In prelude to General Elections, several radical ideas are being circulated. Baba Ramdev is believed to have propounded this idea, supported by Gadkari and finally, endorsed by Modi, though they have not committed to it as yet. Let us examine the merits of the idea. Government never tweaks a tax law unless it expects to get more revenue out of it. Therefore, such experiment must yield higher revenue to the government, and also it should sound simple and fair for the tax payer to warrant any public support.
The rate of banking transaction tax is proposed to be 2%. Our current tax to GDP ratio is about 12%. For a 2% transaction tax to yield at least as much revenue as currently being realized by the government, the velocity of money has to be at least 6, that is, money has be rotated at least 6 times during a year. Is that happening? Most businesses are forced to extend credit ranging from 60 to 120 days, and their rotation is not more than 2.5 in a year. Agriculture doing about 2 crops a year, cannot expect more than 2. Thus, an expectation of 6 times rotation of money is far too unrealistic which should be around 3 for the economy as a whole, considering 90 days cycle on an average.
Soon, we will see rolling out of exemptions for poors, farmers, dalits, minorities, political parties, charitable trusts and so on. One could imagine that these privileged exempt categories will size upto about half the transactions if not more. This will require higher tax on others who will end up bearing the brunt for the entire revenue-thirst of the government. This will force the starting rate itself to be 3% instead of 2%.
Considering the realities of money-rotation ratio, the rate will be pushed upto 6% quickly. Consider 6% tax on investment of savings, 6% tax on transfer of money from father to his son, 6% tax on transfer from savings account to fixed deposit account which will become meaningless because a 6 months fixed deposit will yield interest not even sufficient to pay the transaction tax. In fact, bank deposits will completely disappear as they will leave nothing for the depositor after paying this transaction tax. This will force people to avoid short term transactions and be compelled for long term transactions. This will hurt their liquidity and many other plans, disturbing their peace and happiness tremendously giving rise to massive public unreast.
Naturally, everybody will attempt to avoid banking, and rely on cash as much as possible. This is already guarded against by proposing complete illegality of any cash transaction, and demonetization of currency notes exceeding Rs 100 in denomination. On one hand, we will have complete criminalization of the society like a de facto ban on gold import has made people gold smugglers. On the other, people will still indulge in cash transactions even if it is completely illegal, like they still do property transactions in cash knowing that it is illegal. Murder and rape are illegal, but that does not matter to a society which is far more practical than lawmakers expect them to be.
As regards demonetization of currency notes exceeding Rs 100, the idea sounds like a benign joke indeed. Rupee has lost so much of value that a 100 rupee note is not sufficient even to buy vegetables. One needs 25 such notes for one time petrol refill, 5 such notes for one time cooking gas refill, 25 such notes for buying one quintal of wheat and so on. The logistical problems of managing with so much of currency notes will remind people of Germany of 1929 when people used to carry currency notes in bags for their daily shopping.
Finally how will netas and babus manage their bribing with such a small currency note? Surely, bribe is not going to be legalized to allow its payment by cheque or through debit/credit card.
Since turkeys are not going to vote for an early Christmas, and this idea will never be implemented. But it has been considered worthy of serious consideration by those staking claim for ultimate power in the country, and major newspapers have been compelled to come up with editorials. This does not sound good for times to come. However, Europe and USA may relax and need not be afraid of India which we are told, is going to become an economic giant soon after Modi has taken over, such that dollar will cost just Rs 10 and India will be able to repay all its foreign currency loans like petty cash and so on.