Pratap Ravindran

THE somewhat saucier sections of the media have acronymised the name of the Finance Minister, Mr P. Chidambaram, to PC — and then expanded the initials into "politically correct Chidambaram."

The Minister, for his part, has lived up to his sobriquet by seeking to introduce a tax similar, for all practical purposes, to the Tobin tax which, for a time, was quite the rage among the anti-globalisation crowd, and fancifully referred to it as the Robin Hood tax.

While the bourses in India have, for a variety of reasons, reacted negatively to the so-called turnover tax, the initiative has been welcomed in other quarters, essentially on the basis of the argument that it will minimise blatantly speculative and potentially disruptive adventures in the capital market. All are agreed that money-capital, when used in pure speculation as against the creation of additional wealth and new surplus value, is a zero-sum game in which the total amount of profits remains the same but merely gets redistributed differently among the speculators.

The turnover tax, proposed by Mr Chidambaram, is nothing but a variation of a financial transactions tax (FTT) which is generally defined as any tax, fee, or duty, imposed by a government upon the sale, purchase, transfer, registration and so on of a financial instrument. A financial transaction tax can be broad-based or it can exempt a variety of instruments and/or transactions by certain types of traders. It can be an ad valorem tax or a specific tax. It can be levied against transactions by residents or against domestic transactions, or both. The law can levy the tax on buyers (as in the UK), sellers (as in Japan), or both (as in France).

The international experience is based on a wide variety of tax designs. Thus, it is usually not levied on transactions such as bank withdrawals or the securing of consumer finance, for instance.

And then again, transactions outside national boundaries are, by and large, not subject to the tax. In cases where they are, such levies have invariably thrown up substantial enforcement problems. Trading in national government securities tends not to be subject to the tax. It bears emphasis here that specialised traders, such as market makers or others providing liquidity to the market are also usually not subjected to FTT on their trades — or are subject to minimal tax rates.

The turnover tax has been, quite validly, been described as a Tobin-type tax.

James Tobin, an American Keynesian economist, had proposed a tax on currency transactions as a means of reducing speculation after the 1944 Bretton Woods agreement on exchange rates collapsed in 1971 when the US floated the dollar. This is what Tobin had to say about the tax he mooted in an interview with Der Spiegel, reproduced in Le Monde, September 11, 2001: "This tax aimed to limit exchange rate fluctuations. The idea is simple: On each operation, a minimum levy is made equivalent to, say, 0.5 per cent of the transaction. Enough to put off speculators. For many investors place their money for very short periods in currencies. If this money is suddenly withdrawn from the market, countries have to raise their interest rates considerably so that their currencies remain attractive. But high interest rates are often catastrophic for the internal economy, as the crises which hit Mexico, South-East Asia and Russia in the 1990s show. The Tobin tax would give back some margin for manoeuvre to the central banks of small countries to fight against the tyranny of financial markets."

Tobin got the idea for such a tax from Keynes who had suggested a national tax on internal financial speculation as one of his reforms to get out of the Great Depression of the 1930s. The idea was to encourage money-capital to be invested productively instead of being used for unproductive speculation. Tobin was given a Nobel Prize for Economics in 1981 — but, significantly, no government took up his proposal. And that was because the Tobin tax, in order to work, required the involvement of all governments which was one of the reasons he recommended that it should be paid to the World Bank or the IMF.

It is interesting to note that Mr Chidambaram, defending his turnover tax proposal in the course of his July 12 interactions with the Federation of Indian Chambers of Commerce and Industry (FICCI) and the Confederation of Indian Industry (CII), said the initiative is "efficient, neat, non-regressive and eliminates tax avoidance" — and then went on to hold out the assurance that he was prepared to "revisit the numbers in order to fin-tune the tax." As it happens, the Tobin tax proposal too had a modification bolted on to it whereby application could be refined so that the levy increased in times of severe crisis. This modification, known as the Spahn mechanism, in effect gave the tax the power to act as a circuit-breaker in times of great financial turmoil.

Without going into the specifics under debate, it is instructive to recall that, in the late 1990s and the beginning of the new millennium, Tobin-type taxes received massive support from widely diverse quarters. Leading economists and high-profile legislators from various parts of the world touted Tobin-type taxes as a panacea for all socio-economic ills. In fact, at one point of time, its introduction at a global level was under consideration by the United Nations.

However, a good deal of the enthusiasm waned when studies based on empirical data suggested strongly that the international experience with regard to financial transaction taxes was distinctly ambiguous.

Studies on FTTs have tended to focus on the experience of the UK and Sweden, both of which backed away from them. In the case of the former, the government did not pursue FTTS even though it did not face any significant problems in levying FTTs.

As for Sweden, the Government chose to discontinue FTTs when it became apparent that they were not yielding satisfactory revenue and that they triggered off several negative side effects. Those studies dealing with the experience of other countries have also thrown up mystifying results.

For instance, it has been found that Switzerland, which adopted FTTs in some form or the other from time to time to stem large capital inflows, usually applied tax rates not very different from that of Germany — but raised 12 times more revenue in relation to the size of the economy.

Italy went in for a relatively low tax rate, but generated a massive amount of revenue. However, its tax revenue as a proportion of the market value of equity was so out sync with that of other countries and so huge that it was thought to be untenable.

The bottomline is that FTTs may be politically correct — but barely so, because even those who oppose anti-globalisation now acknowledge that Tobin-type taxes do not eliminate the more deplorable aspects of capitalism but only gives governments an opportunity to regulate them and, in the process, make some money.

Given that such taxes have proved to be wildly unpredictable in terms of their consequences in those countries where they have been attempted, Mr Chidambaram would have been better off if he had sought its introduction with greater circumspection and thought.

If the Finance Minister is intent on combating speculation in the capital market, he could have slapped a turnover tax on the foreign exchange market to discourage the more disruptive practices of short-term funds and also required jobbers and day traders to register themselves with the Securities and Exchange Board of India (SEBI) so that their trading gains/losses are open to ready scrutiny.

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