Tax private capital flows to guard against volatility: Survey

The government should put in place some sort of taxation measures on foreign capital inflow into the domestic economy to guard against high volatile nature of such funds, the Economic Survey said today.

"The events of 2007-08 and the outflows and inflows of FII equity has brought home, with renewed force, the volatile nature of certain capital flows," the Survey said, adding that such volatility negatively affect real sectors of the economy.     

"Though the private flows provide critical risk capital with long-term benefits to the economy, the volatile nature of these flows creates a negative exeternality for the real sectors in the short term. This negative externality can be overcome by internalising this exeternality through some form of Pigouvian taxation," it noted.     

A Piguvian Tax is defined as a tax levied on a market activity to guard against the negative externalilities associated with such market activity. It is named after noted economist Arthur Pigou, who had developed the concept of economic externalities.     

According to the Survey, global capital flows to emerging and developing economies tripled from 202.8 billion dollars in 2006 to 617.5 billion dollars in 2007, and then collapsed to 109.3 billion dollars.

"India shared in the global boom in private capital flows to emerging economies, with private capital inflows (to the country) more than doubling from about $36.7 billion to about $88.8 billion in 2007, then falling back to $31.2 billion in 2008.     

"Total net capital inflows consequently increased from 4.4 per cent of GDP in 2006 to 9.1 per cent of GDP in 2007 and back to about 3.3 per cent of GDP in 2008," the Survey said.     

While suggesting a 'Pigouvian tax' on private capital flows, the Survey also suggested that "tax incentives for long-term debt makets can be considered" as a potential policy option.     

The Survey further added that the rights to invest in government securities by the FIIs is being succesfully auctioned and "this idea can be considered for all forms of volatile cross-border capital flows."     

An Economic Division working group had also suggested that the auction of ECB (external commercial borrowing) could be one way to reduce the volatility in ECB flows and since then a part of ECBs, subject to certain conditions, is being succesfully auctioned under the supervision of SEBI, it added.