Today's Editorial

13 November 2016

Demonetisation drive bigger move than GST


Source: By Surjit S Bhalla: The Financial Express


It was as far back as 1990 when I coined the phrase Bis-mil-muflis, or “I begin in the name of the poor” (with help from my good friend, Saeed Naqvi) to characterise the attitude of the government and Left intellectuals towards policy formation and execution (Bis-mil-muflis—And why anti-market policies hurt the poor, SUNDAY, 7-13 January, 1990).

Not much has changed in the last 25 years, a period in which absolute poverty has fallen from 60% to less than 10% (Tendulkar poverty line). The recent anti-corruption, anti-black money move of the BJP is being characterised by the same intellectually old people as being against the interests of the poor. Just think about what these politicians and “intellectuals” and TV anchors are saying—that the poor are going to be hurt by the confiscation of the 500- and 1000 -rupee notes.

AAP and Arvind Kejriwal: Real culprits who have stashed black money are “sitting tight” while lives of farmers, small shopkeepers and housewives “have been thrown in utter chaos”

Rahul Gandhi: “Once again Mr Modi shows how little he cares about ordinary people of this country—farmers, small shop-keepers, housewives”.

Mayawati: “Poor people, middle-class citizens, small businesses and farmers have been hit the most and not the people who have black money”.

Note how frequently the farmers (who are not taxed) and the poor (who have no black money) are mentioned in the (old) politician’s fight against black money!

Cash consequences

The accompanying table reports several relevant statistics for the current Bis-mil-muflis debate. First, the Tendulkar poor today are close to 7% of the population (say, a 100 million people). The new policy states that each bank-account-holder can only withdraw cash equivalent to R20, 000 a week. It is a nice coincidence that there are 4.5 weeks in a month and the average family size in 2011/12 was 4.4. Assume there is only one bank-account-holder per family.

Two estimates of consumption are reported for FY12 and 2016. The first is the NSS estimate based on a household survey; the second is the national accounts estimate by the CSO (part of GDP accounts). In FY12, the NSS consumption was only 50% of actual consumption. Both figures are provided but the discussion about the impact of policy is based on the more accurate NA estimates.

Just look at the consumption level for the 99th percentile—R13, 910 per person per month. But each person is allowed a cash withdrawal of R20,000 per month. There is no law that says that you should not use credit cards or cheques for consumption. The policy of a maximum of R20,000 cash withdrawal is to be reviewed by RBI on November 24—let us hope it is not increased—the R20,000 a week limit should stay. Actually, what the data in the table suggests is that this cash limit should be reduced.

Political fallout

There should be no question that this BJP policy is bold and courageous. The trading community has long been identified as BJP’s core constituency and PM Modi has gone counter to this powerful support group. So, let us give Modi a considerable amount of credit for taking a bold step for the country—a genuine “in the name of the nation” step, if you will.

Let us also recognise that there is likely to be positive political fallout for the BJP. Five state elections are due next year. It is alleged that opposition parties like the Congress, BSP and Samajwadi Party have historically relied on greater amounts of black money than the BJP. It is just a rumour, but likely to be correct. Thus, the political positives may more than balance the negative.

The fight against corruption and black money in India has just begun. If successful, this will go down as the biggest reform in India, bigger than GST (though the two are related) and bigger than the industrial policy reform of 1991. But, and there is a ‘but’—while the policy is very effective in its attack on past black money, it is silent on the creation of future black money.

What is black money? And what are its remedies?

First, let us identify what is black money, and its determinants. Black money is money income earned for which tax is not paid. This black money generation is not due to corporates or due to salaried individuals (both sets are in the tax net). Most of the generation of black money is on the part of professionals (e.g. accountants, doctors, lawyers)—the missing middle identified in the Kelkar Report of Task Force on Direct Taxes, 2002.

Most of the spending of this black money is for expenditures on gold, purchase of foreign exchange, and purchase of real estate. Transfer of money abroad into “anonymous” accounts is now a difficult exercise for all the world’s black money residents. Gold purchases, and hoarding, are also becoming more difficult. So, the prime outlet, for big-time black money use, is real estate.

If a salaried professional buys a house and pays part of the purchase price in cash, she has inadvertently converted her own white money into black money for the seller.

The policy conclusion for the Modi government is obvious. First, reduce income tax rates so that the incentive to avoid taxes (on the part of the not-fully-compliant middle) is reduced. No amount of punishment disincentive is as potent as a monetary incentive. Second, decrease the onerous and prohibitive tax rates on purchases of houses. With GST, there should be no such thing as a stamp duty on land at any of the stages of “sale”. That is a relic of the British, and the Congress, and should have no place in a GST India. Third, reduce the capital gains tax on property to less than 10%, if not zero. Just note how much tax revenue the government collected from long-term capital gains (on houses, stocks, etc) in FY14. A net amount of R7,000 crore (LT tax of R65,000 crore versus loss set-off of R57,000 crore) from total direct tax revenue of R600,000 crores. That is less than 1.2%!

I have often claimed (and the Kelkar 2002 and 2012 report concurs) that morality has no place in taxation—and efficient, and legal, revenue generation has all the place. Far too often the “in the name of the poor” advocates have led the economy, and the aam aurat, hostage to their “moral” recommendations (often joined with whiskey). This must end, and Modi must do that with large-scale tax reform. And when the BJP does that, time to attack that other holy cow relic — no taxation of agricultural incomes. The new beginning has begun—times now to complete the journey.