Demonetisation: The productivity of black money

Published: January 23, 2017 5:42:52 AM

If all black earnings were accounted for, would the government have spent the money as efficiently as a private party?

money-lCredit and debit card use is still restricted to educated and mainly better-off people.

Some, particularly politicians, might say yes to themselves in answering this question. After all after the recent demonetisation, some politicians who had held high offices and expect to do so again, asked for demonetisation to be rolled back for a week or withdrawn altogether. This could have been for many reasons. One could be that they wanted to safeguard party and/or personal interests. The money could help ensure continued service to the country. Another may have been a desire to help those in industry and commerce to protect their money, so that their businesses could continue. Possibly they anticipated the hardships it would cause to ordinary people and wanted to minimise them.

India is today largely a cash economy. Credit and debit card use is still restricted to educated and mainly better-off people. Most people are self-employed, on daily or short term employment and are paid in cash. Agricultural income is free of tax and accounts for major proportion of the population. It is not known how much of agricultural income escapes tax. But it is common knowledge that non-agricultural income is hidden under the garb of agriculture to evade taxes. Most agricultural labour is paid wages in cash. Despite the huge expansion in bank accounts under the Jan-Dhan programme, few accounts actually have money to deposit there, and their transactions are all in cash.

Some of it may even feature in the payer’s accounts. But in the hands of the receiver it goes untaxed. In that interpretation, all these earnings are black as they are untaxed. However, all this adds to the production in the economy. People spend this money, and their consumption and other expenditures stimulate the economy.

There is no doubt that there is much evasion of sales and other local taxes. A proportion of trade is ,therefore, black, escaping direct as well as indirect taxes. The beneficiaries use it for purchases that are similarly outside the tax net. This must apply also to many other service providers. These proceeds earn profits and the amounts accumulate over the years and might go into other finance and capital investments.

The earnings that remain untaxed, might also be sent overseas, for consumption, investment in capital assets, or to bank accounts. Such money also gives employment to intermediaries like illegal hawala operators. The earnings of intermediaries is also black, but their spending again stipulates the economy.

A good part of all this black money earning is invested in actual production, in India, wholly or partially. Thus, they generate employment and output. Our electoral system has few serious penalties for huge election expenditures. It is, therefore, an outlet for black money. If the limits were set and implemented, we could close a big outlet for the use of black money.

If instead, all these black earnings were accounted for, they would be taxed. The government would then spend these tax revenues. But would government spend the money as efficiently as a private party? Also, should black money be encouraged if it is more productive for the economy? Or should every effort be made to suppress it and expand tax revenues?

Is demonetisation of high value notes the best way to rid the society of black money? Is it not merely an attempt that will ultimately fail unless system of controls, a large role for the government in the production process, large government spending on defence and infrastructure, continue?

Moreover, would it be better at the same time to change the rules for doing business in India to reduce the constraints imposed by the government? Do we need to change drastically the mentality of our administrators in the government, their accountability and increase greatly the penalties for making and enforcing rules that open a window of corruption?

Demonetisation will stop fake currency and send those making black money into hiding. But only for a while before they return. Without radical changes in our system of administration, there will be no lasting effect from demonetisation.

Perhaps it would be better, if we are unwilling to reform the system as described, to continue as we have for decades and allow black money a role in the economy.

by,SL Rao

The author is former director general, NCAER, and was the first chairman of CERC. Views are personal

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