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Curbing generation and outflow of black money are more important than bringing it back

Thursday, 1 May 2014 - 6:00am IST Updated: Wednesday, 30 April 2014 - 11:03pm IST | Place: Mumbai | Agency: dna

The election manifestos of most prominent political parties have included a reference to the issues related to black money in the country. The common feature across the manifestos is the focus on bringing the money back from foreign bank accounts. While the commitment to addressing the issue is welcome, the political attention on bringing this money back is partly misguided and needs to shift towards how the generation of black money and its outflow from the country can be curtailed in the first place. There needs to be a greater clarity on the concept of black money to move towards a more informed debate on these issues.

Economists working on this issue have been highlighting the need for conceptual clarity between ‘flow of black income’ over a period of time and ‘stock of black wealth’ at any given point in time. ‘Black money’ often continues to be used to mistakenly mean both income and wealth, though in technical discussions, it only refers to income which has not been reported or disclosed to public authorities. This would include money earned from illegal activities like crime (such as drug trafficking, smuggling, human trafficking etc) and corruption, as well as proceeds from legal activities that are not fully reported (ie commercial tax evasion). Contrary to popular opinion, the biggest contributor in generation of black money in India is not corruption. According to a report on black money by the Central Board of Direct Taxes, ‘Measures to Tackle Black Money in India and Abroad’ (2012), the main method for generation of black money in India is through commercial tax evasion by under-reporting revenues and inflating expenses adopted by a range of business entities. This is also in line with global research trends that show that of the entire amount of illicit outflow of money from countries, commercial transactions account for about 60%; 35% are the result of criminal transactions and 5% generated through corruption (United Nations Economic Commission for Africa, 2014). Studies commissioned by the Government of India in 2011 (but yet to be published) to assess and provide estimates of the extent of black money in India may help provide further insights on this debate in the Indian context.

Estimating the magnitude of the black economy (in terms of black income over a period of time) has been fraught with methodological difficulties. One of the earliest estimates was provided by the Direct Taxes Enquiry Committee, 1971 (popularly known as Wanchoo Committee), which had suggested that India’s black economy was approximately Rs1,000 crore for the year 1965-66. Since then the estimates have varied from the black economy being around 20% of GDP for the year 1980-81 (NIPFP) to 40% of GDP for the year 1995-96 (Arun Kumar). Adding to the complexity of these debates is the misconception that political will is needed only to recover the money ie bring the money back, which is based on the assumption that all black money is lying in offshore bank accounts. While this is one aspect of the issue, in reality a large portion of the money that flows out comes back into India through a process called ‘round tripping’ ie the money that had left the country (and generally ends up in a tax haven) is invested back into the country as ‘white’ money. Research on FDI inflows into India by KS Chalapati Rao and Biswajit Dhar (2011) noted that almost 70% of inflows were through tax havens and at best half the total inflows could be considered as genuine FDI. In such a scenario, the intense focus on recovering black money from offshore bank accounts is partly misguided and it would be much more prudent to invest in mechanisms that will help restrict the generation and outflow of such money.

These mechanisms would include reforms in a number of areas identified as most vulnerable to generation of black money such as real estate, bullion and jewellery, financial markets, public procurement, cash economy, trade mispricing and transfer pricing. Moreover, while there are a number of legislations to tackle this problem, the implementation of these needs to be strengthened. In this context, the administrative machinery needs to be fortified, especially addressing staff shortage across various agencies indicated to be over 30,000 in the report by CBDT. The existence of tax havens and the scope for round tripping could induce not only the outflow of black money but its generation as well. Deterrents to this include greater transparency measures such as introduction of registries (which could be made public with adequate safeguards) of ultimate beneficial owners of trusts, foundations and corporations to address the issue of incomes being hidden behind shell companies or benami accounts. Effective exchange of tax information between countries, which the Indian government has been pushing for in global forums such as G20, would be a step in the right direction. Also, improved corporate reporting standards, which include data by country on employees, sales, profits, taxes etc, will provide tax authorities with more information to tackle misuse of tax haven routes. While some sections in the policy community argue that high tax rates induce the generation of black money in our country, it is important to note that India’s tax regime is already moderate. The highest marginal personal income tax rate in India at 33.99% (as of 2013-14) is moderate compared to several countries such as Japan (50.84%), China (45%), UK (45%), South Africa (40%), and USA (39.6%). Our corporate income tax rate is 30 % but the effective tax rate (ie after taking into account the exemptions/deductions), as per the Union Ministry of Finance, is around 23%.

Continuing to focus solely on recovering black money will not be very effective in addressing these issues. Considering India’s low tax-GDP ratio at around 17%, which is one of the lowest for G20 countries (above only Mexico and Indonesia) and the lowest among BRICS countries, mobilising additional revenue is the need of the hour. Appropriate policy measures to curb the generation and outflow of black money could enable the government to step up the country’s low tax-GDP ratio significantly, which in turn can help improve public provisioning in a range of important sectors.

The author works with Centre for Budget and Governance Accountability (CBGA) in New Delhi

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