Impact of Commodity Transaction Tax on Market Liquidity, Volatility, and Government Revenues: An Empirical Study for India

Abstract

Executive Summary A commodity transaction tax (CTT) of 0.01 per cent is levied on non-agricultural commodity futures trading since 1 July 2013 by the Government of India. This article examines the impact of CTT on market liquidity, volatility and government tax revenues for the Indian commodities market. We use daily data of five sample commodities, namely gold, aluminium, copper, zinc and crude oil available from 1 May 2010 to 31 August 2016. It is found that CTT imposition has destroyed the parity of the Indian commodity futures market with the international markets as CTT is absent on COMEX, LME, NYMEX, and so on. Moreover, evidence of trade migration can be found by drawing a comparison across MCX and international exchanges. This argument is further substantiated by observing the decline in liquidity after the imposition of CTT. It should be further noted that parity with the equity market is also lost as the transaction taxes imposed in equity and commodity markets are not in line with the level of volatilities of the two markets. CTT has also failed to curb speculative pressure as average volatility on major commodities has risen significantly by about 33 per cent post its imposition. Considering the transaction tax, income tax and service tax aspects and decline in the trading volume attributed solely to the CTT imposition, it is found that CTT results in huge revenue loss to the exchequer. It is estimated that at the current CTT rate, government is losing an annual net tax revenue worth ₹30 billion. Even at a lower rate of 0.001 per cent (which is one-tenth of the current rate of 0.01%), the government’s fiscal loss is expected to be about ₹2.50 billion. Even if we make a conservative assumption that CTT accounts for only 25 per cent decline in the trading volumes, the optimal CTT rate, in terms of tax revenue collections, is found at 0.003 per cent, well below the current rate. There is, therefore, no justification for retaining CTT on the commodity futures trading in India as it leads to a huge revenue loss to the government, owing to reduced trading activity and trade migration. Withdrawal of CTT would be ideal for Indian commodities market development, improving its liquidity and making it more internationally competitive.