<b>Parthasarathi Shome:</b> Demonetisation: An (un)necessary evil?

No adverse impact on GDP, but on the vulnerable

Fears of a gross domestic product (GDP) setback from the government’s demonetisation action are unfounded. At the macro-economic level, whatever is the amount of black money coming into banks by December 31 and into the Reserve Bank of India (RBI) by March 31, would be estimated by RBI on March 31 – what has come in and what has not – in comparison with the cash earlier issued by it. RBI will thus arrive at a calculation of change in its liabilities, and quantify mismatched assets and liabilities in its balance sheet. It will then return some government bonds it holds thus enabling government to increase spending and, in turn, restoring GDP to normal. Also, the view that black money holders will find refuge in gold is based on merchants assuming tax evaders’ risk by accepting old Rs 500 and Rs 1,000 notes since, until December 31, that is legal. Unlikely again, since currently risk aversion is pervasive. 

The problems lie elsewhere. First, consider why demonetisation was rendered essential. The lacklustre success of the income tax department (ITD) during previous and current governments to contain black money is one explanation. A white paper on black money listed measures they had taken to curb it. It was unconvincing since black money persisted despite those measures. Admittedly, Budget allocation to ITD’s investigation function is too small compared to needs, in contrast to the Budget for fruitless routine assessment of all taxpayers, an uncorrected imbalance even after the Tax Administration Reform Commission (TARC) made its recommendations. If the recommended reallocation of staff resources were undertaken, black money could have been unearthed in a more unobtrusive, imperceptible and consistent manner. 

Second, the government’s Income Declaration Scheme (IDS) initially reported a base of Rs 5,000 crore from undisclosed foreign accounts, followed by Rs 65,250 crore of undeclared income in cash and other assets in India that was “likely to be further revised upwards”. While the Rs 5,000 crore base was believable, the Rs 65,250 crore number requires deconstruction. It is likely to reflect to no small extent the expected outcomes of already ongoing actions of the tax or intelligence departments. After all, income tax officers are regularly carrying out investigation and search and seizure so that they continually gather information and possess expected collection estimates from such activities. Only if and when the government releases a break-up of the sources of the Rs 65,250 crore could one assess the nature and reality behind it. Also, how much tax can be procedurally recovered from this tax base remains unclear. 

It would be superfluous to repeat the inequity that emanates between good and bad taxpayers from repetitive tax amnesties irrespective of the government, a habitual quick fix of Indian policymakers that could only have exacerbated tax evasion behaviour over decades as is well known from international experience. Lamentably, India continues to eschew benchmarking itself with other tax administrations or prevalent good practice elsewhere. 

Third, tax avoidance – and evasion – occurs even in the organised sector through tax base depletion reflecting misapplication, misuse or illegal use of incentives and deductions, thus adding to the tax gap. The government’s annual revenue loss calculation presented to Parliament in every Union Budget – we introduced this international practice in 2006 – is testimony to tax base depletion. Yet this government too has done little to cut back incentives and has indeed given more of them for ever-new so-called leading sectors, benefitting primarily the already rich and wealthy. The Union finance minister’s promise to bring down headline corporate tax rate to 25 per cent remains unfulfilled though he mentions its need occasionally. 

Fourth is impact on the poor. To hear leaders opine that farmers can also put their money into banks is reminiscent of a policymaker of the previous government asserting to me that there must be a ration shop every 50 yards. The current authorities may take a few trips to India’s deep interiors to view if all farmers do, or can, access banks and how far is their nearest bank; a mere statistic regarding new bank accounts is insufficient. Policymakers would realise that not just tax evaders, smugglers or terrorists use cash, but also the poor. Neither have the leaders of democracy been observed to queue at banks like the urban commoner. Thus it is ironic for political representatives to proclaim that the entire country is with them. It reveals little reality check of the vast ocean of ordinary Indians. 

Sadly, the suffering of the poor and the sick could have been averted. For such deeply cross-cutting action, the government should have had ready counter-measures to ensure the poor did not go unfed and the sick received treatment. Reports indicate that daily sellers in Kolkata’s vegetable and fish markets were unable to sell since bangali babus do their shopping with Rs 500 notes —understandably, given fish prices per kilo. Fish rotted. The sufferer was not the buyer but the seller whose daily earning feeds the family. Such examples abound. 

Illustration by Binay Sinha

Understood that the government’s action had to be kept secret for effective outcome. But news flashes, for example, that Rs 3 crore were deposited in old 500s and 1000s by government’s political party, or its use of new 2000s, just before the demonetisation announcement, are disturbing. The government’s full explanation is warranted. Indeed, the prime minister’s advisers should have counselled him to leave behind a national address before being flashed on a Japanese bullet train ostensibly pursuing the luxury Mumbai-Ahmedabad bullet train project. A prior address would have been reassuring and effective rather than exhorting punishment post-event from Goa’s shores. Is the team that assured him that it would be just a two-day pain being asked to resign or is absence of accountability being ignored as always? 

Finally, further draconian policy could be expected to square the circle. Complementary would be reinstatement of the Bank Cash Transactions Tax that was introduced, and removed, by the previous government despite BCTT’s success in diminishing fictitious long-term – therefore untaxable – capital gains by limiting the high velocity of bank transactions that illegally converted black money into white. Whatever occurs ahead, a monitoring cell should be established to minimise adversity, reflecting its gravity, for honest taxpayers and the vulnerable.