, at least five times before, has been criticised but at least no one can accuse the authorities of being hasty. One may argue that the Kelkar reports and the VAT moves represent fundamental shifts in the fiscal policies and the administrative machinery needed to implement them. But equally relevantly, it is unwise to ignore the damage that an ill thought out turnover tax can cause to sections well beyond the financial sector.

The proposal to tax all share market transactions — equities in the cash market, futures and debt instruments — at the rate of 15 basis points (0.15 per cent) met with universal opposition when introduced. Certainly, the proposal announced towards the end of the Finance Minister, P. Chidambram's speech neutralised whatever good the rest of the budget had done to boost stock market sentiment. Yet at least conceptually there are a number of points in its favour. It is also true that some market participants had advocated it in the pre-budget meetings with the Finance Minister. Along with the new tax the budget had proposed an abolition of the long-term capital gains tax and a reduction in the short-term capital gains tax to 10 per cent. Thus, the new tax being an indirect tax is meant to be in partial replacement of a direct tax (capital gains). From the point of view of the Exchequer, the new tax is easier to administer. Compliance will be high. The realisations will be much more than from the capital gains taxes on securities.

However, the new tax is iniquitous as it falls on every transaction irrespective of whether there is a capital gain or not. In practice, it does not draw a line between the different types of transactions in the share market: the nature of these is fundamentally different from one another and the margins earned (if any) are different. The equities segment is dominated by a large number of operators taking speculative positions and in sheer volume the trades they generate outnumber those emanating from the institutional segment. Moreover, the jobbers, the day traders and others even if numerically small, are vital for ensuring liquidity. It is this speculative segment that will be worst hit by the new tax.

The debt segment trades on wafer thin margins. Taxing each trade at 15 basis points will wipe out even this. The secondary debt market came to a standstill in the wake of the budget. Commercial banks, including the government owned ones, are the principal players in the debt market. Any move that can bring activities to a standstill will have major repercussions. The options segment too is badly affected as the tax falls on the capital value of the transaction and not just on the options premium.

Mutual funds too are complaining: the new tax will make the debt schemes unviable. And in what is definitely a glaring omission, the benefits of capital gains tax modification are apparently not available to mutual funds. All these once again point to the disconnect between the stock markets and official policy. Even the capital market regulator, the Securities and Exchange Board of India, appears to have been kept in the dark while implementing the tax. There has been poor appreciation in official quarters of how capital market operates. Unless official policy is redefined there will be other instances of public policy mindlessly inflicting damage on this critical segment of the financial sector.

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