The colour of evasion

Indian Express, 8 June 2011

Black money of Indian citizens held abroad might only be a fraction of the black income in the domestic economy. All black money, whether held in India or abroad, should be traced to individual accounts, and legal proceedings undertaken to ensure payment of taxes. At the same time, black money is being generated in the domestic economy all the time. This is a consequence of the failure to implement the GST, to remove loopholes in the tax system, to get rid of high statutory tax rates and weak tax administration. These are issues that can be sovled more quickly.

Black money is income on which taxes are due, but have not been paid. It gets created every time taxes are evaded. It may arise when a respectable citizen engaged in perfectly legal activities, like a lawyer or doctor fails to declare income received, such as that received in cash. Or, it may arise when indirect taxes are evaded, such as when excise duty or service tax is not paid.

A fraction of the black money in the economy is ferreted out of the country and held in assets abroad. Banks account for only a fraction of these assets. Real estate, companies, bonds, shares, gold, and cash may be others.

Finding evidence of tax evasion and tracing the money to individual assets, both at home and abroad, is a part of the job of the tax department and should be done on an ongoing basis. In addition to money held in banks, other assets purchased domestically with income on which taxes were not paid also constitute black money. Considering the practice of cash payments in real estate transations, almost every second house owner in Delhi and Bombay holds a certain amount of black money. Increased capacity of the tax department to uncover black money should be able to bring this, and other such wealth into the open.

But even if all this black wealth is traced and its owners are made to pay taxes and fines, it does not solve the problem of new black money being generated as individuals and businesses continue to evade taxes. It is this problem that needs to be addressed urgently with equal, if not more, emphasis.

How is black money being generated? A large part of the economy is below tax limits. Income earned by the bulk of the population falls below taxable limits, and thus does not constitute the black economy. Further, there are ways in which taxes can be avoided, rather than evaded. These involve using legal means such as taking advantage of various exemptions. The income on which taxes are not paid because of various exemptions provided legally by the tax system is also not black money. However, when income is misrepresented, such as shown as agricultural income (which is exempt from income tax) for the purpose of avoiding taxes, it constitutes black money.

OECD economies have used a two pronged approach to improve tax compliance. On one hand tax policy has been modified. This involves simplifying the tax system, getting rid of exemptions, improving incentives to report income and pay taxes, as well as lower tax rates. On the other hand, tax administration has been improved. Modern information technology systems have been used. The principle behind this strategy is that the gains from tax evasion should be low, the likelihood of being caught should be high, and the when caught the punishment should be high. This should reduce the attractiveness of evading taxes.

India needs to move further on this strategy. In India also we have seen that when tax rates are low, people are more willing to pay taxes. That was part of the strategy India used in reducing the huge black money problem that had arisen in the 1970s, when the statutory marginal income tax rate was 97 percent. While income tax rates have been brought down, there is scope for further reduction. Proposals for rationalisation and reduction of rates were made in the Direct Tax Code, but have not yet found their way into budget proposals.

Excise duty has traditionally been seen to be another of the main sources of tax evasion. The tax falls on the entire value of goods manufactured. In cases where the value of raw materials is high and excise had already been paid on inputs, the manufacturer is expected to pay tax on the value of the goods which included taxes paid. The amount to be paid is determined by excise inspectors. The growth of manufacturing has been much faster than the growth of excise duty collected by the revenue department. This constitutes one part of the evidence of excise theft. The way out is the imposition of a value added tax which would allow producers to get a tax offset. The proposed Goods and Services Tax (GST) if imposed on all goods and services across the country would reduce the complexity of the system and improves compliance.

Reducing black money in the real estate sector would need both reduction in stamp duties, to reduce the incentive to under-report purchase prices, as well as improve information about property prices.

Policy makers need to improve tax compliance through improvements in tax policy and administration to reduce the generation of new black money. Bringing money back from abroad will be a long and time taking exercise and may yield limited returns. Few countries have been able to do it at a scale that has macroeconomic consequences. Improving tax policy, improving tax administration and improving tax compliance, on the other hand, have reduced distortions, improved tax revenues and have GDP scale consequences.

Back up to Ila Patnaik's media page
Back up to Ila Patnaik's home page