As a loose rule, I avoid analysing policy decisions in India in this newsletter. A long time ago, I used to write about things like the budget, vaccine strategy, and the second-order effects of taxes, but I stopped doing that primarily because I realised I could no longer tell the difference between: 

a) A policy that appeared ludicrous on the surface, but was actually extremely considered, deliberate, and sometimes even admiringly devious, intended to achieve a long-term objective, except that we couldn’t see it yet. Or

b) Random nonsense

Since I could no longer figure out whether the government was playing 4-D chess or if it was just clumsy and incompetent, I played it safe and ignored it altogether. Often, something really big and interesting happens and I’m tempted to interpret it as strategic brilliance, but then, someone important says something stupid in a press conference or a ministry issues a strange clarification or suddenly I’m standing in an ATM line for no apparent reason, and I’m not so sure anymore. 

Anyway, with that caveat, I’m going to break that rule today. 

Today’s edition is about the 20% tax which the Ministry of Finance announced in a notification on Thursday. Or as I call it, the Incredible India tax.

Let’s say you are the Indian government and for some reason, you believe that people aren’t paying their income taxes properly. You observe that people are making a lot of money and even seem to be spending it liberally. But at the end of the year, when you ask them, “hey, tell us how much money you made so we can figure out how much to tax you”, they tell you that they have in fact made much less than you thought, so you shouldn’t be taxing them at all. 

Normally, the Indian government would slap notices on everyone and ask them to show up at the income tax (I-T) department’s offices with photocopies of their last six months’ bank statements to explain how they spent all the money they claim they didn’t make. But India has a lot of people, so the I-T department has a nice workaround. 

Instead of waiting for you to declare how much money you’ve made at the end of the year to deduct taxes, it straightaway deducts taxes every time you make money. Company give you a salary every month? The government mandates that it cut tax at the same time and give it to them. How much tax? Oh, just make a random assumption. If someone says, “wait you cut too much tax, let me explain why…”, the government just says, “tell it to me at the end of the financial year and we’ll adjust accordingly”.

If you start with the assumption that everyone is a criminal trying to defraud you, you can come up with a pretty effective tax collection process.

One consequence of this is that, effectively, you are collecting tax upfront and placing the burden of justifying why it needs to be lower on the taxpayer. 

But this approach breaks when people have complicated, informal sources of income. Maybe they don’t get salaries from a company, but get money credited into their account every month via some strange sources. Or maybe it’s not in their bank account at all. 

So you take this logic one step further. Instead of collecting tax at the time when money is credited to a bank account, you can collect it when money is spent. This is much easier to track and if you do it, you don’t really need to think too much about all the tax you aren’t collecting at the income side. The only problem is that you are already collecting tax when money is spent, usually as a goods or service tax, so you end up with double or even triple taxation, which is generally unpopular. 

But what if you collected this spending tax in situations where you do not levy a goods and services tax? Especially at places where all these tax-cheating people go and spend their (presumably) untaxed income?

Well, that’s more or less what happened.

Here’s the latest Finshots, as usual, doing a great job of explaining how it works.

Unsurprisingly, this decision was very unpopular. A lot of people—mostly credit card holders who also have a Twitter account—got very upset. Even the people who proudly sat in premium seats on airplanes and applauded demonetisation back in 2016 were furious. In multiple news reports, experts were unanimous in their criticism, and claimed that such a regressive move would incentivise people to resort to illegal hawala routes, and discourage online payments. Others pointed out that this would be a compliance nightmare, especially because the government has indicated that this tax will not apply to all foreign credit card transactions, but only some transactions (things like corporate card expenses would be exempted, as would health and education). 

The outrage rolled on. Others pointed out that if you really needed to tax foreign transactions to trace those with illegal income streams, you didn’t need to levy 20%. A smaller percentage would be sufficient. One prominent entrepreneur got really upset and suggested that tax collections at source only seem to affect credit cards, and not, say, electoral bonds. 

The finance ministry came back with a set of clarifications arguing why it was doing this. In it, it claimed that the real reason it was doing this was nothing to do with tax collection, but to control foreign exchange. Right now, Indians have limits on how much rupees they can spend abroad—that limit is US$250,000 a year. In its notification, the ministry stated, “data collected from top money remitters under LRS reveals that international credit cards are being issued with limits in excess of the present LRS limit of US$250,000.”

I’ll do the calculation for you. US$250,000 is a little over Rs 2 crore. 

How many people do you know who own credit cards with limits exceeding two crores? 

This is the heart of the mystery. 

The government introduces something that hurts everybody who spends money abroad. The people who are most vocally upset by it are the moderately affluent people who go abroad often and use their credit cards to make transactions. So the government comes back and clarifies that it did this to close a loophole that those really, really affluent people (all seventeen of them) were using with their two crore plus limit credit cards.

None of this makes any sense. 

There’s a lot written about how poor this policy is, and a ton of analysis about the first and second order effects of such a move. 

I have a different question—what is this intended to achieve? Why do this at all?

And I think I have an explanation. My theory is that this has little to do with tax collection, money laundering, black money, or protection of foreign exchange. 

The answer lies in a completely different place. 

Domestic tourism. 

This is why I’m calling this the Incredible India tax. 

Let me set the stage. Perhaps you haven’t noticed, but over the last few months, the Indian government has been working extremely hard to make Indians spend their vacation in India. 

Earlier this year, they began by cutting down on overseas tourism promotions and using that money to make domestic tourism more attractive. In essence, India is now less interested in getting foreign nationals to visit India, and more keen to convince Indians to visit Indian destinations. 

This made a lot of tour operators unhappy.

A lot of people believe that the TCS on credit cards overseas came out of the blue, but it didn’t. 

Everyone loves to analyse India’s biggest distraction, but few noticed or cared that the push to dissuade Indians from going on international vacations began a full three months ago when the Finance Minister introduced something seemingly innocuous in her budget. 

India hiked the tax collected at source for multiple aspects involved in an overseas vacation from 5% to 20%. This includes various bookings that tour operators make for a foreign tour, like hotel bookings, hiring transportation, or multiple other miscellaneous activities. India’s credit card users with a Twitter account didn’t care, mostly because it didn’t affect them at all. 

But you know who were actually affected? And spoke up?