Why Modi's bold move on black money may not eliminate black money

Demonetisation of high-denomination notes to tackle existing black money, but not future generation

The government move to demonetise old currency notes with denominations of Rs 500 and Rs 1,000 is one of the boldest steps taken by the Narendra Modi government. It comes in less than two months of the Income Disclosure Scheme 2016, where people were given an opportunity to declare their unaccounted income and come clean after paying a higher rate of tax on the amount disclosed. There seems to be a strategy and plan at work to tackle the black money menace.

However, it is debatable if the move would eliminate the generation of black money.

There are five clear reasons why it may not wipe out the scourge of black money from the economy
 

One, black money is both a problem of stock and flow in any economy: The stock of black money is what people have in their possession gained through unaccounted transactions and evaded taxes. The flow of black money is the process that creates black money. For instance, black money is generated when a cash transaction takes place without any record of it being kept or any taxes being paid on it.

The move to demonetise the old currency denominations of Rs 500 and Rs 1,000 will tackle the stock of black money, but not its future generation or the flow.  There is no guarantee that people would not enter into new unaccounted transactions with the use of new currency notes in the coming days. 
 

Two, elimination of black money would require a host of taxation changes by the government
The exemptions raj must be phased out quickly. But going by the manner in which the proposed goods and services tax regime is being planned, a large number of entities and sectors would be outside the pale of GST.  Even the recent attempts to phase out exemptions and bring down the direct tax rates have been feeble so far.
 

Three, election funding continues to remain unreformed
Spending on campaigns is often far in excess of the stipulated limits and all that generates black money. No reform of election funding is on the cards. Five state assembly elections are to be held next year. There is no reason to believe that candidates in the fray in these elections would not use cash and most of their transactions would remain unaccounted, creating more black money. 
 

Four, cash is used for almost 87 per cent of all transactions in India, compared to 62 per cent in China

 The move towards plastic money (credit cards, debit cards or payment wallets) has been encouraging but quite slow. There is need for a bigger push to make more transactions cashless. Unless that push comes with some policy initiatives, the tendency for people to use and rely on cash would continue. There are always good chances of such cash transactions remaining unaccounted and turning black. 
 

And five, there is nothing not preventing people from depositing their unaccounted cash with denominations of old Rs 500 and Rs 1,000 currencies with the banks and paying tax at the rate of 30 per cent.
It would thus be a fairly easy opportunity for black money hoarders to come clean without even paying any penal rates of tax. Of course, there is a chance of the income-tax authorities tracking such disclosures and issuing notices. But that again would not be an effective and  sure way of preventing generation of black money.   The hope that such a route would exist will continue to prop up generation of black money.