Taxing capital gains

It has always been an anomaly in tax policy that the hard-earned income is taxed while the speculative investment in stocks is not.

The markets always reacted aggressively and adversely to any idea of imposing long-term capital gains tax. Perhaps, worried about the bears in the capital market, governments refrained from touching it.

A capital gain is defined as the profit made by a tax payer on the sale of an asset – sales price less cost basis. If a capital gain is realised after the underlying asset has been held more than a year, it is called long-term capital gains.

At present, dividends and long-term capital gains on shares traded in stock exchanges are totally exempted from income tax.

Prime Minister Narendra Modi is right when he suggested that those who profit from trading in capital markets be also taxed.

However, Finance Minister was quick to clarify that the government does not intend so, perhaps, in a bid to pacify the markets.

Still, markets fear that the Budget 2017 may see some kind of taxation on long-term capital gains from trading in stocks.

It’s imperative that all capital asset classes must be brought under the tax net. The supporters of tax exemption on long-term capital gains from stock markets argue that such sops are required to boost investment in the capital markets that have a tendency to be volatile.

But, experts feel that there is no empirical evidence to substantiate this argument. Instead, abolition of long-term capital gains tax has turned Indian financial markets into virtual tax havens.

Even the common man pays taxes on a wide range of consumption. The regressive indirect taxation continues to increase in India.

There is no reason why the speculative stock markets be provided with tax exemption even when the tax to GDP ratio in India is one of the lowest in the world.

A comparative study of investment patterns reveals that gold and real estate attract more investment than the stock market despite no such tax exemptions.

This is precisely because the retail and small investors are scared of stock markets due to unprecedented volatility.

The potential for profits from a particular asset class impacts investment decisions rather than the levels of taxation.

Investment behaviour in stock markets also reveals that short-term capital gains tax does not deter investors from short-term trading when equities are bullish.

This defeats the rationale of tax exemption to spur long-term investment in capital markets. The long-term capital gains can be imposed prospectively to avoid any possible bloodbath in Dalal Street.

It’s more important to widen the tax net to rationalise high taxation that encourages tax evasion. This requires such irrational tax exemption to go.

It’s also important to channelise household and corporate savings into productive sectors of the economy.

Healthy financial markets are essential for any economy. Stability is the key to ensure mature financial markets.

The economic policies cannot be sensexy. The fiscal health of the nation cannot be held hostage to predatory financial flows.