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Minhaz Merchant

Minhaz Merchant is the biographer of Rajiv Gandhi and Aditya Birla and author of The New Clash of Civilizations (Rupa, 2014). He is founder of Sterling Newspapers Pvt. Ltd. which was acquired by the Indian Express group

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Long Term Capital Loss

There are practical and philosophical reasons why the LTCG tax is a bad idea

Photo Credit : Subhabrata Das


One of the most puzzling proposals in the 2018-19 Union Budget was the imposition of long term capital gains (LTCG) tax. Finance Minister Arun Jaitley justified the move by saying that long term capital gains were the only assets exempt from tax.

The argument is spurious on two grounds. First, equity shares held for the long term are a hedge against inflation. With fixed deposit rates at an all-time low and taxable at over 30 per cent for many taxpayers, Jaitley has targeted the one asset that helps create individual capital. Second, the amount likely to be raised by the LTCG tax will be around Rs. 5,000 crore, according to economist Surjit Singh Bhalla.

Bhalla is a member of the Prime Minister's Economic Advisory Council (PMEAC). His views on the LTCG tax, which he calls "a bad idea", are trenchant: "The 2002 Kelkar report had advocated the abolition of LTCG tax, the abolition of dividend tax, the retention of short-term tax to 10 per cent and the introduction of the Securities Transaction Tax - STT. Average annual STT revenue has been around Rs 7,000 crore, and is forecast to be Rs 11,000 crore in 2018-19. Regardless of market direction, STT makes revenue for the taxman. Isn't it much simpler to increase STT by 25 per cent? This will yield Rs 3,000 crore more per year. It would seem prudent for the finance ministry to withdraw this LTCG tax proposal."

There are practical and philosophical reasons why the LTCG tax is a bad idea. In practical terms: for a small tax revenue benefit, the government has discouraged long-term investment in the stock market. That will diminish the attractiveness of Indian stocks among foreign investors. The protectionist decision by the BSE and NSE to end global trading in SGX Nifty and sensex futures in Singapore, Hong Kong and Dubai has compounded the problem for Indian stocks.

Equally disconcerting in the Union Budget, which will be discussed threadbare in the second part of the Budget session in parliament from March 5, is the move to increase customs duty on mobile phones, TV panels and other consumer items. This is ostensibly to discourage imports and encourage the Make in India initiative. The trend of hiking customs duties takes India back to the pre-1991 era when import duties were deployed to keep foreign goods out. The result was disincentivising competition. Local manufacturers became complacent.  Prices rose. Quality fell. Jaitley is transporting India back to a swadeshi era which could be dubbed Make in India 1.0. The prime minister's Make In India 2.0 should certainly not be aimed at such damaging protectionism.

The way forward for any modern economy is openness. Even US President Donald Trump, known as an "America First" votary, has been forced to clarify that this policy does not imply "America Alone" but seeks fair and reciprocal trade tariffs. The slashing of US corporation tax from 35 per cent to 21 per cent has transformed President Trump's poll numbers. Before the dramatic tax cut in December 2017, Trump's favourability rating was between 35 per cent and 39 per cent. Once the corporation tax cuts led to US companies increasing their employees' pay cheques and bonuses, his poll ratings have leapt to between 41 per cent and 49 per cent.  

Democrats, gung-ho about winning back their majority in the House of Representatives in the November 2018 Congressional mid-term elections, are now worried. The momentum has suddenly turned against them. Things worsened after the leader of the Democrats in the House, Nancy Pelosi, called the increase in employees' pay mere "crumbs". For middle-class Americans who have seen real wages stagnating for over a decade, the Left-of-centre Pelosi's comment was seen as patronising and insensitive. It could cost the Democrats the House later this year.

There's a lesson in this for the Narendra Modi government. India's tax policy has become a lightning rod to fuel anger among the middle class. While jobs remain scarce and fixed deposit returns low, the last thing Modi needs in an election year is a disgruntled tax-paying middle class.

Several other countries too are wrestling with tax reform. In Britain the debate is assuming greater urgency with the Brexit deadline looming on March 31, 2019. Public services in Britain are under increasing budgetary strain. Tax reform is a panacea. As The Economist wrote recently: "Almost every morning Britons wake up to another alarming story about their threadbare public services. Broadly speaking, a government can tax three things: income, consumption and wealth. Economists like taxes to be simple and to avoid unintentionally distorting behaviour. Where should the government cast its net? Any move to raise taxes on income has a cost. Research by the OECD suggests that income taxes, more than those on consumption and wealth, strongly discourage people from working, cramping economic growth. This implies that Britain's relatively low income taxes are a strength, rather than a problem to be fixed."

In India, tax reform is now a priority. GST will soon become compliance-friendly. Only one return will need to be filed every quarter in place of three every month for all companies, regardless of annual turnover. The number of tax slabs is also likely to be reduced, as I have argued on these pages in the past.

Given this, the LTCG tax is both baffling and regressive. RBI Governor Urjit Patel appears to agree. At a press conference following last month's monetary policy meeting, Patel said: "The taxation on capital in India is from several sources. You have the corporate tax rate, you have the dividend distribution tax rate. For dividend income above Rs. 10 lakh, you have the marginal tax rate, which is at whatever tax bracket people come in. You (also) have a securities transaction tax and you have a capital gains tax. There are five taxes on capital and that would obviously also have an impact on investments and savings decisions."

RBI governors are usually careful with their criticism of the government's tax policies. Urjit Patel's tangential comments on the LTCG tax and levies on other assets carry a nuanced message for the Modi government.

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