The Scourge of Black Money

The government of India announced the Income Declaration Scheme (IDS) earlier this year.  The purpose of IDS is to unearth black money in the country. It is an amnesty scheme, and allows people to declare undisclosed income or assets. They will pay 45% tax on the disclosed income, and will not attract any further action. No criminal charges will be brought against them, and their information will be kept strictly confidential. The IDS ends on September 30. After that deadline it is possible that a massive crackdown will ensue, since the government has been capturing and collating financial data from various sources. Using all that date the tax authorities will pursue the black money hoarders. The Prime Minister himself has warned that after the deadline harsh measures may follow. He also reminded us that one of his first decisions, as PM, was to set up a Special Investigation Team to go after undisclosed assets in foreign banks.

The problem of black money has two aspects.  One is the existing stock, accumulated from the past. This could be sitting around in the form of cash or other assets like land and gold. The second aspect is the creation of new quantity every year, as part of the shadow economy.

Attacking the scourge of black money was one of the key promises in the BJP manifesto prior to the national elections. When the BJP was in opposition, it had constituted a task force on black money and published a report in 2011. The UPA government too presented a white paper in parliament in 2012, based on which several actions were initiated. It turned out that extracting information from Swiss banks was not as easy as expected. The estimates about how much black money was in foreign banks varied from a few billion to a few trillion dollars.  The Swiss authorities reported that as per their data the amount held by Indians in their banks was less than 3 billion dollars. Earlier this year we had Panama leaks, which listed names of Indians who held offshore assets. But the exact value of their undisclosed wealth was not known.  So it looks like recovering foreign undisclosed assets of Indians is a difficult task.

By comparison, the black money at home is easier to unearth.  The IDS is targeting ill gotten money at home. It is quite likely that the quantity of black money within India is much more than that held abroad. Just how much is this underground economy? The World Bank estimate for India is about 21% of GDP. This is quite a significant part of economic activity. This is a flow, not a stock.  The problem of black money has two aspects.  One is the existing stock, accumulated from the past. This could be sitting around in the form of cash or other assets like land and gold. The second aspect is the creation of new quantity every year, as part of the shadow economy (which is what the World Bank estimated). The IDS addresses the first aspect, but does not have any impact on new creation in the future. To stop generation of new black money we need strict laws, stiff penalties and earnest implementation. Of course it is also connected to the larger issue of corruption.

Amnesty schemes like IDS have been offered from time to time, with limited success. That is because the people at whom they are directed, are not convinced that they will get complete immunity from further harassment or penal action in the future.  Hence they hesitate to come forward. Amnesty schemes also illustrate a perverse incentive. Honest taxpayers feel cheated, when tax dodgers are offered amnesty.  It is as if law-abiding citizens are witnessing lawbreakers being rewarded.

Tackling the scourge of black money requires a multi-pronged approach. For instance it is well known that three sectors are particularly prone to usage and creation of black money. These are elections, real estate and education (capitation fees).  Election spending in India is far in excess of official prescribed limits.  All that excess expenditure is illegal, and is made with black money by definition. In real estate transactions, a significant portion of the payment is made in “cash”, hidden from tax authorities, which is black money.  That “cash” component represents owner’s equity, and cannot be financed by banks. Because of this “cash” component that the owner invests in his property, mortgage defaults are relatively rare in India.  The owner cannot afford to lose his property that contains a big part of his “hidden” equity. Hence the owner does not default on bank loans.  Black money also gets generated from bogus agriculture income, inflated or bogus billing of government contracts, under invoicing of exports, over invoicing of imports, etc. It’s almost like a non-stop cash generating machine.

Thankfully the economy is moving toward becoming a digital and less-cash society.  Debit and credit cards, digital wallets and mobile payments are proliferating. All large transactions happen electronically.  This makes it possible for tax authorities to get a 360 degree view of transactions. The recently launched Unified Payments Interface will enable payment directly between any two mobiles, persons or bank accounts. The Jan Dhan Yojana has covered more than 240 million new bank accounts. The Direct Benefit Transfer scheme puts money electronically directly into people’s bank account. Almost all income tax payments are made online now. All of this will hopefully reduce “cash” generation and hence black money.

The government should also consider demonetizing large notes like the 1000 rupee note. Ordinary Indians rarely have to use this high value note in their daily affairs.  High denomination notes are used in all sorts of illegal activities – like drug deals, terrorist financing or financial crimes. Criminals prefer cash because it gives them anonymity and leaves no trail.  Large notes like 100 dollar or 500 Euro will most likely be withdrawn from circulation in America and Europe, and India too should follow suit. The suggestion to retire high value notes was made by Baba Ramdev, and a group called Arthakranti. Recently Ken Rogoff, former chief economist of IMF too made a passionate plea to retire high value notes.  This is just one of the several instruments needed to curb the scourge of black money.

Black money has a debilitating effect on institutions and governance in society. It represents the outcome of corruption. It affects the poor disproportionately.  It reduces the legitimate funds that would have been available to build public goods like schools, hospitals and roads. It increases the trust deficit in society, especially between the government and the people.  Hence curbing black money, both its existing stock and new creation must be accorded high priority.

(The writer is a senior economist based in Mumbai)