By Kavaljit Singh
20 July, 2004
On July 8, 2004, India's Finance Minister,
P. Chidambaram, presented Finance Bill (Bill No. 22, 2004) in Parliament
in which he proposed the introduction of Securities Transaction Tax
(STT) in the Indian financial markets. Under the proposal, every transaction
in securities in a recognized stock exchange in India would attract
a turnover tax of 0.15 per cent. Transactions in stock and index options
and futures would also be subject to transaction tax. Whereas transactions
carried out on the Negotiated Dealing System (a screen-based system
for trading in government securities and bonds) operated by the central
bank, Reserve Bank of India, have been kept out of the purview of this
tax. Only the buyers of securities would pay the proposed tax. After
collecting this tax from the buyer, the broker would pay it to the stock
exchange, which would then pay it to the exchequer. The proposed STT
would come into effect only after the Finance Bill is passed by Parliament.
After acquiring the assent from President, the government would issue
a notification to make the tax operational. This entire process may
be completed in the next three months (September 2004).
The mandarins in
the Finance Ministry have supported the introduction of the STT in order
to simplify the tax regime on financial market transactions. The authorities
believe that the STT is a clean and efficient way of collecting taxes
from financial markets. That is why, the introduction of STT has been
linked with the dismantling of existing tax structure on capital gains.
While introducing the STT, the Finance Minister proposed to abolish
the tax on long-term capital gains altogether and reduced the short-term
capital gains tax from 33 per cent to 10 per cent.
There is no denying
that STT could act as an efficient instrument to collect the taxes,
as many market players fudge transactions to evade capital gains taxes
but it would be erroneous to consider STT (indirect tax) as a substitute
to capital gains tax (direct tax). If there are problems in collecting
capital gains taxes, these should be sorted out rather than reducing
and abolishing it altogether. Further, to justify the introduction of
STT only in terms of smooth collection of taxes would be a serious mistake.
There are several other benefits of STT in the Indian financial markets
There are several
justifications for the adoption of STT in the Indian financial markets.
First, the underlying
logic of securities transaction tax is to slow down the flow of speculative
money, as it would be taxed each time a transaction takes place. The
STT is expected to curb purely short-term speculation by day traders,
noise traders, arbitrageurs and big operators without significantly
affecting the long-term investors. The tax on equities held for a long
period would be marginal while the tax on short-term trading would be
higher. The STT would be a significant deterrent to speculators and
day traders trying to make a quick profit on a huge sum by just trading,
without taking any deliveries of stocks. The proposed tax would keep
such players away, as they would have to factor in the tax cost.
The STT is expected
to reduce the speculation in Indian financial markets, which are amongst
the most speculative markets in the world. Compared with several leading
international financial markets, the sheer volume of speculative trading
in Indian markets is extremely high. It has been pointed out that Indian
financial markets are second only to NASDAQ in speculation, thereby
surpassing some of the leading international financial markets such
as the New York Stock Exchange (NYSE), London Stock Exchange, and markets
in Hong Kong, Singapore and Japan (2). Despite a sharp increase in the
daily turnover in the Indian financial markets, actual deliveries are
less than 20 per cent of trading. Due to excessive speculation, much
of trading in the Indian markets is concentrated in a handful of stocks.
The top 10 stocks account for over 80 per cent of the turnover of the
Indian financial markets. The top 100 stocks account for almost 99 per
cent of the turnover. While there are several thousand stocks listed
in the markets that are not traded at all.
nature of Indian financial markets can also be gauged from the fact
that the volume of secondary market trading has increased several times
while new capital raised through primary market has significantly declined
over the years. As rightly pointed out by L C Gupta, former member of
SEBI, the high volume of speculative trading has not helped even a bit
in strengthening the market's capital raising function, rather it had
the opposite effect (3).
Over the years, we have witnessed that excessive speculative trading
by big players more often than not degenerates into market manipulation.
