Demonetization: Restoring Probity in public Life

By Prof.R.Vaidyanathan

The dramatic announcement by the Prime Minister on the 08-11-2016 regarding De-monetising Rs 500 and Rs 1000 notes from the midnight of the same day has electrified the national mood and has altered the paradigm of public life.

All black money is not due to corruption even though all corruption results in black money.

If a Government servant gets bribe for a favour done then he generates black money since that amount will not be shown for tax. But if you go to a doctor and pay him say Rs 500 in cash without receipt or buy petrol without bill then you are generating black money since they may not show all amount for tax purposes. But neither act involves corruption.

In the case of income declaration scheme 2016 –64275 declarations were filed up to the midnight of 30th September, 2016 with an aggregate of Rs.65250 Crore worth of hitherto undeclared incomes in the form of cash and other assets being declared. On an estimate 45% taxes centre will collect Rs 30000 Crore. The declaration was much higher than expected even though compared to the estimated amount of black money it is relatively very small.

There are also comparisons with the 1997 scheme of P. Chidambaram which netted Rs 33000 Crore. But the GDP has grown much during this period and that time tax rate was different.

During 2014-15 total taxes [direct Plus indirect] constituted nearly 10% of our GDP at market prices and Direct taxes  of Rs 7 Lakh Crore was 55% of total taxes.

 

In 2012 the then Finance minister Mr.Pranob Mukherjee presented a White Paper in Parliament on Black Money

[http://finmin.nic.in/reports/WhitePaper_BackMoney2012.pdf]

This white paper on black money produced by the ministry of Finance and presented to parliament has evoked a mixed response.

One of the major criticisms it has faced is that it has mixed up domestic lack money and illicit money kept in tax havens abroad by Indians. These two need to be dealt with in different ways. Some part of the domestic black money is used in productive activities like real estate, trade, construction, mining, transport, restaurants and other businesses. The illicit money kept in tax havens abroad is, by and large, not used for domestic purposes unless it is round-tripped through share markets or foreign direct investment (FDI) to domestic operations.

Domestic black money is a no-confidence motion on the government of India while illicit money kept abroad is a no-confidence vote on India itself – its stability and its people.

Domestic black money is primarily dependent on the cash economy and tries to avoid formal transactions through banks due to fear of being captured by electronic systems and the tax authorities. So the holding of black money is usually in the form of cash and transactions undertaken in cash. This implies that substantial portions have to be kept in high denominational currency, since storing or carrying huge quantities of cash in small denominations is relatively difficult.

In India, if we take only currency notes (and coins), we have the lowest denomination at Re 1 (of course, the Rs 1 currency note has been replaced with coins) and the highest at Rs 1,000 – which implies that the differential is 1,000 times between lowest and highest pieces if currency. In the US, the most popular highest denomination is $100 – and the differential is 100 only.

Not only that, we find from Table 1 below that the Reserve Bank of India (RBI) seems to favour printing higher denominations currency even though the mass of poor people may transact only in lower denominations. We find that in 2005-06, around 57 percent of the total amount of Rs 4 lakh Crore of coins and notes introduced in circulation comprised Rs 500 and Rs 1,000 notes. But by 2010-11, the share of the higher notes had become 79 percent of the total value of Rs 10 lakh Crore and by 2015-16 it is 85% of the total value of Rs 17 lakh Crore.

Table 1: Notes and Coins in circulation (Rs. Crores)

Notes/ coins 2005-06 2010-11 2015-16
Small coins 1358 1458 700
Re 1 (notes) 299 299 309
Re 1 (coins) 1894 2968 4178
Rs 2 (coins) 1365 3068 5926
Rs 5 (coins) 2735 4535 7045
Rs 10 (coins) 300 3703
Notes:
Rs 2 451 851 853
Rs 5 1980 3430 3680
Rs 10 6274 21288 32015
Rs 20 4077 6040 9847
Rs 50 27842 15980 19450
Rs 100 134637 140243 157783
Rs 500 182332 445311 785375
Rs 1000 64346 302713 632568
Total 429590 948484 1663432

Source: www.rbi.org.in

This implies that more and more of the denominations in circulation are skewed to higher value notes when the mass of people may need lower value denominations. The very high denominations also facilitate transactions in black money.

Prime minister has already announced on 8th November 2016 such a step wherein the existing 500 and 1000 Rs. Notes are withdrawn and public given option till end of year to change it. Also for larger sums like more than Rs 2 lakhs IT plus penalty will be levied if not covered already.

For instance, nearly Rs 14 lakhs Crore would be converted from Rs 500-1,000 notes to new Rs 100s, etc. Of course, an adequate number of new Rs 50-100 notes should be made available from the operational point of view for this conversion.

Also RBI is introducing new Rs.2000 and 500 notes with increased safety and features.

Most interesting point will be –how much of this Rs 14 Lakhs Crore will be coming back to the banks. That will reveal the nature of black economy. Kindly observe this does not include assets like land /gold etc. held using black money.

 

Another issue about holding cash in our context is this. The black money report says: “As of now there are no legal restrictions to keeping very large amounts of cash with oneself or transporting it from one place to another. One is neither required to report it nor provide any explanation for it. There have been suggestions that the government may consider amending existing laws, including the Coinage Act, 2011, the Reserve Bank of India Act, 1934, FEMA, and the Indian Penal Code, or enacting an entirely new statute aimed at regulating the possession and transportation of cash above a particular threshold limit. This may include creating a limitation on cash holdings for private use, as well as provisions for confiscation of cash held beyond such prescribed limits. However, such laws need a broader political consensus to emerge for their acceptance in Parliament.”

