Demonetization and Taxing of Hidden money: How India can solve the problem?
- In Economics
- 04:06 PM, Dec 27, 2016
- Bhanu Gouda
In Democracies, the ruling party makes a decision which the opposition opposes, like a ritual. There are exceptions, those related to National Security are agreed by all with no opposition. However these decisions might end up as short term success only to create long term problems. Iraq war is one such decision. The second largest democracy took that decision with minimal opposition only to see short term success but failing in terms of long term effect on the security and economy of the country.
In the world’s largest democracy, India, the government’s decision to “Demonetize” the currency will end up as a failure for the economy in the short term, but when the dust settles it will end up as the one of the best decisions taken by the Indian Government. Previous decisions The Liberalization of the country and the Nationalization of the banks, both by the Congress Party were bold at that time. However they did not impact the common man. Also those decisions were during the days of no internet and definitely not many banks around. Comparing the fact that the relentless media scrutiny and limitless social media participation, the demonetization is probably boldest decision taken by the Indian government post-independence. Many are taking sides passionately arguing for it and against.
The news about longer lines at the ATM are true, also the news about the vegetable vendor adopting to electronic payments. The Indian press and media often look for ‘Sensations’ to show news item in both negative and positive manner. For them if it’s not sensational news, nobody is going to consume it. This sensationalism is changing the public discourse. We see the naysayers terming the decision as a disaster based on long lines at the banks. The pragmatists think people are adapting digital economy. They show vegetable vendor using the electronic payments. Then the social media groups full of posts often with no insight into the issue. Who should we believe?
Should we believe that demonetization is not working based on cash starved ATMs? Or should we feel proud that citizens are quick at adopting electronic payments? We should not believe both sides. Why? Because jumping to the conclusion of Demonetization so quick is wrong. The results of this rather irrational looking exuberant activity will not be visible in the coming months. However in couple of years the systems will take over like a well-oiled machine helping the country not just in improving economy, but in almost all of citizen services. The Demonetization helps recover black money, but more importantly brings “Transparency” to the government systems. The government wanted to clean the black money, but demonetization is more than that.
The media, government and just about any “expert” is forgetting what the RBI said in the notice
Black Money recovery is one of the below reasons for demonetization.
- Removing Fake Currency (From Public information 30 Thousand Crores, Actual Impact Unknown)
- Storage of Unaccounted Wealth
- Financing subversive activities such as drug trafficking and terrorism
There is no way of finding fake currency unless people actually deposit them in the bank. The RBI noted that the banks are hardly registering large cash transactions. Which means the country’s cash is flowing outside the banking sector. So for countering all of these activities i.e. controlling fake currency, finding hidden black money and finding sources of those supporting terrorist activities, the government must account all of the money to individuals or legal entities. Until this “Unaccounted” money is not found the RBI cannot achieve the three reasons. Tagging the currency with an account is the first step.
Using currency for small purchases like ice cream or tomatoes is fine, but most of the public buy real estate property with cash. The real value of the transaction is hidden from the government. Its cash flow from a bag stashed with currency to another empty bag. No record of the transaction. No trace. The country’s real estate exploded in the last couple decades. That amounts to large hidden transactions. There is that hidden money that political parties use during the election time. There is the money paid to do demonstrations/riots. There is cricket betting money. There is money that the terrorists’ use. There are many transactions that happen with no trace of who is paying whom. Just to give a statistic on how many crores get used during election time look in to the below table. There are close to 10 thousand elected members who spends crores of rupees during elections. Most of the time this money lacks transparency.
Estimated Contestants with significant campaign spending
Total MLAs |
4120 |
Total Lok Sabha MPs |
543 |
Total Opposition |
4663 |
Total Expected Contestants |
9326 |
Part of this ‘Hidden Money’ is owed to the Government. Some of it makes to outside India, the “Black Money of Swiss” and the other part is “Black Money in India”. The current and the past governments, irrespective of which party has been in power, have no idea how much of this money was transacted between citizens. There was no way of tracking the accumulated wealth in reliable manner. The wealth which is accumulated in the form of currency, stocks, real estate, precious metals and Gold cannot be accounted to individuals in a reliable manner. Without having an idea about the earnings and wealth of individuals, the government cannot verify or question the tax filings of the person.
