Devangshu Datta: Why India is a cash-economy

WORM'S EYE VIEW

When the US Internal Revenue Service nailed Al Capone for tax evasion in 1931, "Scarface" made a priceless comment: "This is preposterous! You can't tax illegal income!" The answer is, of course you can.

Most income tax (IT) definitions are broad enough to include income derived from whatever source. But nasty as the concept of taxation is, most tax systems balk at taxing the same income twice.

This is the justification for not taxing dividends in the hands of the shareholder. The company issuing a dividend has already paid tax on its profits (and a withholding tax on dividend).

It is even more unusual to tax the same income twice in the hands of the same person. But that is exactly what the tax on cash withdrawals amounts to. Most people, who are in a position to withdraw Rs 10,000 in a bank account, are reporting that income because the bank account is linked to a permanent account number.

Taxes will have been paid on that money or taxes will be due on it "" that money is out in plain view. Unless the tax charged on the cash withdrawal is credited to future IT payments (and there is no such provision), this taxes the same income twice.

The inequity is even worse for businesses, which pay wages. Most labour intensive businesses (such as tea-gardens, factories, fashion designers, transporters, driving schools, construction and civil engineering works and so on) pay wages in cash. The tax will add significantly to cash expenses "" and a business could well register a loss and still be forced to pay this tax.

The tax would cause less friction in a developed nation "" where it wouldn't be needed. In the first world, nannies, manual labourers, plumbers and gardeners possess chequeing accounts and credit/ debit cards.

Even $10-20 transactions are paid through plastic or by cheque rather than in small, dirty, used, bills. The better class of first-world dope dealers and brothel-keepers also process credit card transactions (they generally offer clients a choice of "flowers" or "perfumes" as a means to record the transaction).

In India that is Bharat (rural India), there are several large obstacles to cashlessness. Banks don't exist across much of the hinterland of Bharat. Even banking majors like SBI and ICICI don't issue credit cards in more than 60-70 towns. So, a large proportion of the citizenry, the aam aadmis for whom our politicians selflessly work, lack access to cashless financial services.

Apart from the lack of geographical penetration, there are other good reasons why India is predominantly a cash-economy and will remain that way for a long time. Much of the urban population cannot offer proof of residence, which is mandatory for opening bank-accounts.

In the urban context, ayahs, drivers, mechanics, plumbers, garbage-collectors and most people below a certain income level live in places euphemistically described as "JJ colonies". Since these slums are largely unauthorised, such people have difficulty proving residence.

This is endemic in under-developed countries. De Soto won a Nobel for pointing out how economic growth could be unlocked in Latin America if titles to such unauthorised residences were clarified. Be that as it may, it is a failure of the state that large numbers of law-abiding people dwell in circumstances where they have no access to bank account or plastic.

Such people have no alternatives to accepting cash remuneration and this tax inflicts suffering on the employers of such people.

On the positive side, the tax will be a useful driver of plastic issuance and usage and it may provide a push for e-commerce through mobile telephony as well. The combined penetration of credit and debit cards is now around 65 million and plastic is acceptable in 70-odd towns.

By 2010, if a 2004 McKinsey estimate of the Asian banking industry is credible, India could have over 165 million plastic users (35 million credit and 130 million debit card). What happens to the other one billion-odd citizens and the people who pay them? Perhaps bank ATMs will start issuing Rs 99 vouchers that can be redeemed in cash?