We find that political parties do disburse cash to voters prior to elections and for which a huge amount of cash is held and transported from one location to another. For instance, suggests that in the recent Andhra Pradesh by-elections cash valued at as high as Rs 32 Crore was seized prior to the polls. These were presumably meant for distribution to voters.

[http://indiatoday.intoday.in/story/it-is-raining-cash-in-andhra-pradesh-bypolls/1/199369.html]

An earlier news pertaining to recent elections in Tamil Nadu suggested that more than Rs 100 Crore in cash was seized by election.

[officialshttp://www.thehindu.com/news/cities/chennai/tn-elections-cash-seizure-by-ec-crosses-rs-100-cr/article8592604.ece]

There are many other reports which give us a clue that cash is held and transported in huge quantities not only for bribery at elections, but for other black money transactions. It is important that we bring in the necessary changes in the Coinage Act, 2011, and other relevant acts to make holding of cash above a threshold level, say Rs 10 lakh, punishable. This threshold can be arrived at by the Reserve Bank after taking into account the requirements for genuine cash transactions in the economy like marriage and religious ceremonies, wage disbursals in construction activities, etc. This limit should not be applicable to obviously banking institutions and corporates having construction/project activities where substantial amounts of cash disbursals take place.

In developed economies like the US, there are no restrictions per se in terms of holding or transporting cash domestically, unless it is suspected to be drug money. Even there, transactions beyond $10,000 in cash are expected to be notified to the Internal Revenue Service (IRS) by shops and establishments. Of course, there are restrictions on the amount of dollars one can transport during immigration/emigration. But since the US is a well-developed economy, most of the transactions are conducted through plastic cards or banking channels.

The Fifth SIT report has been submitted before the Hon’ble Supreme Court by the SIT. An extract of the report has been uploaded on Department of Revenue website www.dor.gov.in.

[http://pib.nic.in/newsite/PrintRelease.aspx?relid=147082]

The SIT has made the following recommendations in the Fifth Report:

Cash transactions: The SIT has felt that large amount of unaccounted wealth is stored and used in form of cash. Having considered the provisions which exist in this regard in various countries and also having considered various reports and observations of courts regarding cash transactions the SIT felt that there is a need to put an upper limit to cash transactions. Thus, the SIT has recommended that there should be a total ban on cash transactions above Rs. 3, 00,000 and an Act be framed to declare such transactions as illegal and punishable under law.

Cash holding: The SIT has further felt that, given the fact of unaccounted wealth being held in cash which are further confirmed by huge cash recoveries in numerous enforcement actions by law enforcement agencies from time to time, the above limit of cash transaction can only succeed if there is a limitation on cash holding, as suggested in its previous reports. SIT has suggested an upper limit of Rs. 15 lakhs on cash holding. Further, stating that in case any person or industry requires holding more cash, it may obtain necessary permission from the Commissioner of Income tax of the area.

We have elaborated on these two issues as early as 2012 in an article “We should abolish Rs 500 and Rs 1,000 notes completely”

https://rvaidya2000.com/2012/09/25/domestic-black-money-some-methods-to-reduce-it/

 

Hence these two mechanisms—further to be attempted — may not eliminate domestic black money but may reduce the generation and use of it. Even developed countries have not completely abolished black money but have taken steps to reduce its generation and usage.

 

The major impact is on the holding of black money by political leaders/party and corrupt Government officials both at centre and States. If this measure brings in the concept of probity in public life then it will go a long way in cleansing our public life. Along with this we need to have swift and severe punishment for wrong doers. Our court cases get dragged for decades and we rarely send any one to jail for 80 or 100 years as in the case USA.

Next step to enhance probity in public life is to make holding of cash per se beyond say

Rs 10 L a crime and Of course ordinance to nationalise all money kept in Tax havens.

We are witnessing cleansing times which are interesting times and as in the case of all deliveries there will be some labour pain.

_______________________

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4 comments

  1. Sukhraj Dhillon · · Reply

    Prof, would you please justify your example in paragraph 3 where you stated that accepting bribe does not constitute corruption?

    1. Dear Sukhraj,

      Kindly read it carefully, we have said that corruption leads to black money but not all black money is generated from corruption.

      Thanks,
      Prof. RV

  2. Respected sir,

    Wishing you Good health and peace.

    Thank you for for providing such insights and a new perspective all together regarding the Demonetization policy by NDA govt.

    Few questions regarding Demonetization remains still unanswered in our minds sir, whenever we discuss this among ourselves in student communities/forums

    1. Ever Changing RBI stance on Withdrawal limits or for any transaction for that matter.Has it not resulted in chaos.

    2. Introduction of 2000 Rupee Note. It makes sense only when it is assumed that it has been introduced as a temporary measure by RBI to ease distribution channels. But if not, doesnt it give an opportunity to hoard money again.

    3. What are the measures taken by Govt in ‘NOT SO SECURE AREAS’, where Bankers can be threatened and money can be easily converted into PINK CASH at gunpoint.

    4. Tenure through which liquidity deficit would last.

    5. RBI had been stubborn on Repo Rate which has been a shocker actually. because the rates should come down, not only to increase liquidity but also to indicate that black money has been wiped out.

    6. This one is a comic one. Will this decision, instead hamper chances of BJP winning elections in UP(9th largest state by population if imagined)

    Kindly answer me sir. I will be delighted and thanks in advance.

    1. Dear Ankit,
      Your point regarding Rs.2000 seems to be valid and for the others things, we have to wait till the end of the month.

      Thanks,
      Prof RV

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