IN assessing the impact of the Modi government’s demonetisation measure on the black economy, the fact that nearly 99 per cent of the outlawed currency came back to the RBI has been widely taken to indicate that the measure was a failure – its costs far outweighing any benefits. The obvious reason for this is that the return of almost all the notes establishes the fact that hardly any black wealth was destroyed as its immediate direct outcome. Clearly the government had expected a different result and that is the only reason why the Reserve Bank of India (RBI) took nearly eight months to confirm to the public what it knew by the end of December 2016. The attorney general had told the Supreme Court that the government had expected that only Rupees 10-11 lakh crores would be returned. A campaign had also gone around about the benefits that would flow to the public from the ‘gain’ to the RBI and the government of the Rs 4-5 lakh crores that would be extinguished by not being returned and converted into valid modes of payment.
Having failed to achieve the dramatic result that was expected to add to the government’s propaganda arsenal – the finance minister was seen clutching at straws after the RBI’s announcement, trying to convert the failure into a success. The claim made was that deposits of the notes had laid the foundation for future benefits as the anonymity associated with cash had been undone – more illicit incomes would be revealed, the tax base widened and greater tax revenue generated. He failed to note, however, that the return of almost all the currency in circulation also said something about the prospects of such future benefits.
It was known even before the demonetisation announcement that only a small part of black income earned, or black wealth accumulated, up to that point, would have been held on November 8, 2016 in the form cash by their beneficiaries. For one, there was the empirical fact that there simply wasn’t enough currency around in relation to the supposed size of the black economy for it to be otherwise. The currency in circulation was about 12 per cent of one year’s national income and less than 5 per cent of the total household wealth. If the amount of black income generated annually and the amount of wealth accumulated through it were large parts of their respective totals, then clearly the proportions in the form of currency had to be relatively small. This was also not surprising but to be expected. Money is made to be spent and not held on to – even if the objective is simply to make more money rather than consuming it, or to ‘save’ for the future. For anyone not consuming immediately his or her current income but keeping it aside – currency would be the least preferable form for such addition to wealth. Currency does not earn any return and with rising prices tends to lose value.
It follows from the above that even if the beneficiaries of black or illicit incomes taken together were to lose all their existing cash holdings because of demonetisation, it would amount to a one-time loss of a small magnitude relative to their past and prospective earnings and accumulated wealth. The demonetisation measure presented such people with four choices: The first was to suffer fully the one-time loss of losing their illegal wealth held in the form of currency. This is a choice they would have made if this loss was expected to be less than the immediate and future financial and non-financial loss/penalties they would have to bear by revealing these holdings and drawing the attention of tax authorities to themselves and their incomes. In other words, the expected costs of surrendering the “anonymity associated with cash” had to be more than the loss that would be suffered by simply destroying the outlawed 500 and 1000 rupee notes held. Clearly there were not too many people who thought this would be the case and that is why all the currency ended up being deposited! The second choice was to reveal their cash holdings but take advantage of the amnesty scheme announced soon after demonetisation, the Pradhan Mantri Garib Kalyan Yojna (PMGKY). The advantage of this over the first option would be that the one-time loss could have been somewhat reduced, but at the same cost of revealing information on illegal income to tax authorities that would have a bearing on future earnings. We know, however, that the response to the PMGKY has been very poor with just Rs 4900 crores (or less than 0.03 per cent of the total currency deposits) being declared through it. In other words, very little of black income or wealth came to be revealed through this route. The third and final choice was to simply deposit all the cash holdings into their own bank accounts as those without illegal incomes would, or into accounts of ‘trusted’ associates willing to do this favour and not anticipating getting into trouble themselves by doing so. This third choice would be exercised by those who expected the resultant immediate and future losses to be too little in relation to the value of cash held – that is if they were confident that the tax authorities would not be able to impose heavy penalties on them or extract significant amount of additional tax in the future based on the information that would become available to them through such deposits. Is this the choice that was favoured by most beneficiaries of illicit incomes? If almost all the currency held by them was deposited by the public with banks, then it must be true that no one really feared that the effective total of current and future costs resulting from depositing their currency holding would be more than what was deposited. For those who had no unaccounted incomes, this would always have been true – there was no possibility of any additional tax burden or penalty arising for them from depositing of their cash holdings with banks. One part of the total deposit of Rs 15.28 lakh crores came from such people – that part was certainly not insignificant and if it accounted for most of the deposits then clearly very little of the currency deposited was ‘black’. We may not know yet the exact magnitude of the balance which originated in illicit incomes. We can be certain, however, that it must be well below 15.28 lakh crores, which is itself, as mentioned earlier, much less than the black incomes generated annually and accumulated the black wealth. Those who deposited that ‘black’ part, almost without exception it seems, revealed by their own actions that they do not anticipate paying, over several years in the future, more additional taxes than that amount. In effect, therefore, they confidently voted with their money against the finance minister’s claim that the supposed loss of their anonymity would lead to significantly greater tax revenues in the future. Doesn’t this almost unanimous opinion among the ‘experts’ at hiding incomes and evading taxes, arrived at without any explicit coordination, tell us something about what is likely to happen? If some more evidence was needed, here it is. Apparently taken in by the rhetoric of demonetisation, the finance minister had budgeted for a 25 per cent rise in income tax revenues in 2017-18 compared to the previous year. Till November 2017, eight months into the financial year, the actual increase compared to the same period of the previous year has been just over 15 per cent. Even on this count thus, the country waits for the elusive achhe din to arrive!
