Modi’s Current Challenge: Dealing with the DEMON in Demonetisation

A cashless economy is a far-fetched dream in India without any substantive tax reforms, writes Gautam Mukherjee.

A cashless economy without any substantive tax reforms is a far-fetched dream in India. (Photo: Lijumol Joseph/ The Quint)

If demonetisation is not followed up with additional new moves, black money is going to come back redoubled.

Tinkering with income and corporate tax rates won’t do. After all, direct taxes account for roughly a third of the taxes collected, mostly from hapless middle class salary earners, plus the prominent listed companies.

Only three individuals out of 1.3 billion have paid more than Rs 100 crore in income tax recently and the taxpayer base accounts for just 2 percent of the total population.

Also Read: Hollow Policy Sham: Why Demonetisation Fails the Modern Economy

Fate of Cash Economy

As long as 98 percent pay no direct taxes, and exempted ‘agricultural income’ (which is in just a few hands) runs into trillions, the cash economy cannot be vanquished. The 98 percent must join the 2 percent, or clearly, the 2 percent must join the 98 percent.

And yes, all those who have lost money in laundering their cash will be seeking to recoup their losses. Bribe rates will go up, doubling in many cases, as will all kinds of facilitation and service fees.

And the ostensibly untraceable, new-mint Rs 2,000 notes, in their smaller, shocking purple glory, will prove much easier to stack.

Meanwhile, nearly Rs 9 lakh crore of the demonetised currency notes have already been deposited, in less than 20 working days.

There is some consternation, as the tank fills up nearly to the brim, that large tranches of laundered black money are part of the haul.

Also Read: Costly Botch-Up: Rajan Was RBI Guv, But Notes Had Subbarao’s Sign

(Photo: IANS)

Comeback of the Parallel Economy

How much of the black money will finally be extinguished is a point of conjecture, because even the part that has found refuge in mosques, churches, gurdwaras, temples etc in gold, or US dollars, is coming in via their trustees, the jewellers and currency-cum-hawala dealers.

This money has also swelled the likes of Jan Dhan and lakhs of dormant accounts, sometimes, with the collusion of bank officials, before moving around again, all for an alleged facilitation fee between 30-50 percent.

This, before it was known that the government proposes to tax the unaccountable money at 50 percent as per the amendment to the Income Tax Act which was just passed.

The 50 percent looks so much more reasonable than the early threats of a 200 percent penalty on the top marginal tax rate.

Other objectives, that of disrupting the flow of counterfeit currency, black money generation and use in the distribution of election tickets and poll war chests, of moving towards a digital, cashless economy, have gained traction, and indeed succeeded for the moment.

But they all threaten to resume, with the ‘parallel economy’ coming back with a vengeance, unless more is done.

Also Read: Bad Idea, Badly Executed: ‘The Economist’ On Demonetisation

Need for Tax Reforms

The choices are fairly stark. Either bring in all the rich farmers and various other questionably exempted entities and tax shelters (such as wealthy political parties, trusts, NGOs, religious institutions, and so forth) into the direct tax net, or abolish direct taxes altogether, in favour of a minimal bank transaction tax.

The former will take multiple legislative amendments, time and enforcement, which are prone to corruption afresh.

The latter option is better, not only because it will yield more money for government coffers, but because it makes tax-dodging, and even hawala-borne capital flight, unattractive.

If there is no tax to pay, except for those that are embedded in the indirect taxation system via GST, why would anyone want to hide the money in cash?

Also Read: Demonetisation, Aadhaar, and the Great Rural ID Theft

(Photo: PTI)

Repercussions of Digital Transition

GST, administered digitally online, is expected to plug evasion and increase the bottom line of the two-thirds of the total sum collected via indirect taxes.

And merging the unofficial economy with the official one will result in gains of anywhere up to double -- taking it from $2.3 trillion to $4.6 trillion.

The vast unorganised sector, both rural and urban, will take to banking for its safety and security, and prefer cashless digital transmission for its cost savings.

Future moves towards a fully convertible currency, always resisted because of the fear of capital flight, could, on the contrary, see a voluntary reverse flow of hoarded money abroad, keen to seek better returns in the world’s fastest growing economy.

It is a general canard that people would rather continue working the cash economy, than put themselves to the expense of 1-2 percent on every bank transaction.

But to prevent those who would grudge even this paltry amount, strict ceilings on cash transactions under GST will persuade them into entering the consolidated big tent of the economy.

As for those activities that still must be conducted in cash, there is little difference in taking it out from the bank, as opposed to from under the mattress.

(Gautam Mukherjee is a plugged-in commentator and instant analyser. He can be reached @gautammuk. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)

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