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Demonetisation: Why India may never be free from income tax

24 November, 2016

Ever since Prime Minister Narendra Modi announced to a shocked nation that high denomination currency notes of Rs 500 and Rs 1,000 were no longer legal tender, there has been incessant speculation across both the mainstream and social media on what more steps could be in the offing. In fact, Modi has himself said that his next target could be the so-called ‘benami’ properties, although there is little clarity yet on how the government will go about it.

Even as the debate rages around the efficacy of demonetisation in curbing black money, a new debate, on whether India should do away with the idea of direct and indirect taxation, in favor of a ‘bank transaction tax’ has moved from the amorphous confines of the social media onto the front pages of the mainstream media.

What is ‘ArthaKranti’ and what exactly is it proposing?

Arthakranti Pratishthan is a Pune based socio-economic think tank that is proposing a complete overhaul of the country’s taxation system. Promoted by Anil Bokil, a mechanical engineer, and some colleagues, Arthakranti advocates repealing the existing tax system, except customs and import duties. It says that all direct and indirect taxes should be replaced by a banking transaction tax (BTT), which it says, will more than suffice, perhaps even out do, the current tax collections both at the central and the state level. Arthakranti says that customs and import taxes need to be retained, as they act as effective trade barriers.

So what exactly is the proposed BTT?

Put simply, Arthakranti says that every transaction routed through a bank should be taxed, at an “appropriate” rate. It says that such a deduction should be effected on receiving or credit accounts only. This means, that only if you receive money in your account, would you be taxed a certain amount, at source. Such taxation will be progressive. Such taxes collected will be divided among the central, state and local governments. Out of the 2% tax the think tank proposes, it says that 0.7% should go to the central government, 0.6% to state governments, 0.35% to local bodies, and the rest to banks themselves, since it says banks have “a key role to perform.” However, cash transactions will not attract any transaction tax, according to Arthakranti’s proposal.

What are the think tank’s other proposals?

It wants the government to withdraw high denomination currency and cap it at Rs 50. Bokil however told The Economic Times that in scrapping Rs 500 and Rs 1,000 notes, the government had only taken one part of their proposal, and so is not in favor of what has been done. Moreover, it wants cash transactions to be restricted to a maximum cap of say Rs 2,000, above which all such transactions should, it says, be declared illegal.

So what are the pitfalls of such a proposal?

First, there is no guarantee, that if a tax is levied on bank transactions, a person will necessarily continue to transact using a bank account. If anything, the tendency, at least for individuals or small traders would be to deal as much as possible, in cash, precisely the sort of thing the government has been trying to curb. Second, as a column in The Financial Express also points out, the simplistic proposal does not even consider the effect of cascading. At present, a firm or an individual pays a one-time tax on their profit or income as the case may be. But if a tax is levied on every transaction, the same company or individual will simply keep paying the proposed 2% tax on every rupee credited to their accounts. This, depending on their volume of trade, could even become higher than the highest tax slab at present. Moreover, indirect tax systems like the present value added tax or the future Goods and Services Tax have a system of input credits, that are in place to check cascading.

Moreover, it may also mean that certain income classes, like from agriculture and certain other specified avenues, which at present, are not taxed, may effectively come under the tax net. Although this would augur well for the economy, it could be politically inexpedient, and hence parties, including Modi’s own Bharatiya Janata Party may not be open to the idea.

But there are questions that go beyond such technicalities. Taxes, you see, are central to a democracy. “Taxes are what we pay for a civilised society,” US Supreme Court justice Oliver Wendell Holmes Jr. had said in 1904. Taxes are key to an unwritten social contract between the citizen and the state – citizens pay taxes in order to be protected and governed fairly. Therefore, taxes are, in effect, inextricably linked to a democratic society. Although Arthakranti is only talking of replacing one form of taxation with another, the re-organisation could have a significant impact on the relationship between the citizenry and the state.

But aren’t there several countries that have no taxes?

Yes, there are at least 10 countries that have zero or very minimal taxation. These include oil rich countries like Saudi Arabia, United Arab Emirates, Oman, Qatar, Kuwait and Bahrain. Others include tax havens like Bermuda, Cayman Islands, Monaco and the Bahamas. To be sure, several among these countries do require their citizens to contribute a certain percentage of their incomes toward social security benefits. Not only are the Gulf countries not representative democracies, they are also known for their tough laws and a dismal human rights record. Moreover, almost all these countries have small populations, and high per capita incomes.

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Demonetisation: Why India may never be free from income tax

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