Demonetisation and its effect on black money

The biggest mission of demonetization is described as fighting black money. India’s economy historically holds a big parallel economy where unreported income is the norm.

Demonetization is a currency side step. That itself will not fight black income. The most important policy should be tax administration where the tax authorities can monitor expenditure and matching it with income of the respective individuals.

The effectiveness of demonetization against black money depends upon the follow-up and supportive measures were made by the government. For example, the enactment of the modified Benami Transactions Act from November 1, 2016 will be a big associated tool in the hand of the government to tackle black income. Thus, to assess the effectiveness of demonetisation, we should examine how these steps are complementing each other to fights black money.

Effects of demonetization on black money

Already, several analysis projects that demonetization will bring several long-term besides netting black money deposited in the form of banned notes.  Hence, it is logical to classify the black money fighting effect of demonetisation as (a) direct or immediate and (b) long term.

(A) Direct or immediate effects

Immediate effect of demonetisation comes through the netting of black money deposited in the banking system in the form of banned Rs 500 and Rs 1000 notes from November 10 onwards.

Around Rs 12 lakh crore of the Rs 15.44 lakh crore demonetized currency is with banks now and the extent of black money identified out of this will be the direct effect. Here, it is believed that an estimated Rs 1.5 to 2 lakh crore may be identified as black income. Out of this, around Rs 1.2 lakh crores may be collected as taxes at 50% to 85% tax rate.

If Rs 2 lakh crore is revealed as black money out of demonetisation, it will amount to around 1.75% of India’s GDP. According to National Institute of Public Finance and Policy (NIPFP), black income amounts to nearly 40% of the coutnry’s GDP.

Direct effect depends upon two steps: the Benami Act and the Pradhan Mantri Garib Kalyan Cess

A recent case study on black money front is the non-acceptance of tax from a Gujarati trader -Mahesh Sha and Mumbai family by the Tax Department. In both these cases, the Tax Department refused disclosure under Income Declaration Scheme (which was closed on September 30, 2016) to accept 45% taxes. Instead, the Department invoked provisions of the newly enacted Benami Prohibition Act by waiting till November. The Act prescribes imprisonment up to seven years for having Benami property besides confiscation of the propery.

The same procedure will be repeated in the case of big accounts parked with banks under demonetisation. This shows how effective will be demonetisation when combined with a built-in Income Disclosure Scheme in the name of Pradhan Mantri Garib Kalyan Yojana and the sharpened Benami Prohibition Act.

(B) Long term effects of demonetisation on black money

The long-term effect will be much impactful and depends considerably upon how government deploys more measures to depress the shadow or black economy.

Shadow vs formal economy

A high proportion of the economic transaction happens in the shadow economy and hence are unaccounted. The real estate sector is the most important example. Reducing the size of the shadow economy by enlarging formal economy is the way out. Here, transactions should be recorded. To be recorded, disclosure about the buying and selling people by quoting their financial ID or PAN card is mandatory especially for big transactions. The real estate sector amounts to nearly 45% of India’s parallel economy.

The process of formalization

Formalization means under the monitoring of the government. Here, two formalization options are needed: recording (a) high value transactions and (b) low value transactions.

Formalizing high value transactions: Post demonetisation legal steps should be made to ensure mandatory PAN quoting for high value physical assets – gold/land etc. Though this measure is still prevailing, fragmentizing transactions into small helps black money. To avoid this, every small physical asset transaction should be made with Aadhaar ID proof. When each money is to be reported and recorded; land deals will become automatically white.

Formalizing small value transactions: Here, digitalizing transactions in the form of prepaid payment instruments, debit and credit cards and online payments will reduce black money. Several post-demonetisation steps were made by the government to promote digital payments.

A social shake up against black money

An awareness against black money and consciousness about legal and punitive measures is an intangible positive effect of this demonetisation. It will change the mindset of the people to keep away from black income. This shakeup of Indian society will be a big outcome though it may not be measurable.