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BW Businessworld

Clever Tricks Of Tax Raisers

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Governments love to spend beyond their means; our government is an excellent model. They can always find good reasons for the bad habit, such as feeding the poor. And they can make good resolutions that they will run surpluses when good times return. Economic theory supports deficit financing when demand is deficient. This has been the state of many European economies, so their governments have run large deficits. But growth has not returned, and since they do not resort to printing money, they have piled up rising debts. Unlike our government, they feel guilty about such improvidence, and tell themselves that they will get back to the path of righteousness in the foreseeable future. They asked the European Commission to work out that path. 
It did not start with a clean slate. Many of its member countries had themselves been thinking of new taxes, which it could build on. The first victim that comes to their mind as a possible source of revenue is the financial industry. Crises have given it a bad name, so it looks the most deserving for a haircut. Profits are money, and are taxed everywhere; so the easiest way would be add a surcharge to corporate income tax, as Chidambaram did some years ago. That is, however, too easy; the advanced countries have been looking for more advanced razors. The first innovation, proposed by James Tobin in 1978, was for a tax on foreign exchange transactions to raise the cost of speculation and give countries more scope to use monetary policy. Brazil imposed such a tax in 2011. It regarded payments incidental to foreign trade as essential and exempted them from tax. But exports and imports create debts, at least for a while; so Brazil had to draw a line between permitted and disfavoured debts. That led traders and financiers to replace taxable with tax-free debts; when the government found out what they were doing, it redrew the boundaries of permitted debts. Eventually, the regulations became so convoluted and achieved so little that Brazil repealed the tax last week. On the other hand, Britain has levied taxes on property transactions for centuries; taxes on stock exchange transactions have become popular more recently. These taxes have never given much trouble. Is that related to the taxes, or to the governments that imposed them? That will form the subject of many a dissertation. In general, a transactions tax will inevitably lead to efforts to disguise or substitute the transactions. That argues for a more general and pervasive tax; but a very general tax can impede an entire industry and hurt the competitiveness of a country in that industry. That is what happened to Brazil. The lesson is that low taxes on well defined transactions may be all right even though they are not always fair. Such taxes will continue to be used by countries. But overreaching taxes on finance must wait until all major countries of the world agree to impose them simultaneously. Our prime minister and his Sherpa will continue to discuss such taxes with their peers in the Group of 20 for a long time to come, but little is likely to come out of them.
The other taxes identified by the European Commission relate to climate change. Again, leading countries recognise that they must reduce carbon and nitrogen emissions. The fuels that lead to their emission are easily defined and measured, and should be easy to tax. An alternative is to ration carbon emissions through cap-and-trade schemes. Nor­dic countries introduced one in the 1990s, and have since the­n continued to raise modest revenues without any mish­a­p­s. The EU introduced a cap-and-trade system in 2005. In 2009, it imposed a single cap for the entire region, and started auctioning the capped emissions. In 2012 it extended its controls to aviation, and started taxing incoming and outgoing flights unless the originating or destined country imposed similar taxes or controls. This time, however, the protests from the US, China and India were such the EU backed down and turned the tax into a voluntary contribution. I think India is holding out unnecessarily. It should pay the EU tax, and turn its domestic aviation tax into a carbon tax. 

The author is Consultant Editor of Businessworld.


(This story was published in BW | Businessworld Issue Dated 15-07-2013)