Should the government use black money to fund social sector scheme ?

The idea that the hoards of black money in the economy can be unearthed and then used to provide resources for social schemes or any other purpose is conceptually flawed.

Subir Gokarn
Chief Economist
Crisil

It is based on the presumption that when money becomes "black", that is, it disappears from the tax authorities' radar screen, it is simply held as an idle asset. Its opportunity cost, therefore, is zero. Bringing it out of concealment and putting it to use will, then, inevitably add to gross output.

The reality is entirely different. Black money is, unquestionably, outside the tax radar, but it is definitely not idle. All money, whether black or white, circulates in the economy, financing transactions of all kinds, either in the form of current expenditure or by way of asset creation.

To the extent that the chain of transactions leaves a paper trail "" cheques, bank statements and so on, remains on the radar screen and is potentially liable to be taxed. But, transactions that leave such a trail are typically executed by what we might loosely call the "formal" or "organised" sector.

As we all know, a substantial part of our economy "" most of agriculture, which is close to half of industry, and a substantial proportion of services "" is outside this framework "" it is informal or "unorganised".

This doesn't mean that business is done differently; it just means that since the agents engaging in exchange are not identified, their transactions cannot be traced and, therefore, cannot be taxed.

In a sense, all transactions entered into in the informal sector create black money, because it simply disappears from the tracking system. For instance, when I pay a carpenter for services rendered, I withdraw the amount from my bank account, which is traceable and give him cash.

If he keeps the cash and enters into further transactions with people who also deal exclusively in cash, my original payment has been "dirtied". At some point, the money may return to the surface by being deposited in a bank account; it has then been "laundered".

The high volume of everyday transactions taking place in the informal sector and the wide interface between the formal and the informal in everyday life ensure that there is continuous movement from white to black, and occasional movement in the other direction.

The essential point is that money, whether black or white, is constantly circulating and, by doing so, providing the liquidity needed to support economic activity.

To the extent that black money is "unearthed", by way of large stashes of cash being discovered during income tax raids and suchlike, it is in temporary storage, looking for activities "" legal or illegal "" in which it can be deployed. It is by no means permanently idle money.

The right way to deal with the problem is to figure out how to convert the informal and unorganised into the formal and organised. The more transactions that take place within the formal umbrella, the less black money the economy will need to support a given level of economic activity.

Two sets of initiatives need to be taken. One, the enormous regulatory barriers and costs to formalisation, and the prospect of post-registration harassment needs to be substantially and credibly reduced.

Two, the tax burden needs to be streamlined and balanced across the range of transactions. Anyone who has bought a house will appreciate both the pressure and the temptation to pay a large proportion of the purchase price in unaccounted-for cash.

For one thing, the seller needs the cash for his next purchase and to hide the extent of his capital gain. For another, the buyer wants to avoid the stamp duties and other levies that add 10 per cent or more to the declared purchase price.

The challenge to government "" central, state and local "" is to push through the required changes in rules, regulations and procedures and rationalise tax incidence so as to create an incentive for transactions to take place on the radar screen.

The way things are, as far as most economic agents are concerned, to take a little bit of liberty with Henry Ford, they can have any colour you like, as long as it's money.

Mahesh C Purohit
Director,
Foundation for Public Economics and Policy Research

The government has recently indicated that it is likely to announce schemes to channel black money into a dedicated fund for financing social-sector programmes.

The urgency for announcing such a scheme is understandable from the fact that the United Public Alliance government has pronounced in its Common Minimum Programme its intention of bringing out such "special schemes to unearth black money and assets".

It is desirable to unearth unaccounted money and to mobilise resources for the social sector programme, the design of which is likely to be modelled on the basis of the recommendations of the report of the committee on this aspect, appointed by the Central Board of Direct Taxes (CBDT).

Whatever the design of the proposed scheme, the idea behind it could be right from the short-term view of raising resources for the social services. However, from a long-term perspective, this is not consistent with the principle of tackling distortions at their source.

The so-called black money is illegal money that is outside the tax net, creating a parallel economy. Some part of this illegal income is saved and turns into illegal wealth over time. Presumably, a part of such wealth is held as cash, too.

These components of black money create problems when it comes to the enforcement of income tax. Therefore, it is important to not only unearth this money but also to stop the generation of illegal economic activities, which continue unabated in spite of many disclosure schemes announced in the past.

Various committees, especially the Wanchoo Committee, have highlighted the vital issues involved in bringing out such schemes time and again. The real issue is why black money is brought into being and how its generation can be curbed.

It has been established that these schemes do not curb the generation of black money. It has also been discovered that it is the same set of people who have declared such money, through different schemes, time and again.

The menace of black money is an integral part of the socio-political fabric of the country. It is, therefore, of utmost importance to unearth all black money in one go and to ensure that the illegal activities that contribute to its generation do not continue.

The enforcement of income tax must guarantee that all such activities can and will be tracked down.

While there could be a variety of ways to handle the menace of black money, this can possibly be tackled best through the following three major steps.

First, the enforcement of income tax needs to be attempted seriously by the tax authorities. This is done by taking into account the theory of risk management for assessment of the existing taxpayers.

Unlike the present impression of the taxpayers, who believe that the income tax for non-corporate taxpayers is "voluntary" and paid according to the advice of the tax practitioners and not according to the tax liability, the enforcement authorities must ensure that it is paid according to the estimated tax liability.

Second, the tax department should ensure that income from all sources (salary, business, consultancy and so on) is reported by everyone through tax deduction at source (TDS) as also by the taxpayers. This is possible only when an integrated management information system (MIS) is put into place for all taxes.

Today we have separate MIS for each tax and related independent identification numbers. For instance, for income tax, we have permanent account number (PAN); for CenVAT there is a tax identification number (TIN); and for sales tax there is a separate TIN for each state "" there is no co-ordination for any of these taxes.

An integrated MIS will ensure that the evasion and, hence, the generation of black money is stopped.

Finally, it is of great importance for all the taxes, especially when Value Added Tax is introduced at the state level, that each source of income and all transactions are reported without fail.

It is time the country introduces a system of information exchange and income as well as tax reporting for all the tiers of governments.

Efforts on the above lines will ensure that the menace of black money is curbed, provided there is a will to do so.