Black Money: Reduce Creation

There are three major sources of Black money creation. Government controls, government expenditures and taxes. The government control and licensing system was taken to its peak during the seventies and resulted in the infamous License-Permit-Quota Raj (LPQ Raj). A gradual process of de-control started in the eighties, with a major spurt taking place in the early nineties. Since then it has continued at a modest pace. Those who operate at a very general level believe that the LPG Raj has largely been dismantled and is no longer hindering growth. Detailed study and/or experience of any sub-sector, however, reveals that this process is far from complete. The control mentality has pervaded every sector of the economy and every control is viewed by the majority of enforcers either as an opportunity to generate funds for themselves or as an imposition on their normal relaxed schedule. As there is little incentive, the minority of honest bureaucrats have by and large given up the struggle. Worse every law gives rise to rules and procedures that are first exploited to make money rather than to fulfil the basic objective of the law. The bottom line is therefore that a considerable amount of black money continues to be generated despite liberalisation. A determined and systematic effort at weeding out controls is needed in every sector if the generation of black money is to be reduced drastically and we are to accelerate growth.
The second and perhaps most important source of black money generation is the government expenditure system. Two decades ago one used to hear about commissions of the order of 15% on such expenditure. These commissions have apparently increased over time to the 30% range (plus/minus 15% where the opportunity is more/less). Higher siphoning off is possible in remoter areas where the objective is intangible (eg employment generation) and does not specify a concrete output. It is somewhat more difficult in Urban areas where specific projects are being carried out (e.g construction of a hospital or college building) and where relatively alert citizens and media can expose gross non-performance. The right to Information Act can be an important tool in the hands of citizens for increasing the accountability of the public expenditure system and reducing. The act must focus sharply on complete and comprehensive information about expenditures carried out(justified) in the name of the people/poor instead of getting distracted by controversial issues of national security, defence, foreign affairs and personnel files.
The third source of black money generation is tax evasion and corruption in the tax bureaucracy. As somebody once said, “There are only two things that are certain in Life, Death and Taxes.” Taxes are going to be with us for ever and over time as incomes increase more and more people will have to directly pay taxes. Simplification and rate reduction with a view to increasing voluntary compliance, has been the mantra of Indian tax reform since 1991. Though anti-reform moves have sometimes been sought to be palmed of as reforms and will perhaps be done again, the basic philosophy and direction of tax reform is now widely accepted across the political spectrum. Revenue increases through base broadening is the preferred means of increasing tax revenue.
What role does a tax amnesty have in this context. In 1997 when we recommended a sharp reduction in the marginal income tax rate, we also reviewed the experience with amnesties. There was only one research paper on India, that had tried to directly estimate the effect of an amnesty on tax collection. This paper showed that though tax amnesties increased revenue in the amnesty year they had a negative effect on revenue collection overall (i.e in subsequent years). At that time a carefully formulated amnesty was nevertheless recommended on the argument that a drastic reduction in marginal rates would create a new situation, by permanently bringing people into the tax net through voluntary compliance. The amnesty would therefore provide these new entrants an opportunity to start on a clean slate. This argument would work in the opposite direction when average marginal rates have been creeping up because of the imposition of various surcharges. In our view therefore an amnesty would be an anti-reform measure rather than a reform one.
Despite reforms, black money generation has not necessarily declined because of the deterioration of governance (expenditure & taxes). This factor also needs to be addressed if we are to make a major dent in this problem.