There is an entire history of frauds in the financial markets starting
from the securities scam of 1992. The financial frauds recurring at
regular intervals reveal that our financial markets are prone to abuse,
manipulation and excessive speculation.
India has also the
distinction of having extreme price volatility at the individual stock
level. Short-term trading is one of the major factors responsible for
increased market volatility. The financial literature suggests that
transaction taxes increase asset price efficiency by curbing excessive
volatility. By raising the cost of speculative trading, STT would contribute
towards restraining short-term trading, thereby making Indian financial
markets less volatile and more efficient. In the present times, the
stability in financial markets is of utmost importance because the Indian
policy makers are determined to invest pension funds in the financial
markets. As any negative development in the financial markets can adversely
affect savings, investments, exchange rates and interest rates, it is
high time that financial stability should also be treated as a public
Second, the revenue
potential of a 0.15 per cent of STT provides another justification.
On an average, the daily trading in the Indian stock markets is about
Rs 100000 million. By imposing a 0.15 per cent STT on this volume, the
Indian tax authorities can collect Rs 150 million every day. As Indian
financial markets operate on an average 250 days a year, STT could generate
revenue of Rs 37500 million every year. This is a substantial amount
in the present times when country is finding it difficult to raise revenues
through taxation. India's tax-GDP ratio is among the lowest in the world
and has fallen particularly in the 1990s - the decade of economic liberalization
Further, the need
of the hour is to tax the financial economy that has remained undertaxed
despite tremendous growth in the recent years. To a large extent, this
has happened due to several loopholes in the present tax system, which
have been consistently exploited by the big operators in the financial
markets. For instance, the foreign institutional investors (FIIs) avoid
paying taxes in India by routing their investments through Mauritius,
which has signed double tax avoidance treaty with India. Under this
treaty, corporate bodies registered in Mauritius would be taxed under
the Mauritian law rather than Indian law. Since Mauritius does not tax
capital gains and dividend, it is no surprise that bulk of portfolio
investment as well as foreign direct investment into India is routed
through Mauritius. But once the STT is implemented in India, evasion
of taxes by the FIIs and other international fund managers through such
tax treaties would be effectively curbed.
The revenue raised
through STT could be utilized in several ways. Given the fact that Indian
authorities are too much worried over the current fiscal situation,
they can use this tax revenue to reduce the fiscal deficit. Alternatively,
a part of these financial resources can be deployed to support specific
developmental and anti-poverty programs in the country.
Third, an additional
advantage of STT is that it could discourage hot money flows,
which are known for their volatile and destabilizing behavior. As recent
international experience shows that developing countries are more vulnerable
to hot money flows, STT could ensure some degree of insulation
to the Indian financial markets from the deleterious effects of such
volatile financial flows.
Fourth, by cutting
back financial resources in unproductive speculation, STT could encourage
long-term financial flows. The speculative activity in the financial
markets diverts large amounts of resources away from productive purposes.
As a result, fewer financial resources are available to fund long-term
economic development. In the long run, STT has the potential to benefit
the real economy.
Fifth, another main benefit of the STT lies in its progressive outlook.
As the major players in the financial markets are big speculators, day
traders, arbitrageurs, brokers and wealthy individuals, whose numbers
in any case are miniscule, STT would only affect their businesses without
directly affecting the majority of Indians. As the victims of volatile
financial markets are often small investors, the proposed tax would
help in providing some protection to the community of small investors.
The wider economic
and developmental gains of taxing speculative money are more than the
private gains of a handful of speculators, financiers and traders. If
gambling in a casino or a state lottery ticket is considered an immoral
act and therefore heavily taxed, there is nothing wrong with a modest
tax on speculation. Gambling in the financial markets is no qualitatively
different from gambling in a casino.