Do we think that all Indian Citizens are honestly paying tax on the earned income? May be or May be not. Some might pay minimum tax using the existing tax loopholes, some might hide the profits. However by looking at the tax paying population in India, 1% in 2000s and close to 3% in 2011, it makes sense to think that many Indian citizens avoid tax. Which means that a vast majority of Indians hide their earnings. Except for the Government employees, IT workforce, jobs where tax is deducted at the payroll , the farmers, agriculture workers daily wage workers the rest of the upper middle class do not pay tax. This results in failure to tax the hidden wealth.
Thomas Piketty, the French economist known for his popular book ‘Capital in the Twenty-First Century’ cautioned that this whole thing of hiding wealth will lead to inequality in India.
In his BBC interview in May 2016 he said the below
"There is an extreme lack of transparency for data, especially income tax data, in India,"
"We simply don't know," was his succinct response when I asked him how unequal India was.
"But where exactly we don't really know, partly because of lack of access to proper data.
From Credit Sussie World Wealth Report, here are number of millionaires in India.
Credit Sussie Wealth Report |
|||
Millionaires Earning Greater |
Year |
Expected |
Expected Year |
158000 |
2012 |
242000 |
2017 |
182000 |
2013 |
302000 |
2018 |
182000 |
2014 |
294000 |
2019 |
185000 |
2015 |
305000 |
2020 |
178000 |
2016 |
280000 |
2021 |
This is what the reports noted
“Personal wealth in India is dominated by property and other real assets, which make up 86% of estimated household assets.
While wealth has been rising in India, not everyone has shared in this growth. There is still considerable wealth poverty, reflected in the fact that 96% of the adult population has wealth below USD 10,000.”
In a country with 1.2 billion population just about 3% paying tax is similar to only 3 persons earning for a family of 100. If the situation continues the family is going to face dire economic troubles in the coming years. How do the other democracies compare to India? Here are the largest democracies of the world by population.
- India
- USA
- Indonesia
- Brazil
- Pakistan
Pakistan is not a true democracy. If we ignore Pakistan, here is the data among the large democracies on how much they pay tax.
Country |
GDP in $ Millions |
Population |
% Tax Paying Population |
Per Capita GDP |
Tax Tracking Identification |
India |
2,073,543 |
1326 |
~ 3 |
$1,582 |
AADHAR, PAN |
USA |
17,946,996 |
336 |
~ 55 |
$55,837 |
SSN (Social Security Number), EIN (Employer Identification Number) |
Brazil |
1,774,725 |
209 |
6 |
$15,778 |
CPF (Cadastro de Pessoas) CNPJ(Cadastro Nacional da Pessoa Jurídica ) For Employees |
Indonesia |
861,934 |
260 |
~11* |
$3,347 |
Nomor Pokok Wajib Pajak (NPWP) |
* http://www.thejakartapost.com/news/2016/11/18/indonesia-up-44-places-in-ease-of-paying-taxes.html
USA has a much larger GDP and less population than India. Indonesia has smaller GDP than India and lesser population. Brazil is closer to India in terms of GDP, diversity and economic growth. Comparing Brazil with India is somewhat realistic. Brazil has 6% of its population paying tax. Compare it with India’s pathetic 3%.
Comparison of the three countries GDP, TAX and Tax Contribution to the GDP
|
Income Tax Rate |
Corporate Tax |
Population In Millions |
GDP in Billions |
GDP Per Capita in US $ |
FDI in Millions |
TAX % on GDP |
Brazil |
27.5 |
34 |
202.8 |
3263.8 |
16096 |
62494.8 |
33.4 |
India |
30.9 |
32.4 |
1259.7 |
7375.9 |
5855 |
34416.8 |
16.7 |
USA |
39.6 |
35 |
319 |
17418.9 |
54597 |
92397 |
25.4 |
* Heritage Foundation & WSJ Report
Tax contribution to the GDP is one issue where India is behind the other two large democracies. There is lesser tax contribution because the government cannot tax the earnings of citizens accurately.
In America the second largest democracy, Social Security Administration came into existence in 1935. The purpose of Social Security Administration was to pay pension and retirement benefits for the American Workforce. The government created a unique identification number called Social Security Number (SSN) a 10-digit number for tracking tax of individuals. For employers another number called Employee Identification Number (EIN) was created. Similarly Brazil uses CPF (Cadastro de Pessoas) for Individuals and CNPJ (Cadastro Nacional da Pessoa Jurídica) for Employers. These systems were established decades ago. America started SSN in 1935, Brazil did it in 1970. What about India? How was Indian tax system built? How is the tax tracked?
