BANKING TRANSACTION TAX
(BTT)
By: Shashank Shenoy, Devanshu Bothra and Tushar Sharma
INTRODUCTION
• Banking Transaction Tax (BTT) is a tax assessed on cash debited and
credited to the assessee's bank account.
• It is also known as the Financial Transaction Tax and is charged on
various financial transactions.
• Other lesser-known names include Currency Transaction Tax,
Automated Payment Tax, etc.
HISTORY
• These concepts were first introduced by James Tobin and John M. Keynes.
Hence, this concept of replacing the taxes with one single banking transaction
tax is not new in Modern-day economics.
• It has been in existence since the 1700s when philosophers like Baruch Spinoza
had suggested a single tax on the land revenue which would be replacing all
other forms of taxes.
• Banking Transaction Tax was first suggested (in India) by the Arthakranti – A
Pune-based think-tank and was made public when the Budget process for 2018-
19 was on. It was to replace all the existing taxes with the exclusion of the
customs with a single banking transaction tax.
WHAT COULD BE THE FEATURES AND
HOW IT MAY WORK?
• BTT shall be a part of a big whole reform. Following may be the further proposals that may be:-
1. Scrapping all direct and indirect taxes excluding import and customs duty;
2. Recalling and scrapping high-denomination currency notes;
3. Ensuring that all high-value transactions are made only through banking systems like cheques, DD, online and
electronic;
4. Fixing the limit of cash transactions and stopping taxation on cash transactions;
• BTT may work in the following way:-
1. A single-point tax in the form of tax deduction at source by a single person – Banks.
2. A deduction to be effected on receiving or credit of the amount only.
3. Deducted tax to be credited to different government levels like central government, state government and local
governments at specified frequencies, which may be as short as daily.
4. The transacting bank also gets a share as the banks perform a key role.
• Suppose that the tax is levied at the rate of 0.2% and you write a cheque for Rs. 10,000 to pay for your
purchase in a mall.
• When the shop-owner takes your cheque to a bank, the bank charges your account Rs 10,020: Rs 10,000 go to
the grocer and Rs 20 goes to the government.
• In this simple example, the bank is assumed simply to shift the entire tax burden to the account holder, while
the government raises Rs 20 for every 100 rupees’ worth of taxable bank transactions.
• In practice, the amount of government revenue depends on the behaviour of individuals and firms that use
taxable banking services, as well as the behaviour of financial intermediaries
PURPOSE AND OBJECTIVES
• Crackdown on Black Money- Since all the taxpayers which would include the
maximum population be required to switch to electronic methods of transaction, the
scope of hoarding of wealth in the form of cash and evading taxes through loopholes
would not be available.
• More people within taxation ambit- less than 10% of the population pays direct taxes.
By scrapping the current tax regime and imposing a tax on all banking transactions, a
large number of people would come within the tax ambit.
• Increase in disposable incomes- Disposable income out of one’s income may get
directly reduced by 20-30% under direct taxes once their income exceeds the basic
exemption limit. However, say for example a 2% of BTT would allow 98% of the
income to remain as disposable income.
• Cashless economy- Shifting towards electronic modes of transactions and cheque
payments would lead to greater transparency and accountability.
CHALLENGES
• Low Bank Penetration- Only 40% of the nation currently has bank accounts.
• Impact on Rural Economy- The rural economy of India largely deals in cash. A
majority of India is still not connected with Banking Operations. Hence, BTT will be a
harsh move as far as rural India or the agrarian sector is concerned.
• Regressive structure- In the case of BTT, a uniform rate of tax will be levied on all
transactions irrespective of the income bracket under which a person receiving the
money falls. Therefore, it will fail to tackle inequality.
• Increase in regional disparity- States with less emphasis on the banking sector will
lose revenue.
States with massive amount of bank branches are about to gain, whereas, those
backward states where banking is still at its ordinary stage is bound to lose a major part
of the revenue.
• Economic impact- There’s a possibility that this kind of tax may discourage consumer
spending and investment.
• Impact on financial markets- it may discourage investment and economic activity.
Higher borrowing costs for businesses due to increased interest rates (banks may raise
rates to offset the tax) and a "lock-in effect" for investors who may avoid selling assets
to avoid the tax can hinder growth.
CASE STUDY- LATIN AMERICA
• As of end-2004, BTT was in effect in six Latin American countries: Argentina, Brazil, Bolivia,
Colombia, Peru and Venezuela. Ecuador levied such taxes in the past.
• BTTs have generally been introduced as an emergency means of raising revenue in times of, and in
response to, economic crises. In each case, the tax was introduced temporarily, although in some
cases it was subsequently extended.
• BTTs have not been levied continuously in most countries.
How effective was it?
• A useful way to see how well a tax performs is to look at its revenue productivity- the ratio of tax
revenue (in per cent of GDP) to the tax rate.
• If revenue productivity is stable or increases over time, then the tax is a reliable source of revenue. If
it does not, the tax can be used only as an emergency tool over a short period.
A study collected data on the statutory rates and revenues of BTTs at the monthly frequency for six
Latin American countries: Argentina, Brazil, Colombia, Ecuador, Peru and Venezuela.
Country and Year Tax Rate Gross Revenue/GDP Revenue Productivity
Brazil
1994 0.25 0.06 0.24
1997 0.2 0.8 4
1998 0.2 0.9 4.5
1999 0.22 0.83 3.77
2000 0.34 1.33 3.91
2001 0.36 1.45 4.03
Ecuador
1999 1 3.5 3.5
2000 0.8 2.33 2.91
Peru
1990 1.41 0.59 0.42
1991 0.81 0.46 0.57
K E Y F IN D IN G S
• Relationship between rates and productivity- There existed a significant negative
relationship between BTT effective rates and productivity.
A 0.1 percentage point increase in the effective rate reduces productivity by 0.23-0.30
percentage points. Increasing effective rates from 0.6% to 0.8% would decrease
productivity from 2.4% to about 1.9%.
• Time Effect- Positive and significant relationship between time since BTT introduction
and productivity initially. Productivity increases with time but later decreases due to
tax avoidance.
There is also a revenue decline: For a tax rate of 0.2%, second-year revenue is 9%
lower than the first year. For a tax rate of 0.3%, BTT revenue is nearly 30% lower in the
second year compared to the first year.
• Laffer Curves- The Laffer curves depicted in this figure show a notable shift towards
the origin as the Bank Transaction Tax (BTT) remains in effect over time.
This shift indicates that the rate at which the government can maximize revenue from
the BTT decreases over time. In other words, as the tax persists, the optimal tax rate to
generate maximum revenue becomes lower.
Increasing the BTT rate speeds up the depletion of the tax base. This means that higher
tax rates lead to a faster decline in the amount of revenue collected from the tax over
time.
A 0.1 percentage point increase in the statutory tax rate reduces the revenue base (or
productivity) by 0.18-0.30 percentage points.
• Influence of Financial Market Depth and Inflation: BTTs yield
more revenue in countries with deeper financial markets or higher
inflation and deposit-lending interest spreads.
Deeper financial markets imply higher opportunity costs of
conducting transactions outside banks.
Higher inflation increases the opportunity cost of holding money.
Higher interest spreads indicate a greater risk of lending money
outside banks.
• Inhibited financial intermediation and fostered informal
economy- When the transaction tax was revoked in Argentina and
Peru ahead of time, the lawmakers stated that the policy increased
disintermediation and pushed a lot of transactions to the informal
economy.
It also increased off-shore bank accounts. People also started using
endorsing cheques and stopped en-cashing them.
