Syllabus
GS Paper 3 – Government Budgeting
Context
Budget 2024-25 raised taxes on both short-term and long-term capital gains from stock market investments
Source
The Hindu| Editorial dated 5th August 2024
The social benefits of stock market speculation
The Government recently raised taxes on both short-term and long-term capital gains from stock market investments and increased the securities transaction tax on derivatives transactions. This move stems from the belief that stock market speculation equates to gambling and that higher taxes on these gains can mitigate inequality and resource misallocation. However, this perspective overlooks the essential role of capital gains and speculation in efficient capital allocation and economic growth.
Key Terms
- Capital Gains Tax is levied on the profit made from the sale of an asset, including stocks, which you’ve held for a certain period.
- Short-Term Capital Gains (STCG) -Holding Period: Less than 12 months
- Long-Term Capital Gains (LTCG) – Holding Period: More than 12 months
- There’s an indexation benefit available for LTCG on equity shares and equity-oriented funds, which helps reduce the taxable gains by adjusting the purchase price for inflation.
- Securities Transaction Tax (STT): This is a tax levied on every transaction on the stock exchange.
- Indexation: This is a method to adjust the purchase price of an asset for inflation, thereby reducing the taxable capital gain.
- Loss Carry Forward: Losses from the sale of shares can be carried forward for up to eight years to offset future capital gains.
Stock Market
- Stock markets are platforms where buyers and sellers trade equity shares of public corporations.
- Indian Stock Exchanges: India has two main stock exchanges – the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
- Regulatory Authority: The Securities and Exchange Board of India (SEBI) regulates the securities market in India.
Laws for Regulation of Stock Market
- SEBI Act, 1992
- Purpose: Empowers SEBI to protect investor interests, promote market development, and regulate the securities market.
- Functions and Powers: Details SEBI’s functions, powers, structure, and management.
- Securities Contracts (Regulation) Act, 1956 (SCRA)
- Legal Framework: Regulates securities contracts in India.
- Coverage: Includes listing and trading of securities, registration and regulation of stockbrokers and sub-brokers, and prohibition of insider trading.
- Companies Act, 2013
- Regulation of Companies: Governs incorporation, management, and governance of companies in India.
- Securities Rules: Establishes rules for the issue and transfer of securities by companies.
- Depositories Act, 1996
- Depository Regulation: Regulates and supervises depositories in India.
- Procedures: Sets procedures for the dematerialization and transfer of securities in electronic form.
- Insider Trading Regulations, 2015
- Prohibition of Insider Trading: Prohibits insider trading in securities listed on Indian stock exchanges.
- Code of Conduct: Prescribes a code of conduct for insiders, procedures for disclosures, and penalties for violations.
Capital Gains Tax on Stock Markets
The Budget 2024 raised taxes on both short-term and long-term capital gains from stock market transactions.
Rationale Behind the Changes
- Speculation vs. Investment: The government views stock market gains from speculation as similar to gambling profits and aims to discourage this behavior.
- Economic Survey Insight: The Economic Survey preceding the Budget highlighted that a developing country like India should not waste limited savings on stock market speculation.
- Finance Secretary’s Perspective: Finance Secretary T.V. Somanathan noted that capital gains, being the fastest-growing income class, are suitable for higher taxation.
- Perception of Easy Profits: There is a societal perception that capital gains are easy profits earned without contributing a useful service.
- Addressing Inequality: Higher taxes on capital gains are intended to address growing inequality by redistributing wealth.
On the other hand, stock market speculation, plays a crucial role in the efficient functioning of financial markets. Beyond the potential for personal profit, speculative activities contribute significantly to the broader economy and society.
Social Benefits of Stock Market Speculation
- Market Liquidity :Speculators increase market activity, ensuring that there is always a buyer or seller available for transactions.
- Benefit to Long-term Investors: Enhanced liquidity allows long-term investors to enter or exit positions without significant price impact, facilitating better portfolio management.
- Price Discovery: Speculative trading contributes to the process of price discovery, where the true value of assets is determined through the collective actions of buyers and sellers.
- Reflecting Information: Speculators react quickly to new information, helping to ensure that stock prices reflect the most current information available about a company’s prospects.
- Efficient Markets: Accurate pricing of assets leads to efficient allocation of resources, as capital flows to the most promising investment opportunities.
- Stabilizing Effect: By providing a mechanism for risk transfer, speculation can stabilize markets and protect participants from adverse price movements.
- Attracting Investment: Active and liquid markets attract more investors, both domestic and international, increasing the pool of available capital.
- Funding Growth: Companies can raise funds more easily and at lower costs in a vibrant market, facilitating expansion, innovation, and job creation.
- Venture Capital: Speculative capital often flows into venture capital and high-risk startups, fostering innovation and technological advancement.
- Economic Growth: By supporting new and innovative businesses, speculative activities contribute to overall economic growth and development.
- Wealth Creation: Individuals can build wealth through strategic investments in the stock market, contributing to greater social mobility.
Conclusion
The recent increase in taxes on capital gains and securities transactions by the Indian government aims to curb speculation and address inequality. However, this approach underestimates the positive impact of capital gains and speculative trading on economic efficiency and growth. A nuanced understanding of these financial mechanisms can lead to more balanced and effective public policies.
References
Related PYQ
Comment on the important changes introduced in respect of the Long-term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT) in the Union Budget for 2018-2019. [ UPSC Civil Services Exam – Mains 2018]
Practice Question
Discuss the rationale behind the Government’s decision to increase taxes on capital gains and securities transactions. Analyze the potential economic impacts of this policy? [250 words]