STT as Sin Tax, and the Quiet Cost to India’s Markets

In a Budget that leaned heavily towards incrementalism and continuity, one provision signalled a more aggressive shift in approach: an increase in the securities transaction tax on futures and options.

STT on futures was raised from 0.02% to 0.05% of contract value. The levy on options premium was increased from 0.1% to 0.15%, while STT on expiring options now stands at 0.15% of intrinsic value. The market’s initial response was swift. Index and capital market stocks sold off sharply on the Budget Day. The subsequent rally in the same name, driven by the signing of a trade deal, has since threatened to reduce the STT hike to a market footnote.

That would be a mistake.

The first question worth asking is what the STT increase was intended to achieve. For most participants, it is largely inconsequential. Real-economy companies have limited exposure to STT in the ordinary course of business. Long-term investors can absorb the increase without a meaningful impact. Even arbitrage funds, which depend on exploiting small mispricing between cash and derivatives markets, will merely see returns shaved by a few tenths of a percent.

The real incidence falls elsewhere.

The Finance Minister’s explanation for the hike has been consistent. In her Budget speech and post-Budget comments, the increase was framed as a deterrent to excessive speculative activity in derivatives and as a measure to protect retail participants from losses. Short-term trading, in this view, is treated less as a productive financial activity and more as a behavioural risk that needs to be priced out of the system.

From a regulatory standpoint, higher STT serves two purposes. It raises government revenues, estimated at around ₹300 billion, and simultaneously raises the cost of market access for short-term traders. It is the latter effect that matters far more.

SEBI’s own research shows that more than a third of retail short-term traders’ losses are accounted for by transaction costs, including STT. A hike of this magnitude mechanically raises those costs and, by extension, expected losses. This author has previously argued that such traders are caught in a trap of high complexity and high friction. The STT increase only deepens that trap.

Seen in this light, STT begins to resemble a sin tax. Much like levies on cigarettes or alcohol, it reflects a policy judgment that certain forms of behaviour are socially undesirable and should therefore be discouraged through higher costs. The parallel is reinforced by the experience with tobacco taxation itself, which has seen repeated increases over time rather than a one-off correction.

The difficulty with this approach is not the intent, but the instrument.

Short-term trading has been treated as a problem to be suppressed, rather than a phenomenon to be understood. The official narrative implicitly assumes that retail participation in derivatives markets is driven by excess risk-taking or misinformation alone. It pays less attention to the economic conditions that have drawn large numbers of participants, particularly younger ones, into these markets. For many, frequent trading has functioned as a stopgap rather than a speculative indulgence, shaped by weak income growth and limited alternatives rather than by optimism or leverage.

Using STT as a deterrent may reduce participation at the margin, but it does so without addressing those underlying drivers. It substitutes higher friction for deeper reform.
There are other ways to limit harmful participation without damaging market structure. Just as non-tariff barriers such as quality control orders act as indirect constraints on trade, market access can be shaped through mechanisms that genuinely test understanding and suitability, including qualification requirements that assess comprehension of derivative risks. Such tools target behaviour more precisely than an across-the-board tax.

STT, by contrast, is a blunt instrument. While global markets have spent decades trying to reduce trading frictions and improve price discovery, India appears to be moving in the opposite direction. Increasing transaction costs risk eroding the depth and efficiency of one of the world’s most liquid derivatives markets, with consequences that extend well beyond retail traders.

Price discovery is widely regarded as a public good. Treating STT as a sin tax may satisfy regulatory intent in the short term, but its indiscriminate application risks undermining that public good in ways that will only become evident over time.