“The repose of nations cannot be secure without arms. Armies cannot be maintained without pay, nor can the pay be produced without taxes.” – Publius Cornelius Tacitus, a Roman historian

The word “tax” draws its earliest reference in a decree by Caesar Augustus, the first ruler of the Roman Empire, nearly 2000 years ago mandating taxation in all spheres of the world. The origin of the word “tax” stems from the Latin expression, “taxo” meaning, imposition of a financial charge or other levy upon a taxpayer.  India has had a system of taxation since ancient times, as is evident from references in early treatises such as Manusmriti (between 200 BCE and 200 CE) and Arthasastra (4^th Century BCE). The conventional criteria of economic neutrality, equity, simplicity, and transparency have been regarded as the foundations of most tax systems. However, with the power of taxation in modern times shifting from the domain of a monarch to that of every sovereign, the regime of taxation has come to be associated with the four “R”s — revenue, redistribution, repricing, and representation. Moreover, for every benefit that mankind receives today, a tax is imposed thereby, redistributing the underlying burden.

The adoption of a flat tax has been debated by various countries in Eastern Europe over the last decade. A flat tax regime is a tax system with a constant tax rate and is usually referred to as a tax in rem, meaning “against the thing.” In 1994, Estonia became the pioneer in instituting the flat tax regime, levying a tax rate of 26% on all personal and corporate income with no deductions or exemptions. The success of the Estonian example led to the adoption of a flat tax regime by various European countries, such as Latvia, Lithuania, Bulgaria, and many others. Nevertheless, the debate continues in Western Europe and the United States.

The dawn of the global financial crisis in 2008 diverted attention to new tax regimes around the world. Rising government debt levels, reduction in bank lending, and instability in the financial markets have cast a shadow over the nascent economic recovery. Though the experiences of different countries vary, as do their priorities as they emerge from the economic crisis, none can claim to be immune from the risk of a future, and inevitably, global financial crisis.

In this respect, a universal policy cannot be imposed across various jurisdictions and each nation’s response to the crisis must be fine tuned in accordance with the assessment of their respective challenges. For example, Sweden has introduced a levy on banks that goes into a ring-fenced fund, created to protect against future bailouts. Germany and Britain are also contemplating a similar measure, and the Obama administration has proposed a levy to recoup $90 billion of public money used so far to shore up banks. However, while there is support in Europe and the United States for some form of levy, other western economies are against the concept of imposing an additional burden on their banks because they did not require rescuing.

There seems to be global recognition of the need for new taxes. The International Monetary Fund has proposed two new taxes on banks—a Financial Stability Contribution (FSC), and a Financial Activities Tax (FAT). The FSC is essentially linked to a resolution mechanism to pay for the fiscal cost of any future government support to the banking sector. Any further contribution, if desired, will be facilitated via the FAT, which would be levied on the profits and remuneration of financial institutions.

However, during the June 2010 G-20 meeting of Finance Ministers in Seoul, the proposal for a global bank tax to protect the public and ensure economic stability was rejected. A bank tax was viewed as increasing costs to consumers and requiring strict consumer and competition regulations for effective enforcement.  Rather, emphasis was put on pressuring countries to adopt more passive economic measures to recoup public funds used to protect against bank failures. Individual countries still may impose the levy in their own jurisdictions, despite the G-20’s collective recommendation. The Indian stand on additional taxation of financial institutions is similar to the G-20’s recommendation. Instead of a fiscal stimulus or additional taxation, India places greater emphasis on financial sector regulation.

Though there seems to be little support for the imposition of new taxes on banks while the economies of countries are still recovering from the global financial crisis, other new taxes are being considered in certain jurisdictions. Australia, for example, has proposed a resource tax, i.e., a tax to be levied on the “additional” profits on account of the use of limited natural resources through 2012. Moreover, the United States has proposed to levy an “excise tax” on U.S. companies that use an offshore call centres.

The levy of new taxes, apart from being viewed as a reactive measure to the global meltdown, forces one to revisit the purpose of a taxation regime. The existing regime is premised on Adam Smith’s core canons of taxation—equity, certainty, economy, and convenience. Today’s economic realities necessitate the addition of two additional principles, restitution and avoidance of double taxation. In this regard, it may be argued that the evolution of novel axes embodies, to a certain extent, the manifestation of the principle of restitution. Ian T. G. Lambert’s treatise, Modern Principles of Taxation, is founded on the principle of restitution. He argues that one cannot take the benefits of government expenditure without taking the burden. That view would justify the imposition of a bank tax or resource tax, effectively widening the scope of the existing four “R”s associated with taxes to include the principle of restitution.

India has been debating the levy of a “Tobin” Tax. The Tobin Tax derives its origin from Nobel Prize-winning economist James Tobin’s proposal to levy a tax on short-term capital currency transactions. Chile, Colombia, Brazil, and Malaysia have experimented with variations of the Tobin Tax. Various jurisdictions view this tax as compensation for the billions of dollars spent by governments to bail out banks.

India, until now, has been silent on the question of additional taxation. As the governments of various countries impose new taxes, the question is whether India will follow the same course. However, before taking this kind of leap, India must exercise caution to ensure that it does not fall prey to the dangers of an evolving short-term tax, susceptible to rapid fluctuations, and ensure that any proposed levy serves long-term stability by avoiding significant wholesale economic restructuring and facilitating the growth of business.

The authors are Mr. Aseem Chawla, Partner, and Ms. Surabhi Singhi, Associate, Amarchand & Mangaldas & Suresh A. Shroff & Co., based out of Delhi. Mr. Chawla leads the tax practice group of the firm and can be contacted at aseem.chawla@amarchand.com. Ms. Singhi is an Associate with the tax practice group of the firm and can be contacted at surabhi.singhi@amarchand.com.

by Aseem Chawla and Surabhi Singhi