Sixth, the securities
tax is much easier to implement. It is a clean and efficient instrument
of collecting taxes from financial markets, as collections will be centralized
through the stock exchanges. Further, unlike Tobin tax (4), STT does
not require any international consensus or agreement to levy it. India,
like any other country, is free to levy STT.
Not long ago, taxes
on financial transactions have been imposed in several countries including
the US, Japan, France and the UK. Several countries are still implementing
different types of financial transaction taxes. Some countries have
imposed tax on stock trading while many others have taxed a variety
of financial transactions.
The US imposed a
financial transaction tax from 1914 to 1966. During this period, the
US had a federal tax on stock sales of 0.1 per cent at issuance and
0.04 per cent on transfers. Currently, the US has a 0.0034 per cent
tax which is levied on stock transactions. The tax, known as Section
31 fee, is used to support the operation costs of the Securities and
Exchange Commission (SEC). In 1998, the federal government collected
$1.8 billion in revenue from these fees in 1998, almost five times the
annual operating costs of the SEC.
The UK has a financial
transaction tax in the form of a stamp duty, which is not levied on
transactions per se but on the registration of securities. The stamp
duty has been in effect for many decades, and in recent years, it has
been reduced. Presently, UK levies a 0.5 per cent stamp duty and stamp
duty reserve tax on equity and other financial transactions. No one
can claim legal ownership of stock without the stamp. Transactions in
UK registered shares carried outside the country are liable to stamp
duty only when the document enters the UK. While there are no territorial
restrictions on the stamp duty reserve tax. The buyers pay the stamp
duty and stamp duty reserve tax. During 1998-99, the authorities collected
2.1 billion pounds from securities transactions.
Belgium is another
European country which has a 0.17 per cent transaction tax on stocks
and a 0.07 per cent tax on bonds. Transactions in other financial instruments
are also taxed, under varying rates. Both buyers and sellers are subject
to the tax, but the tax base is calculated differently. Further, there
is a ceiling of 10000 Belgian francs on the joint amount payable. However,
certain financial intermediaries are exempted from the tax.
Till 1999, Japan
had also imposed a transaction tax. The tax was imposed on a variety
of financial instruments. The tax was levied on both debt instruments
and equity instruments but at differential rates. For instance, the
tax rates were higher on equities than on debentures and bonds. Implementation
of a FTT in Japan was quite successful as the government raised substantial
revenue from it. In the late 1980s, the Japanese government was generating
revenues of about US $12 billion per year. This is not an insignificant
amount. However, as part of big bang liberalization of the
financial sector, Japan withdrew this tax in 1999.
Italy has a transaction
tax in the form of stamp duty. The country levies a 0.14 per cent stamp
duty on domestic off-exchange transactions. Likewise, Switzerland also
has a stamp duty on financial transactions. Switzerland levies a 0.15
per cent tax for transactions in Swiss securities and 0.3 per cent for
transactions in foreign securities. Besides stamp duty, the country
also levies a share turnover fee of 0.0001 per cent. In recent months,
the Swiss authorities have exempted several financial intermediaries
from the fee.
Sweden and Finland
introduced a transaction tax on a host of financial instruments in the
mid-1980s. However, the existing financial literature suggests that
the introduction of tax was a complete failure in Sweden and Finland.
In the case of Sweden, not only the revenues dropped but the FTT also
contributed towards migration of stock trading from Stockholm to other
France has a transaction
tax on equity trading. The tax rate depends on the amount of transactions.
The country levies has a 0.15 per cent transaction tax on equity trades
exceeding 1 million francs. For transactions below 1 million francs
the rate is higher, at 0.3 per cent. There is a ceiling of 5000 francs
on the total tax amount. The tax is payable by both sellers and buyers.
Certain shares and financial intermediaries are exempted from this tax.
