Fight black money with strategy, not muddled improvisation

It has been 45 days since the sudden move of demonetisation. For India, primarily a cash-driven economy with the informal sector accounting for about 80% of employment and 45% of the GDP, the disruption was, as expected, huge. Jury is still out on whether this move will fulfil the intended objective of flushing out black money held in cash or on the contrary, inflict unintended costs to the economy. The execution has left much to be desired.

Politically, it was a supposed to be a masterstroke. Unlike any other political campaign, the scheme touched every one in the country. When Prime Minister Narendra Modi announced it, there was popular support as people believed in the importance and seriousness of the move.

The Jan Dhan accounts, opened for financial inclusion, saw substantial increase in deposits since demonetisation – a rise of 60% in first two weeks – as these were misused to launder unaccounted money. In the words of eminent economist Jagdish Bhagawati, this will result in redistribution of wealth and the poor will be better off.

This will definitely help Modi’s claim of fulfilling his election promise of unearthing black money and depositing it in every poor man’s account.

The economic impact, in the short-run, will be negative with slow growth and job losses in next couple of quarters. Lower economic activities are already seen in some tier II cities with reduced traffic and retail sales.

The exact impact is difficult to predict as in economics, the ‘rear-view mirror is always clearer than the windshield’. Even the RBI has decided to ‘wait and watch’.

The RBI, which came under a lot of criticism in recent months, signalled its independence by holding the policy rates steady as against the market expectation of a rate cut.

The mathematics of demonetisation is interesting. According to 2010 World Bank estimates, black money in India in the form of cash or physical assets is about one-fifth of the country’s GDP (around Rs 34 lakh crore). Considering that about 12% of this black money is held in cash, this amounts to a mere Rs 4 lakh crore out of Rs 15.4 lakh crore pulled out of the system.

Fighting black money is a commendable move as it increases inequality, deprives government of tax revenues that could be spent on education, health or infrastructure. But the question is whether it was necessary to put the economy that was slowly recovering, at risk for such a small amount.

According to media reports, till December 3, Rs 12.6 lakh crore had been deposited into the banking system. The SBI research report estimated that only Rs 1.5 lakh crore may not return as against Rs 4 lakh crore expected. Most of the black money may have got converted into white in some ways.

The recent discovery of large stacks of new notes at various locations all over India could not have happened without the connivance of some unscrupulous bank officials. In addition, there can be some harassment or further corruption as I-T officials raid more tax evaders.

Does it mean that the whole exercise was in vain? May not be. First, many have come under the scanner of the income tax office – those who had never paid tax before. Second, government’s tax revenues will soar as taxes on these previously undisclosed amounts get paid.

Third, many received money from black money hoarders either in their bank accounts or in cash with a commission for accepting old notes. Accounts of tribal people in the North-East are overflowing with deposits. There will a section of people who are benefitted by working as middlemen helping launder money. This wealth effect will push consumption.

Fourth, digital transaction got a forced push that will help bring in more transparency although it is not practical to expect a cashless society in the immediate future. Fifth, utility companies recovered unpaid bills from defaulters.

Sixth, there is a feel-good factor among middleclass that status-quo on corruption is no longer an option.

Paying income tax
Demonetisation revealed that we do not like to pay income tax and are willing to go to any extent to avoid it. Be it the tuition teacher or doctor, everybody wants to be paid in cash without receipts. Only 1% of our population pays income tax compared to 40% in USA.

In India, income tax is considered a burden and not ‘the price for civilisation’. The salaried middle class has already rejected government schools or hospitals which are in deplorable condition without accountability. They do not perceive any benefits of paying taxes. There is no social security system like the developed economies. So, we just hate to pay income tax.

However, we do not have such revulsion towards indirect taxes which are almost invisible. We have no problem with an increase in excise duty on petroleum products.

There are a plethora of indirect taxes we pay – from excise, VAT, service tax, securities transaction tax, stamp duty to the new ones like Swachch Bharat cess, Krishi Kalyan cess etc. Total indirect tax collection during April-October 2017 has grown at a healthy 26% compared to the budgeted 10% while income tax growth is undershooting the budgeted estimate.

Basic economics tell us that indirect tax is bad as it is levied on every person equally, rich or poor, while income tax is good as it is progressive and is levied in accordance with the paying capacity. However, Indians are conditioned to avoid income tax. So, it may be better to concentrate more on indirect taxes. The GST will be an efficient way to collect indirect taxes.

In the next budget, Finance Minister Arun Jaitley should bring down income tax in steps in order to incentivise people to pay taxes. Further reforms to unearth black money should continue with much more strategic thinking instead of muddled improvisation.

(The writer is a research scholar at IIFT and adviser at Policy Monks)