The Economic Survey estimates that around a third of the increase in individual taxpayers in FY17 was due to demonetisation.
On the face of things, 99% of high denomination currency notes coming back to banks suggest the main purpose of demonetisation—to unearth black money—has been defeated. The government, as articulated by the attorney general, believed Rs 3-4 lakh crore of unaccounted wealth with households may not be disclosed—had this happened, justifying demonetisation and the severe shock it caused to small businesses would have been easier. But the gains are also considerable if the government is able to deliver. There can be little doubt the severe shock to black money—and the resultant jump in digital payments—has been a big positive in terms of changing the casual attitude towards tax evasion; the Economic Survey estimates that around a third of the increase in individual taxpayers in FY17 was due to demonetisation. With all cash back in the banks, there are more people/business in the formal system, and this allows the taxman to investigate the source of their wealth and check further tax evasion by using cash.
The government has already indicated it intends to probe Rs 1.75 lakh crore of suspicious deposits. If a significant part of this is converted to convictions and tax payments, it will suggest demonetisation has worked. Lax follow-up by or connivance by tax officials has, in the past, encouraged people to declare lower incomes; the recent prosecutions of tax officials suggests there is a clean-up of sorts. Given all the data he now has, the taxman must not lose the opportunity to crack down on evaders. The surprisingly robust GST collections for July, at close to Rs 92,000 crore, suggest the compliance has been very high; the information from the GST Network should also help tax officials investigate income tax payments. This is a good way to step up the tax-to-GDP ratio which, though higher at 11.2% in FY17 versus 10.6% in FY16, could be better. It is also likely the high number of units registering for GST, and the initial compliance, also got a fillip due to demonetisation.
However, for there to be a significant jump in tax collections, the economy needs to pick up pace. The real cost of demonetisation has been the big blow to the informal sector—roughly 80% of the economy—and the consequent loss of growth. The pain may not be entirely reflected in the headline GDP numbers, which in themselves are less than impressive, but there is no doubt many small and mid-sized units would have become a lot less viable with their USP—tax-evasion—dealt a blow by, first demonetisation, and then GST. The government must work to resuscitate these businesses and create jobs to undo the damage done by demonetisation/GST. The NITI Aayog-IDFC Institute report reveals how difficult it is to do business in India and, instead of dismissing the findings, the government must work to fix this with flexible labour laws, easy flow of credit and improved access to markets.
While banks continue to support very small units—Rs 1.75 lakh crore was lent to nearly 40 million units under the Mudra scheme in FY17—the share of SME credit in overall bank credit has slipped to 17% in June from 18% in March. Demonetisation may have helped bring down the cost of money thanks to the flood of deposits with banks, but smaller units may not have benefited proportionately given how risk-averse banks are at this point. Until the informal sector is back on its feet and more jobs are created, the economy will remain in a rut.