It’s been a month since government ceased Rs.500 and Rs.1000 notes as legal tenders. Every Indian has something to say about it. Many experts have already given their opinion on the same. Demonetization and black money have been the most discussed topics in the whole month so I was quite reluctant to write on it but unfortunately, all these discussions and opinions are roaming around politics and political economics which motivated me to write this blog.
I intend to write this blog for those who are really confused with whether this move was right or wrong. I will try to be as unbiased as possible and I will try to not to force my opinion on you.
What is black money?
Black money is the money which is earned through illegal means or money which is earned through legal means and which is taxable but not reported to tax authorities (Ministry of Finance, 2012).
According to a 2010 World Bank estimate, the most reliable available, the shadow economy in India makes up one-fifth of the country’s G.D.P. (A 2013 study by McKinsey, the consulting firm, puts the figure at more than one-quarter.) (Basu, 2016). This means as per some official estimates, the black component in the Indian economy is around 20%.
Now the question is how this black money affects people at large? First, if people are earning black money through illegal means or through bribes then that is certainly harmful to the society. It does not need an explanation. Second, if people are earning black money through legal means but avoiding taxation then to who does this affect?
We need to understand that direct taxation is a system to redistribute income. As per the principle of vertical equality, government charges different taxes to different income levels. When the high-income group avoids the tax they take that money out of the system which cannot be used for public expenditure. It results in the lack of funds with the government and then we face the problem of fiscal deficit. When an economy faces the problem of the fiscal deficit it either borrows from overseas or cuts down expenditure on infrastructure, healthcare, and education or even both. It means, due to excessive external borrowing the present is at a risk and due to lower capital expenditure, the future is at risk. Now, when I want to avoid taxation or get into illegal business activities I create a system of corrupt people. This is how the problem of corruption is a self-created problem. I do not want to blame everyone but it is the creation out of some people’s greed.
Let us understand the role of cash in this whole system. I accept that once the black money is created it can be stored in different assets classes like gold, real estate or overseas bank accounts but one thing needs to be understood clearly that only accumulated wealth can be kept in the alternate assets form, generation of black money can only be done through cash. So if you look at the black money issue very closely you will understand that cash is the source of black money generation which gets converted into the other assets classes. When this money gets converted into other assets classes like real estate we experience a drastic surge in the real estate prices. If you want to control such kinds of artificial upsurge then you will have to suck out the lubricator which allows this illegal system to run. Even if we do not discuss the issue of counterfeit currency we still can understand that cash transactions lead to all sorts of black money problem. The share of cash in the volume of consumer transaction in India is as high as 98%. Now you can understand how critical this problem can be.
With this move of remonetization, the government will be able to get the majority of unaccounted money in the system. The government can replenish the currency in the circulation and then they can keep a better track of it. Unless and until the government takes extreme precautions it will be very difficult to stop the generation of black money in the future. The best way to fight with black money is to move towards a cashless economy which can help the government to keep a track of all the transactions happening in the economy.
This is a right mahol (environment) to start thinking about how to go cashless. In my view, this move does not guarantee how much black money will come back to the government but it certainly can help us to curb the future generation of black money.
Note: This blog was intended to discuss only the economic aspects of the demonetization, that’s why implementation and availability of digital infrastructure are not been discussed in the blog.
- Basu, K. (2016, November 27). In India, Black Money Makes for Bad Policy. The New York Times.
- Ministry of Finance. (2012). White Paper on Black Money. New Delhi: Ministry of Finance, Government of India.