Tuesday, November 22, 2016

What is this black money and will this monetisation help in curbing black money ?

Modi government's decision to withdraw INR500 and INR1000 rupee notes to curb black money is bold and stupid! Bold because there are many risks involved in this move. Stupid because it may not curb black money but may just put a spanner in the fledging Indian economy. Let us get a few basics out the way:

What is this Black Money ?
In my view and a layman term, Black money is money earned by a person on which he/she has evaded tax. Black money is the money that you have that the Income Tax department or other government tax agencies do not know about. This could be the money a grocery shop owner earns in cash and never declares in his income statement (or for that matter he never even files an income statement), bribe money that a police man earn on the road, crime money that a drug peddler takes from their customers, crime money that a bank robber has etc.

How is black money create ?
As soon as tax declared money (referred to as white) is out of ATM, it has a fair chance of becoming black. For instance, suppose you have all whites and you take this cash out of ATM and buy groceries worth INR2000 from the local grocery shop. Let us assume that grocery shop owner has a margin of 20% and he makes a net of INR 200 as profit (after expenses). The grocery shop owner does not declare this income to IT department in his tax returns. This money is not accounted at all and is now his black money. He would pay this cash now to buy more goods, he would pay his employees who in turn would spend this in cash and money remains black.

Can this money turn in white ?
Sure it can turn into white. The grocery shop owner goes with his family for an outing and spends this cash in a large multinational coffee chain. This coffee shop chain then declares this income, pays tax of the profit they make, and the employees of this chain get paid in their bank accounts. All this money is white and would remain white till it remains in the banking system. It would also become white if our grocery shop own goes and spends this money for this dental treatment and the law abiding doctor pays his IT dues dutifully. Doc's money is all white then

What about fake currency, drug money etc ?
Black money includes fake money, terror money, corruption money and crime money but the proportion of simple tax evasion money is huge. Let us get some numbers. The amount of money in circulation in India is around INR 17, 54, 000 crores. This amount is about 14% of the GDP! This is a very high figure and in developed world it is around 5%. Fake currency in circulation is estimated to be around INR 400 crores or roughly 0.02% of total currency in the economy. Drug and crime money is higher but in the similar order of magnitude.

Let us be clear about this, amount of black money (tax evasion) is huge in Indian economy and curbing it can make Indian government really cash rich and in turn make India really prosperous in long term.

What about demonetisation ? Will that curb black money ?
Tax evasion happens because money goes unaccounted and Indian public generally does not believe in paying taxes unless forced to. Large firms have very strict rules regarding payment of salaries. This includes cutting taxes at the source. This leads to very less leakage from this source.

However any small business or local shops & establishments which takes cash from their people, do not pay any tax at all or pay tax on a tiny percentage of their income. A lot of self employed people who earn in cash simply don't pay any tax. Farming and agriculture industry is tax free by government. Small scale industries are also big tax evaders. Therefore, we can see here that there is a huge chunk of people in our country who simply do not pay taxes or pay on a small