Among the emerging
markets, Malaysia, Singapore, New Zealand and Hong Kong have imposed
transaction taxes on a variety of financial instruments. Thus, there
is a vast international experience (both positive and negative) with
The Market Response
Since the introduction
of STT has been linked with the dismantling of existing capital gains
taxes, small investors and long-term institutional investors have welcomed
it. But a powerful lobby of brokers, day traders, arbitrageurs, and
noise traders launched an impromptu agitation against the
proposed tax. Some traders even called it the Terminator Tax.
The implementation of STT is strongly resisted by fly-by-night operators
and noise traders, as their speculative profits would be
adversely affected and they are likely to be driven out of the market.
However, one fails to understand the opposition of brokers to the STT
since it is the buyer of stocks (not broker) who would be paying this
of the opponents that STT would drive out large financial transactions
from Indian financial markets may not prove true because the cost of
a 0.15 per cent tax on long-term investments would be almost negligible.
A modest increase in the cost of financial transactions due to STT would
not lead genuine investors (both foreign and domestic) to flee markets.
Another notion that the proposed tax would dry up liquidity in the markets
also lacks conviction. No doubt that trading volumes generated by intra-day
speculators would be affected, but a small tax of 0.15 per cent cannot
bring Indian financial markets to a standstill. Similar apprehensions
were expressed when other policy measures (e.g., banning of Badla system
and implementation of rolling settlement) were introduced in the Indian
financial markets in 2001. But experience shows that such measures had
no impact on the liquidity. Moreover, the sheer dependence on day traders
and speculators to provide liquidity reflects inherent weaknesses of
Indian financial markets.
Given the strong
opposition to the proposed tax orchestrated by a powerful lobby of brokers
and day traders, Finance Minister has agreed to revisit transaction
tax. He has given signals that the government could consider several
alternatives including a lowering of transaction tax rate and differential
rates for different securities. While addressing the captains of Indian
industry, Finance Minister said, If anyone can provide me with
a better set of numbers than the proposed 0 per cent, 10 per cent and
0.15 per cent tax on long-term capital gains, short-term capital gains
and securities transactions, respectively, I will consider that(5).
There is a proposal of exempting day traders and arbitrageurs from the
preview of STT. It is likely that under pressure from powerful interests,
the government may dilute certain provisions of the proposed tax.
While favoring the
implementation of STT, I am not arguing that all problems related to
speculation and volatility in the Indian financial markets would be
resolved by it. In the present times, no single instrument by itself
can solve all problems plaguing the Indian financial markets. However,
if used in conjunction with other policy mechanisms (e.g., banning short
selling and insider trading), STT does offer a potent mechanism to deal
with the multiple problems. Therefore, any attempt to dilute the provisions
of STT should be strongly opposed by all those who are concerned about
stability in the Indian financial markets.
1. While proposing
a securities transaction tax of 0.25 per cent in the Indian equities
markets, the author had discussed other benefits besides revenue collection.
For details, see, Kavaljit Singh, Tax Financial Speculation: The Case
for a Securities Transaction Tax in India, ASED-PIRC Briefing Paper,
2001 (also available online at www.ased.org).
2. See, for instance,
B. G. Shirsat, Indian Bourses Second-most Speculative after Nasdaq,
Business Standard, April 5, 2001; and Rishi Chopra, Excessive
Speculation Plagues Capital Markets, The Economic Times, May 8,
3. L. C. Gupta,
Regulatory Confusion, The Economic Times, November 1, 2000.
4. Professor James
Tobin in his Janeway Lectures at Princeton first proposed a tax on global
foreign exchange transactions in 1972, it came to be popularly known
as Tobin tax. Realizing the need for throw(ing) some sand in the
wheels of global financial markets, Tobin advocated the tax as
a mechanism for discouraging speculation in short-term foreign exchange
dealings. He proposed a 0.25 per cent tax on currency transactions in
order to control volatility in the international currency markets and
to preserve some autonomy in national monetary policies.
5. Quoted in Transaction
tax may be cut, Business Standard, July 13, 2004.
Kavaljit Singh is Director of Public Interest Research Centre, Delhi.