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A case for scrapping STT

A case for scrapping STT
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First Published: Wed, Feb 17 2010. 10 35 PM IST
Updated: Wed, Feb 17 2010. 10 35 PM IST
Adair Turner, the UK’s chief financial regulator, recently spoke in Mumbai supporting a tax on short-term capital flows to curb speculation. While curbs on foreign “hot money” may or may not have merits, domestic transaction taxes are still counterproductive and should be abolished.
Since 2004, the Centre has been scooping out a securities transaction tax (STT) from almost all transactions on India’s stock exchanges. STT can go up to nearly 0.3% of the monetary volume of a trade after adding the tax on both the buy and sell sides. This is not applicable on trading profits like the short-term capital gains tax, but on the entire turnover of trading transaction.
There seems to be little policy coherence in the area. While STT was increased last year by changing it from a full tax credit to a deduction, the government also abolished the commodity transaction tax. Defenders of financial transaction taxes say these curb speculation while increasing revenue and simplify the taxation of financial markets. They are wrong. All these aims can be achieved in less odious ways.
STT doesn’t really reduce market speculation. It merely hinders arbitrage and high-frequency quantitative trading, neutering the profitability of those strategies. Arbitrage is the risk-free capture of pricing differentials for the same underlying asset, and high-frequency quantitative traders incorporate highly dynamic prices, news and data in their algorithmic models. Both arbitrageurs and quantitative traders provide market liquidity and enable efficient price discovery.
A transaction tax on securities barely hurts the speculator, but makes several trading strategies that provide liquidity and depth to the market unviable because of the artificially introduced layer of friction. Frequent trading can result in so much taxation that all trading profits are swallowed up by the transaction tax.
STT contributes only around 1.5% of the government’s direct tax revenue, but its impact through destroying market liquidity and depth is outsized. The government’s net collection from STT runs into several thousand crores cumulatively since the tax was implemented. The absolute tax revenue collection through STT is small but significant, and widely dispersed but internecine for the market. While low taxes are always better for traders, consumers and citizens, the government can make up the shortfall by rationalizing the taxation across different types of equity investors.
In the current regime, capital gains for foreign investors are not taxed at all. Short-term capital gains tax should be applicable equally to all investors irrespective of tax avoidance treaties. Such a policy would be fair and rational, and the current global political environment is also amenable. This would curb so-called “round-tripping”, where Indians send money abroad and route it back to the equity market to take advantage of tax benefits. Equalizing taxation would allow domestic institutional investors to participate in the market on a par with foreign institutions, strengthening it so that our markets do not catch a cold when New York or London sneezes. Pension and insurance reforms will increase domestic institutional investment, making markets deeper and counterbalancing foreign institutional investment.
Financial services help convert savings into investment in a market economy. If we are to build a strong and vibrant financial services sector—not to mention transform Mumbai into an international financial centre—market distorting taxes such as STT must go. Scrapping STT would give a significant boost to trading volumes, enable efficient price discovery,?and?more liquid and deep financial markets. The government is finally considering doing so as part of direct tax reforms. We must press it to follow this through.
Harsh Gupta works at the MIT Poverty Action Lab, and is associated with Pragati: The Indian National Interest Review. Rajeev Mantri is director, GPSK Investment Group. These are the authors’ personal views. Comments are welcome at otherviews@livemint.com
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First Published: Wed, Feb 17 2010. 10 35 PM IST
More Topics: Adair Turner | STT | Tax | Views | OtherView |