The tax with potential side effects

NEW DELHI, INDIA – JULY 23: Union Finance Minister Nirmala Sitharaman during Post Budget Press Conference at National Media Centre on July 23, 2024 in New Delhi, India. (Photo by Ajay Aggarwal/Hindustan Times via Getty Images)

Hindustan Times | Hindustan Times | Getty Images

This report is from this week’s CNBC’s “Inside India” newsletter, which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

The big story

In 1696, King William III of England introduced a radically new tax on his subjects to raise state revenues: under the decree, every household in the country would pay a levy depending on the number of windows in their home. This typically meant that the larger the house, the greater the tax due on it.

Despite its progressive intentions, the tax failed to raise sufficient revenue for the monarch, as people boarded up their windows to lower their tax liability. Over the long term, the policy was a net negative for the state, which had to battle typhus, smallpox and cholera epidemics resulting from the lack of ventilation.

So, what does the window tax have to do with India today?

Property with bricked up windows in the exclusive area of Mayfair on 7th July 2023 in London, United Kingdom. Window tax was a property tax based on the number of windows in a house. It was a significant social, cultural, and architectural force in England during the 18th and 19th centuries. To avoid the tax, some houses from the period can be seen to have bricked-up window-spaces. The tax was introduced in 1696 and was repealed in 1851. (photo by Mike Kemp/In Pictures via Getty Images)

Mike Kemp | In Pictures | Getty Images

For now, the tax hikes appear to have overshadowed many positive developments arising from the Budget. Foreign investors have liquidated nearly $1 billion worth of Indian equities in the two days since the Budget was announced and traders have sent stocks lower every day so far since then.

“The lack of populist spending is in line with our expectation, although the increase in capital gains tax for equities is against our expectation of no change,” said Upasana Chachra, chief India economist at Morgan Stanley, in a note released to clients immediately after the Budget was unveiled.

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Will the government achieve its goal through the levy, even if investors look past the initial pain?

“This rise in short-term capital gains tax from 15% to 20% will thus discourage excess trading activities, while the hike in long-term capital gain taxes from 10% to 12.5% is sentimentally negative for the market in the near term,” said Siddhartha Khemka, head of retail research at broker Motilal Oswal.

Not everyone is convinced.

“It may help to defuse some of the more speculative nature of the market but is unlikely to deter retail investors in a significant way,” said Michael Langham, emerging markets economist at U.K.-headquartered asset manager Abrdn. “This move can be seen as part of the broader effort by regulators to curb some of the financial stability risks building in the equity markets, and it’s not far-fetched to imagine further measures to taper some of the retail investor risks.”

In fact, the risk for regulators could actually be inspired by modern Britain.

The U.K. introduced a stamp duty tax on each transaction in 1974. While the tax raises more than £3 billion ($3.9 billion) annually, it has given birth to far riskier forms of speculation while simultaneously hurting the stock market.

Spread betting and contracts-for-difference (CFD), which exposes traders to far higher levels of potential losses — as well as gains — have boomed since the 1990s. As neither product results in stock ownership, the trading tax is entirely avoided.

The tax also plays a role in suppressing valuation levels for the U.K.’s very profitable companies, according to the Institute for Fiscal Studies.

However, given the lofty valuations that Indian stock markets currently trade, the tax to skim the excesses might be a positive development over the longer term.

Need to know

What happened in the markets?

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On CNBC TV this week, Raghuram Rajan, former governor of the Reserve Bank of India, said the country needs to invest in education and skilling to attract investment in sectors that add more value.

“If you look at the budget, again, what you would worry about is the enormous amount of investment going into infrastructure and the much more limited investment going into human capital building,” he told CNBC.

Meanwhile, Suman Bery, vice chairperson at the Indian government’s public policy think tank Niti Aayog, said it would be “somewhat misplaced” to assume that the Budget unveiled this week was the consequence of the 2024 election results.

“India has been adding jobs, but they have been low-productivity jobs and the only way for India to accelerate its growth rate is to move its demographic dividend — its labor force — into higher productivity jobs, and that’s going to require various kinds of structural changes,” Bery said.

What’s happening next week?

U.S. tariffs on several Chinese imports kick in next week. On the data front, several central banks are scheduled to release some key decisions.

July 26: U.S. core inflation

July 30: Japan unemployment rate, Eurozone GDP, Germany inflation

July 31: U.S. interest rate, Eurozone inflation

August 1: U.K. interest rate

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