The Indian taxation during British rule moved away from the Hindu / Mughal taxation to the British built system. The current Indian Income tax is based on the original British Income Tax Act in 1860. The tracking of income tax was a problem in post independent India. The Tax Laws reformed in 1961, however until 1994 there was no way of reliably tracking the income of individuals. The introduction of Personal Account Number (PAN) in 1994 created an Identity for tracking taxes. However the PAN card had issues. There were people using multiple PAN cards. Then there are fake PAN cards. There were multiple bank accounts tied to multiple PAN cards. It became difficult to tie a PAN card to a tax payer. The solution? Enter AADHAR card.
The AADHAR card was introduced by the Congress to provide a unique identification based on biometrics. BJP did not want to continue the project when it came to power in 2014, but decided to adopt it. The integration of PAN Card and AADHAR card would have created a unique identity to help track the cash movement between bank accounts, legal entities and individuals. If the money deposited is distributed to multiple AADHAR accounts? No problem. The IT department can track them individually and trace the cash flow. Once the deposit is made, IT IS THERE tied to the PAN + AADHAR combo. The Income Tax department might not be able to assess the black money immediately, but they can work as the data gets accumulated in the coming years. It is a clean beginning for the country with information on how much money an individual has deposited or how much money the individual gave to others to deposit as benami. Post demonetization looks like opening a brand new bank account with a first ever deposit. It creates a baseline for all the accounts, individuals for tracking the cash flow in coming years.
It is not just about collecting tax, it is also reaching the poor for citizen services. This unsuspecting video, by Shri Nandan Nilekani, the man behind AADHAR card will show to the many experts predicting doom for the country that the systems for digital transactions are available now. The video is an evidence of government’s preparation prior to taking this risky decision. By tying AADHAR with Mobile phone operators to create payments systems that are not just consumer to business, but person to person using cheap smartphones with iris recognition. In Shri Nilekani’s words, “The Game has begun’. These homegrown payment systems are disruptive technologies which help the poor transact with each other in a quick and reliable manner.
The country’s future into the digital age is guaranteed with cashless transactions. Adaptation pain is normal when an older system gets dismantled for a newer system. For a billion population which went from not having a phone to having a mobile phone, this transition from using cash to using online payments without using the check based payments is a quantum leap.
The government must be applauded for taking this bold decision, however they have their task cut out post the ‘Demonetization’ i.e. after Dec 30 2016 . They must do the steps below in the next year to see the fruits of this tough decision
- Release cash where it is needed, especially rural areas.
- Provide alternate payment systems like card swipe machines
- Reduce the Real Estate Registration Fees
- Give incentives to small business for the cashless transactions
- Finally educate the Public about paying the tax
The Banking sector did a great job of executing this monumental task with no major issues. The Income tax department will have their task cut out. Considering the fact that they were only tracking 3% of population so far, they have their hands full tracking the cash deposits of the entire country’s population for the tax year ending March 31 2017. Perhaps they can create government jobs for tracking and taxing the money
A friend from a business community told me that they were not educated enough on paying the income tax. The way they grew up since the 70s was to do everything in their capacity to avoid the tax. The government has to educate public on “Taxation”. One way is to bring transparency reports on the spent tax money in proactive manner.
Thanks to the technology and Aadhar card, this activity will just not eliminate the fake currency or track the money used for terrorist activities, it creates a solid foundation on which the country transforms into a responsible economic powerhouse.
References:
http://www.uidaadharcard.in/link-pan-card-with-aadhaar-card/
https://home.kpmg.com/xx/en/home/insights/2011/12/brazil-income-tax.html
http://www.pulsamerica.co.uk/2013/02/brazil-over-12-million-currently-pay-income-tax/
http://www.bbc.com/news/world-asia-india-36186116
http://www.ey.com/Publication/vwLUAssets/EY-india-tax-insights-issue-1/$FILE/EY-india-tax-insights-issue-1.pdf
http://indiabudget.nic.in/budget.asp
http://www.thehindu.com/business/budget/Budget-2016-Where-the-money-comes-from-and-where-it-goes/article14130547.ece
https://www.fiscal.treasury.gov/fsreports/rpt/mthTreasStmt/mts0715.pdf
http://www.bndes.gov.br/SiteBNDES/export/sites/default/bndes_pt/Galerias/Arquivos/bf_bancos/e0001854.pdf
https://www.youtube.com/watch?v=HL-YUTFqtuI
http://www.taxpolicycenter.org/statistics/source-revenue-share-gdp
https://www.oecd.org/ctp/tax-global/Brazil%20country%20note_EN_final.pdf
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