Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Tobin Tax and Capital Gains

In response to
my comments on the Indian budget
, Prof. Ramesh Gupta
states that the securities transaction tax can be justified as a kind
of Tobin tax to discourage speculative transactions. I disagree on two
counts. Frist, I do not like the Tobin tax, but I will not get into
this in detail because there is a huge literature on the Tobin tax and
I do not think I have anything original to say on this subject. My
second point of disagreement is more subtle. A Tobin tax and a revenue
maximizing transaction tax are very different in terms of the tax
rate. As Tobin himself emphasized, the rate of the Tobin tax should
be exceedingly small so as not to affect true price discovery. A
revenue maximizing transaction tax on the other hand would be much
higher.

In India, the transaction tax was introduced as a substitute
for the capital gains tax. This I think is a mistake. It forces the
government to progressively move the rate towards a revenue maximizing
rate and thereby endanger price discovery in the market. I believe
that the current rate of the transaction tax is much higher than what
a Tobin tax would be. More important is the question of
fairness. Ideally, the real returns on all investments should be taxed
at the same rate. Today, the return earned on equities is taxed at a
negligible rate. Return earned on bonds is taxed at much higher rates
as is salary income (which is return earned on investment in human
capital). This is unacceptable from a fairness point of view. From a
merit point of view also, it is difficult to make out any case for
preferring investment in equities to investment in human capital.

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