Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Tue, 07 Mar 2006

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.

Posted at 17:30 on Tue, 07 Mar 2006     View/Post Comments (1)     permanent link