Money, inherently, has no colour. In most countries, specified money transactions are taxed. This gives rise to two classes of money—money that is not taxed and money that is taxed. If money that is liable to be taxed is not offered to tax or otherwise escapes taxation, that money is usually referred to as unaccounted money or ‘black money’.
The best known tax on money is income tax. It is regarded as a progressive tax—more the income, more the tax. Not many are happy to pay income tax. They view income-tax rates as excessive and income-tax as confiscatory.
The tax evader is regarded as a villain. Sometimes, wrong persons are dubbed as villains. If, for policy reasons, a significant part of the incomes earned by the people is not taxed, those incomes are perfectly legal and legitimate. The best example is India where agricultural income is not taxed but is legitimate and legal income.
As long as taxable income and non-taxable income co-exist, when money passes from one person to another, it may change colour. Consider money passing from a farmer to a shopkeeper to a doctor. Depending upon who is a taxable entity, it may turn from white to black and to white again.
Besides, as any economist will point out, black money is not entirely ‘stock’. Mostly, it is a ‘flow’. In the old days, perhaps unaccounted money was stored as cash—the proverbial ‘under the mattress’. Nowadays, unaccounted money is mostly hidden in real estate, buildings, bullion, jewellery and shares/securities.
All of the above, make it difficult to stop the generation of unaccounted money and it is also difficult to detect the flow of unaccounted money.
A few days ago, the government announced that currency notes of the denomination of R500 and R1,000 had been ‘demonetised’. ‘Demonetisation’ has a special meaning. It means that the currency note of that denomination will, henceforth, be a scrap of paper! Nothing of that kind happened.
The government’s notification of November 8, 2016, withdrew the “legal tender status” from the notes of the two denominations but made it clear that those “holding these notes can tender them at any office of the Reserve Bank or any bank branch and obtain value thereof by credit to their accounts”. So, we can be clear on one thing, there was no demonetisation, and the government’s spokespersons would be well advised to avoid that word. The correct way to describe the decision is ‘Old notes for new’!
Both the government and the RBI have declared three objectives for the ‘Old notes for new’ decision. Firstly, to “tackle counterfeiting Indian banknotes”. This is nothing new, the RBI does this from time to time, new series notes are issued and the old series notes are impounded over a period of time and destroyed.
The second objective is to “curb funding of terrorism through fake notes”. This is really a part of the first objective.
The third objective is to “nullify black money hoarded in cash”. The assumption is that unaccounted money is stored in R500 and R1,000 notes and therefore they must be “nullified”. At the end of March 2016, there were 1,570 crore R500 notes and 632 crore R1,000 notes in circulation, representing 85%, by value, of all notes in circulation. Step one: pull them out by forcing people to deposit them in banks within a 51-day period ending on December 30. Step two: if it is true demonetisation, destroy the notes, which for obvious reasons the government dare not do—unless it wanted a revolution!
The reality is the old notes will be replaced by new notes. Hence, the true test will be the answer to the question ‘what proportion of the old notes will be tendered for replacement’? It is only the notes that are not tendered that will be ‘demonetised’ in the true sense of the word.
Put on thinking cap
There are many uncertainties and unknowns in the government’s plan:
1. How did the government come to the conclusion that the R500 note was, in the present day, a high denomination note?
2. Was the government prepared to handle the demand for new notes? The first few days have been utterly chaotic and people have been put through a lot of hardship.
3. What will be the cost of replacing the old notes with new notes, including the cost of printing the new notes? My estimate is R15,000 to R20,000 crore. Was the cost worth the effort?
4. The present cash to GDP ratio is 12%. Will it come down to the world average of about 4%?
5. The value of the high denomination notes currently in circulation is about 15 lakh crore rupees. Will that value come down significantly?
6. Will gold imports surge indicating that unaccounted income/wealth will seek refuge in bullion and gold jewellery?
7. How will the government’s plan stop the generation of fresh black money?
8. And the most puzzling aspect: how will the government’s objectives be met if new and higher denomination series of notes (R2,000) are introduced?
I have been derisively referred to as a columnist. Will the bloggers, if not the ministers, please answer the questions of this columnist?