BLACK MONEY IN INDIA

Notes from a lecture by Prof. Manasi Phadke

GDP of a country has to be estimated in the local currency and then converted to dollars if needed, as per the exchange rate which may be decided by agencies. According to CSO (Central Statistical Organisation) GDP of India in the year 2015-16 is roughly 126 Lakh Crore rupees. GDP of India by World Bank estimates is $2.07 trillion and according to IMF is $2.2 trillion. The number of times money changes hands in one year can create a bigger income on the same money base. This is called velocity of money. Hence, GDP is always multiple times the amount of money in circulation. The velocity of money in India is estimated to be between 4 and 5. This figure enables us to find the money supply in the country by comparing it to GDP figures, approximately 30 lakh crore rupees.

downloadWhile money can be defined as something which is printed by the RBI while income has an underlying economic activity to it, such as production of a good or service. On the other hand, the only money which is also income is black money. It is income which is not reported.

Literature on corruption in India

In 2011, Ram Jethmalani submitted writ petition to the Supreme Court saying that there should be an independent agency looking into corruption charges in India. Accordingly, Special Investigative Team (SIT) was formed to figure out sources of black money and how to stop it. In 2013, Anna Hazare was the most influential to pass the Jan Lokpal Bill. Lokpal is a central agency and Lokayuktas are the state level arms of the Lokpal. Certain high level ranking offices are out of the purview of RTI, and hence Lokpal and Lokayuktas looks into corruption at the highest offices of the Govt not covered by RTI.

In 2012, the white paper on black money was published by Ministry of Finance. It firstly defines black money, similar definition also given by NIPFP (National institute of Public Finance and Policy), New Delhi, currently headed by Dr. Rathin Roy. Defined as “assets or income or resources that have been neither reported to public authorities at the time of generation nor have they been reported at any time during their possession.”

There are two sources of black money

  1. Criminal or illegal activity- since the activity itself is illegal, income from this source cannot be reported. Eg. Drug trafficking, smuggling, kidnapping, illegal mining, illegal forest felling.
  2. White collared corruption- These are legal activities which have been manipulated. Eg. Understating invoices, giving projects without due tendering process.

Responses of the government to both these sources also vary. On criminal activity, the government takes a hard stance against it. On the second source, the stance of the government is relatively soft due to loopholes in laws. Hence, its strategy to control it also firstly involves, revision of legal provisos.

Basic elements in which corruption usually found:

  1. Corporate Malpractices– eg. under and over charging of invoices
  2. Gold– Buying and selling of gold in cash and without receipt very easy. It has a two pronged effect as black money hence gets converted to gold and the goldsmith too, gets cash to illegally import gold.
  3. Land and Real Estate– This aspect forms a major portion of white collared corruption.
  4. International Trade and Transfer Pricing– Listed to be the biggest contributor to corruption. This mostly occurs through Transfer Pricing (TP), which can be explained through the following example.

Suppose there is a German Company, ABC which has its subsidiary in India, XYZ. XYZ imports materials from its parent company ABC, produces the good at low cost and exports it back to Germany. As India has a higher corporate income tax rate compared to Germany, it may be beneficial to overprice the materials when importing and then sell the fully assembled product at lower cost, thus under reporting profits and underpaying taxes. The excess money has flown out of the country, a phenomenon called capital flight. It is estimated that 15-20% of India’s GDP is lost through capital flight, as difficult to set norms for TP. Money lost through capital flight is then brought back illegally, through round tripping. This occurs in the form of illegal gold imports, FDI, hawala, Participatory Notes, etc.

Hawala is a banking route through which money moves on the basis of trust and without the actual movement of money, originating in the Middle East. The customer gives money to the hawala operator to be transferred to a recipient. The hawala broker then contacts his counterpart in the recipient’s city with instructions to the remittance of funds, minus commission charged.

The parent company may also choose to create a Special Purpose vehicle, also known as a shell company in tax havens such as Cayman Islands, British Virgin Islands, Mauritius. Further transactions between parent company and subsidiary occur through the shell company, as such tax havens do not declare amounts deposited. Records of such transactions were recently leaked in the Panama Papers, containing 11 million documents relating to 214,000 shell companies set up by firm named Mossack Fonseca in 35 countries around the globe.

Participatory Notes are derivatives issued by Foreign Institutional Investors, without having to be registered at SEBI. However, according to recent norms if an FII registered with BSE wants to create a derivative in the nature of a PN then, KYC has to be compulsorily done on this PN, to find out the source.

Difficult to measure black money or corruption as by definition, it is hidden. Some established measures are as follows:

  1. Input output model by Leontief- This model describes how input from one industry becomes output for another, through a matrix or grid. It shows the technical coefficient i.e proportion of inputs required in each unit of output. It depicts what ought to be the output, which when multiplied by the value gives the income from the output. The corresponding tax can also be calculated by multiplying by the tax rate. The difference between this tax figure and actual amount of tax collected is black money.
  2. Currency method- Difference between GDP as calculated by CSO and GDP calculated by multiplying appropriate velocity of money with the money supply in the country gives value of black money.
  3. National Accounts System- Total national income is divided into salaried and non-salaried component i.e income from business. Then calculate income tax which ought to be collected from these areas. Difference between this amount and actual amount collected will give amount of black money.

NIPFP used NAS in 1985- in 1970s, extent of black money in India was 18%, while in 80s it grew to 21%, which shows the growth of this parallel economy. Today, black money is estimated to be around 25% of GDP. World Bank Research on Inequality calculated the extent of parallel economy for Asia at 34% as a whole, with India being under-average at 22%.

Legislative response to corruption:

  1. CBDT (Central board of Direct Taxes) entrusted with responsibility of tightening direct tax provisions where income could escape.
  2. DTAA (Double Tax Avoidance Agreement) between India and different countries to give fair framework to all companies. It also brings about more transparency in ownership of companies.
  3. Prevention of Money Laundering Act (PMLA)
  4. Prevention of Benami Transactions Act- only relates to property and real estate
  5. Public Procurement Bill – Includes clauses for transparent tendering of procurement process by the government, which is estimated to be 30% of GDP.
  6. Lokpal and Lokayukta
  7. Whiste blowers Bill- Clauses with adequate protection to be given to whistle blowers and also penalties for invalidated information provided.
  8. Unique Identification (UID) – Helps to ensure that subsidies and other benefits provided reach the accounts of the targeted population.

Voluntary Disclosure of Income, was first introduced in 1997 under then Finance Minister P. Chidamabaram and recently under Arun Jaitley. While a huge success the first time, it was a relative dud the time around as it gives a soft signal to the citizens that there will always be amnesty schemes by the government.

Demonetisation is a signal of intent, that the government is serious about the issue regarding black money, which is evidenced by its past measures as well such as the Benami Transactions Bill, Voluntary Disclosures and now monetisation. It too can only be taken up once and not again and again as it is very expensive. It was taken up as its cost is still lesser than the impact of black money in India. The true trick lies in catching these evaders in the intent level i.e through legislative framework through other measures established, rather than at the cash level.

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