Black economy draws the ire of common man and policy makers. In the 2014 elections, the proposal to tackle black money gained currency. More than two years passed and the common man was left wondering if any measure will really be taken in this direction. On 8th November, 2016, the government retracted high denomination notes as a weapon to beat the tax evaders. However, the deliverance of such a promise rests on a heroic assumption that most of the cash that is in circulation is used to dispense unaccounted transactions. A moment of reflection would suffice to cool down such wishful hysteria. A careful understanding of concepts such as unaccounted incomes and unaccounted wealth is necessary to evaluate the merits of this move.

 

Unaccounted incomes are generated from activities that seek to evade tax and once generated, these incomes are absorbed into assets and activities that may in turn be unaccounted. The popular practice is to use real estate and gold for such purposes.  Although one may say that ultimately this cash must come to rest with someone, to assert that those with unaccounted incomes will be caught by this measure is overestimating the cash in the black economy. There is velocity of circulation of black money that in turn generates assets or incomes on its way and moving the cash out only kills the last leg of the transaction. Simple arithmetic may help put this concept in perspective. Before high denomination notes were withdrawn from circulation, there existed currency to the tune of 13 per cent of GDP in circulation, the most conservative estimates of black economy are in the range of a fifth of the GDP.  The cash used for undertaking unaccounted transactions must only constitute a fraction of the total currency in circulation.  Therefore putting high denomination notes out of circulation barely scrapes the surface of the problem. In fact, less conservative estimates that peg the number above 50 per cent make this a costly exercise undertaken to simply tick off a check list.  True, assets held by the hoarders of black incomes might lose their value owing to the uncertainty surrounding future policy actions and the cash needed to keep the money moving has been lost, but the so called ‘black’ assets remain, nevertheless, hidden from the prying eyes of the government, so long as no suspicious transactions lead the government to their source.

 

The other aspect of the shadow economy is that it is not constrained by the borders of the country where these incomes arise. Money accruing from bribes, illegal activities and procured through evasion are known to slip out using sophisticated mechanisms deployed by dubious companies and ‘hawaladars’. The layering of these transactions is facilitated by the marriage of accounting trickery with jurisdictions protected by secrecy laws. The white paper on black money put out by the government in 2012 stated: “72.2 per cent of the illicit assets comprising the underground economy is held abroad”. Various agencies have tried to put a number to the size of unaccounted wealth held abroad through the illicit route which makes India amongst the top five in the world.  Though these estimates are subject to revision and criticism but a cursory glance at the facts makes the present move a bit superficial. On a lighter note it seems like an attempt to go after the small fish in the sea of black. To crack the whip on the illicit money through the route of withdrawal of cash ignores such complexities. I estimate that, in 2014, $12 billion moved out the economy through the channel of import over-invoicing. The sophistication adopted by the users of channels such as trade mis-invoicing makes such transactions seemingly legitimate and, any use of cash may form a very small part of the total transaction. The removal of cash chokes off the hawala transactions temporarily but the global network of such agents operating across jurisdiction with varying financial structures does not rule out gradual evolution around the change that is being imposed.

 

In the battle against tax evasion many secrecy jurisdictions, popularly known as tax havens, are under pressure from developed and developing economies alike. Under the BEPS program, most have caved in to sign conventions that impose the condition of information exchange. Switzerland, in this regard, has become particularly important for India since the government recently signed the joint declaration to share information on accounts held in Switzerland. But such an agreement will be effective only from 2018 and may possibly only be applicable on the accounts that are opened in subsequent financial years. So long as loopholes exist to hold money abroad, the fight against black money in its present form may not matter much. This brings us to question the withdrawal of high denomination cash being branded as a “bold move”? Those painting their canvasses of hope may soon realise that the palette of colours is incomplete. 

 

The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.