Why there is no kranti in Arthakranti’s rather radical tax proposal but it is plain stupid.

Arthakranti Sansthan (literally, “Economic Revolution Organisation”) has proposed a rather radical tax and economic proposal which they believe (emphasis mine, not supported by empirical data or field study or practical application on ground) is “an effective and guaranteed solution of Black money generation, price rise and inflation, corruption and fiscal deficit, unemployment, ransom and criminal activities including terrorism and for GDP growth and good governance”.

So what is the proposal? They have proposed 5 points of actions simultaneously, as noted below:-

1. Scrap all taxes including income tax and indirect taxes but excluding custom duties.

2. Recall and scrap all high denomination currencies of 100, 500 and 1000 Indian rupees.

3. All high value transaction to be made only through banking system like cheque, DD, online and electronic transactions.

4. Fix limit of cash transaction and no taxes on cash transactions below this threshold.

5. For Government’s revenue collection introduce single point tax system on all transaction through banking system – a Banking Transaction Tax (hereinafter “BTT”) (range between 2% to 0.7%) on only the Credit (emphasis mine) amount. No exemptions are proposed on this tax.

(Point 2 to 5 are simply to discourage cash transactions and route all transactions through bank accounts, so that they can be subject to BTT)

A nominal 2% Tax on your incomes when the highest income tax slabs can be around 35%, sounds great.

So far so good.

But think again, the tax is on the amount which is credited to your bank account. For a salaried or passive income earners such as rent or interest, whose credits in bank account are limited to his income and sundry other receipts, this is great. Not for others. Consider the following transactions (Illustrative and not exhaustive list) which are “tax-free” at present will be under the proposed tax net.

1. Credit and Loans of all kind – to business, individuals and governments – from banks or otherwise – all amounts are credited in your bank account. The end of short term credit – your 91 days Treasury Bills – the principal instrument used by RBI to manage Government borrowings or Call money markets Inter Bank Credit – the transaction period is between 1 and 14 days and the interest earned will be less than the BTT.

2. Migration of Bank Accounts / Change of Borrowers – Every credit to your bank account is proposed to be taxable.

3. Inter-se transfer to family members – When you pay your spouse or children – the money will be credited in their bank account and hence taxable.

4. Charities – When you pay a charity (NGO) at present you get a deduction from income tax and the charities are exempt from income tax – underArthakranti it would be liable to BTT.

5. Remittances from abroad – Indian immigrants to the world send remittances from abroad and India is the highest recipient of such remittances in the world and is at present completely outside the tax net. Will taxing them not impact remittances from abroad. So is the case with FDI and FII. Critical to balance our Current and Capital account deficits.

Tax Planning & Tax Avoidance – The lines are but always blurred

(1) Simply have one joint bank account for all your family members – so as to avoid banking transaction tax on inter-se transfers between family members.

(2) Vertically integrated industries across the value chain.

Consider the case of Petroleum. If you have three entities ( such as ONGC (Oil Exploration) and IOC (Refining) and your local Petrol pump dealer (filling), you will end up paying the BTT thrice. If you have a single entity (say Reliance or Essar and hence only one Bank Account) for Oil Exploration, Refining and filling pumps, you will have to pay tax once. This will prompt more and more industries to be vertically integrated, rendering non-integrated industries unviable due to taxation. Simply stated BTT has a cascading effect.

(3) Salary or Fringe Benefits.

If you pay Salary to your employees and he buys goods and services from the marketplace, the BTT will be collected twice. If you provide Fringe Benefits – the employer buys goods and services from the marketplace and provides to the employees, the BTT will be collected only once. Sounds complicated. Heard of “Sodexo meal vouchers”? Extend that business to all goods and services.

(4) Barter – is the action or system of exchanging goods or services without using money.

Barter, as a replacement for money as the method of exchange, is used in times of monetary crisis, such as when the currency may be either unstable (e.g., hyperinflation or deflationary spiral) or simply unavailable for conducting commerce.

(5) Bitcoins, Bullion currency – Gold and silver and Hundis

Central Banks world wide are already facing threat from virtual crypto currencies such as Bitcoins replacing paper money on the internet and also avoiding formal banking systems.

A 12.5 gm Silver Coin will be valued at around INR 500 at current market rates (INR 40,000 per Kg). An 8 gm Gold Guinea (“ginni”) will be valued at around INR 24000 at current market rates (INR 30,000 per 10 gm). Don’t be surprised that if in the absence of high denomination currency, bullion currency – silver coins and gold guineas dominate the transactions in grey and black markets, so to say. They have been in vogue for most on known human history till paper “fiat” currency took over in the early twentieth century. Silver coins were in vogue in India till 1935 (from a historical point of view, that’s recent memory) when RBI came into existence.

Hundis (vernacular for bills of exchange & promissory notes) can also replace paper money.

(6) Invest in Mutual Funds or Shares?

If you invest in MF and they then invest in Shares, you end up baying BTT twice. If you put your money directly in shares, you will pay BTT only once. What would it be a good idea for retail investors?

(7) Go for maximum tenor (time period) of investments. If you invest in a 6 month FD and reinvest the same in another 6 month FD at maturity, you will end up paying BTT twice while a 1 year FD at start will mean a single BTT. The longer the tenor, the better.

Tax Evasion

The emergence of private bankers and the ubiquitous “hawala” networks. They exist now and their creed will only multiply under the proposed Arthakranti.

Your local moneylender (“sahookar”) will double up as a private banker and your “hawala” dealer will have his business multiply because foreign remitters will have a tax advantage to use their network.

Hawala does not require physical cash transfers. It’s an arbitrage mechanism. A in Mumbai wants to send money to B in Dubai. P in Dubai wants to send money to Q in Mumbai. Hawala which literally means “reference” in Indian languages will arrange an arbitrage. A in Mumbai pays Q in Mumbai and P in Dubai pays B in Dubai. In absence of paper currency transaction between A and Q in Mumbai can take place through barter, bullion, bitcoins, hundis on private bankers etc.

Conclusion

Credit will be subject to BTT. Short term credit – the cost of transaction will be higher than gains – owing to fixed BTT will be the end of money markets.

Capital will also be subject to BTT. Capital raised through equity – IPOs , Private placement, FDI, FIIs, etc and Debt – Bonds and Debentures – will be subject to BTT on gross value of transaction whereas at present only incomes are taxed. Secondary market transactions through stock exchanges will also be subject to BTT meaning the lot of securities will turn illiquid due to complete withdrawal of Short term traders / investors / speculators from market – again because of cost of transaction due to BTT will be lower than possible gains .

Finally, this Arthakranti proposal is foolish. No, this is just insane.The end of money markets (credit) and capital markets (capital) will wreak havoc on private and public (“government”) finances – money supply and credit, the economy in short.

And don’t worry about my tax practice. I am not going anywhere soon.

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2 thoughts on “Why there is no kranti in Arthakranti’s rather radical tax proposal but it is plain stupid.

  1. Pingback: India Uninc set for a giant leap post Demonetization & GST : A Contrarian opinion - PGurus

  2. In arthakranti system this things may happen which maybe considered

    1. All foreign companies will take away 98% of their income
    2. All developed states like Maharashtra, Gujarat, Karnataka ( Bangalore) will do more business and the money will shift to them with little money for the underdeveloped states.
    3. It is well known that he who has more money earns easily. So the rich people will continue to earn 98% ( legal money ) and there will be gradual shortage of money for the poor and they will eventually die.

    Arthakranti system should be thoroughly evaluated before implementation.

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