The Black Money Monster

8/6/2011, Times of India

The high drama over Baba Ramdev’s midnight eviction and action against the peaceful gathering has shifted the focus away from the central is sue raised by the Baba – black money overseas – to the right to protest in a democracy. This being the case, there is danger of an uninformed debate on black money taking over, guided more by emotions and populist talk rather than an understanding of the problem and how it is best tackled.

Black money is money that is un accounted for – in other words, money generated by income that has either not been taxed or through criminal means, be it by drugs or arms running, ransom to kidnappers, bribes taken by politicians and officers, and so on. It is important to understand where different kinds of black money converge and where they diverge.

In the pre-liberalization era, it was common for businessmen to siphon their money abroad. While technically this was illegal, there were very good reasons why most businessmen hardly suffered from any sense of guilt Tax rates in this period were unrealistically high; marginal taxes could go up to as high as 97%! To pay such high taxes and generate the necessary surplus for legitimate business activity was virtually impossible.

Not just income tax, other levies stamp duty, wealth tax, building tax too were unrealistically high. There can’t be an argument against necessary taxation needed to create the infrastructure of security, property and law for a well-functioning economy. As The Economist pointed out: "Necessary taxation is not theft. But there are margins at which taxation becomes difficult to distinguish from theft."

Besides lower taxes allow people to enjoy the fruits of their labour. As Edwin A Locke, professor emeritus at the Maryland University adds, "Lowering taxes is to allow the productive keep what they earn rather than forcing them to support the non-productive."

In the pre-liberalisation era, high taxes, how ever, did not diminish the demand for speed money or bribes. Officials demanded and received bribes for clearing import or export licences In the secretariat similar gratification was demanded for industrial approvals while deciding how many scooters a two-wheeler manufacturer or how many tons of cement a company could produce.

Businessmen, therefore, needed to keep unaccounted money to pay off the bribe-seeking babus. Businessmen, seeking to bring the state-of-the-art foreign technology or to find overseas markets, needed to travel abroad. And the permissible limit of foreign exchange was a niggardly $500 – an amount that would be over on a couple of days food and stay, leaving zero for entertainment and networking. Hence there was a clear incentive to keep money overseas.

Two decades into liberalization and easier controls, these norms are virtually forgotten But it’s these which forced businessmen whose salaries, too would be determined and capped by the government – to bend the absurd laws. Now, should they be punished in the heat of the moment when all black money is sought to be painted by the same brush?

The approach to black money should be nuanced. (In our accompanying ‘Times View’ we have suggested a one-time amnesty for the businessman category). Those who have sent out money only to carry out their legitimate business should not be con fused with criminals who have siphoned out money. It is the latter that the government needs to target – the corrupt politician, the bribe-seeking bureaucrat, the drugs dealer, etc.

Laws are much more relaxed now – tax rates are comparable to the lowest in the world. Imports are easy — you can import almost anything as long as it is does not affect the environment or national security. Consequently, more people are paying taxes and smuggling of goods has fall en to negligible levels. This being the case, there is no mitigating reason for even businessmen to evade tax and siphon out their money to overseas tax havens.

However, no one likes to pay taxes. So, despite the fall in rates, importers still under invoice their shipments, while exporters over invoice While under invoicing helps avoid paying taxes, exporters can get additional benefits of export promotion schemes (meant to refund taxes by declaring a higher value of shipments. So, with an easier tax regime there must be stronger enforcement. In the US, for in stance, few take the risk of dodging taxes because the penalty is prohibitively high.

The strongest enforcement should be directed against of course the criminal elements, but also against corrupt politicians and bureaucrats. This is be cause unless the hidden cost in the economy – resulting from the need to pay bribes is removed, it would be extremely difficult to root out black money. Because businessmen will then generate unaccounted money to pay off the neta or the babu.

The economy’s hidden cost often leads to hidden consequences. There is no reason, for instance, why property in big cities like Delhi or Mumbai should be out of reach of every one barring the super-rich. This is because of black money. Often a house costing Rs 1 crore would be registered for Rs 50 lakh, or less. This kind of market distortion suits those with oodles of unaccounted moolah, not the tax-paying salaried class. Once black money is reduced in the economy price levels in the real estate market will naturally seek lower levels, making property much more affordable.

So, the battle against black money is a noble one, so long it’s not allowed to become a witch-hunt against businessmen. After correcting the consequence of past distortions, India should reach international pacts with countries like Switzerland, Mauritius Cayman Islands and the Isle of Man to keep a close tab on money being il legally routed there. And at home there should be proper financial intelligence to minimize tax evasion.


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