With Due Respect, Finance Minister

The government did not celebrate the second anniversary of demonetisation, one of its biggest policy initiatives. It has celebrated the anniversary of all other big policies. Why the diffidence?

The finance minister did come out with a statement listing the achievements of demonetisation. But his statement must be seen in light of the Minutes of the RBI Board Meeting on November 8, 2016, that recommended demonetisation. The Board had made it clear that demonetisation was not the way to tackle black money or counterfeit currency. Thus, two of the main objectives that were emphasised in the PM’s announcement on demonetisation were undermined the very day the policy was announced. No wonder, soon after it became clear the money was flooding into the banks, the government started talking of a cashless economy. And then it started talking about a less cash economy, digitisation and formalisation of the informal economy. It was said that these deposits would create a paper trail and black money generation would become difficult.

Initially, there was a spurt in the use of electronic means of transactions but this pace could not be sustained as more currency became available. The country had anyhow been slowly moving toward a less cash economy prior to demonetisation and this has continued. It was said that the government would restrict currency in circulation to less than what existed on November 7, 2016. But now the currency in circulation is about 10 per cent more than the Rs 18 lakh crore that existed prior to demonetisation. To be fair, it is less than what it would have been if the increase in currency in circulation had continued at the pace prior to demonetisation.

The FM has cited three achievements of demonetisation. First, an increase in digital transactions. Second, expansion in the tax base with more people paying taxes. Third, the creation of paper trails that will make it difficult to generate black incomes in the future. Interestingly, echoing the RBI Board, he said confiscation of currency was not an objective of demonetisation.

The line earlier was that black money, held in the form of high denomination notes, would not return to banks since that would create paper trails. The then Attorney General had told the Supreme Court that Rs 3 to 4 lakh crore would not return to the banks. Soon it became clear that all the money would come back since those holding black money had worked out ways of converting their old notes to new notes. The government then started saying that was good since now the people who had deposited large sums of money could be investigated.

The government issued about 18 lakh notices to those who had deposited more than Rs 5 lakh into their bank accounts. However, there is a misperception that equates cash with black money. Cash is needed by businesses as working capital and households keep cash in hand for transactions and as a precaution against contingency. So, a petrol station may have deposited Rs 20 crore in the demonetisation period of 50 days, based on its daily collections. This is not black money. Most of those who deposited large sums of cash would have worked out how to show the deposits as cash in hand in their balance sheet. So, it would be difficult for the tax department to prove that the money deposited was black. Finally, data shows that the department does not have the capacity to audit so many accounts, in addition to the usual audits it conducts.

Yes, the number of returns being filed and tax being collected has increased. But, the direct tax to GDP ratio has hardly increased compared to the pre-demonetisation period. The black economy is more than 60 per cent of the GDP and even if 10 per cent of it had come into the tax net, it would have yielded 2 per cent of the GDP as additional tax collection. This has not happened.

It is well-known that 67 per cent of those in the tax net file either nil return or very low returns. The effective number of taxpayers has always been low in India. Even in the case of GST, the FM is on record saying that 5 per cent of those under GST pay 95 per cent of the tax. Further, he has lamented that even though 1.1 crore have registered under GST, only about 67 per cent pay tax.

The spurt in filing of returns is partly due to the fine being imposed from this year for late filing. So, many more have filed returns in time. Earlier many waited till March 31 to file returns. The numbers have also increased because of the increase in salaries after the implementation of the Seventh Pay Commission report. However, most of the increase will be in the category of those who have just entered the tax net. So, the increase in tax collection will not be much. The increase in the number of those who filed tax returns is a result of other factors, and only marginally due to demonetisation.

Increased digitisation could have been achieved without causing pain to the economy. Nigeria has a low cash–GDP ratio but a big black economy. Japan has a high cash–GDP ratio but a small black economy. So, digitisation does not necessarily check black income generation.

Finally, formalisation does not help reduce the black economy since the informal sector hardly generates any black incomes. Most incomes in this sector are way below the taxable limit which is rather high in India at three times the per capita income— with concessions and deductions it can be five times the per capital income.