Black Money: Major Causes, Sources and Remedies for the Menace

Black money has been a major problem of all spheres of the economy. It has active operations in the areas of real estate, gold, jewelry and precious metals, money markets, government transactions and non profitable organisations. Smuggling, illegal transport of drugs and corruption are also major fields in which black money can be seen.
Recently, Prof. Arun Kumar of Centre for Eco­nomic Studies, Jawaharlal Nehru University, Delhi has authored a book on black money in India (1999). He holds that black economy is equiva­lent to 40 per cent of the GDP out of which 32 per cent is in the legal sectors (business and professionals like doctors, film-stars, etc.) and 8 per cent in the illegal sector (narcotics, etc.) (The Hindustan Times, September 12, 1999).

What is Black Money?
Black money is the money earned but not shown in the accounts for the purpose of tax evasion. Such money can be earned through legal, illegal and extra-legal means. For example, most of the traders and businessmen never reveal their actual incomes, many government doctors are making money by private practice even when they get non-practising allowance or advocates charging much higher fee than shown in their account books, and so forth.

Historical Reasons
Though generation and circulation of black money is a continuous process, there have been quite a few historical reasons for built up of black money in Indian economy. They are as following:
  1. Shortages during World War II
    During the World War II, many Indian industries found the situation was conducive for black marketing. Supplies of industrial goods from the west were cut off. So, huge profits were made due the short supply. These circumstances formed basis for strong extra-legal economy and tax evasion practices that continued till then.

  2. Faulty Taxation
    Defects in the tax structure are also responsible for black money. Till recently, the tax collection mechanism was anti-tax payer and has several flaws. The tax rates were also high and these factors have forced tax payers to look out for ways and means for tax evasion. According to Dr. Jayaprakash Narayan, member of Second Administrative Reforms Commission, tax evasion has become a national pastime in India.

  3. Redundant Control Measures
    The controls that were established for regulation of economy during the Nehru era turned out to be excessive within two decades after independence. As the moral authority of political leaders has come down these excessive controls have become raison d'être of wide spread corruption at all levels of administration. Due to such institutionalisation of corruption, the costs of business have gone up and forced every stakeholder to take resort of extra-legal practices that has built a vast informal economy. Black money was one of the fundamental constituents of that economy.

  4. Large Public Expenditure
    During the initial decades of independence huge amounts of money was spent on poverty alleviation, subsides, infrastructure development through centralized planning. But the huge spending has neither been efficiently administered nor properly targeted. The result has been leakages into the stream of unaccounted income. Major chunk of black money in India is invested in Real Estate and Share markets as in both these markets capital gains can exceed more than 30% mark. Both are ideal conduits for circulating black incomes

Conduits for Black Money
  1. Hawala:
    Hawala is a traditional system of transferring money used in Arab countries and South Asia whereby the money is paid to an agent who then instructs an associate in the relevant country or area to pay the final recipient. The Hawala is simply understood as manual transportation of huge amounts of money at once.

  2. Economics of Gold:
    The next best option for investing black money is Gold. India is the highest consumer of gold in the world! In the early 90s, import and export of gold was restricted as the government realised that saving and investment in gold was leading to a loss of foreign exchange reserves. This was also because privately held gold did not help India’s balance of payment situation. As a result, gold smuggling became a huge racket which was funded extensively by black money as people got a vehicle to park money which was illegally obtained.

  3. Rising share of services:
    Black money has also played a big role in the development of the services sector mainly due to the fact that valuation of the activity is difficult, as a result of which an activity which is probably worth around Rs 5lakh is instead quoted at 10lakh to hide 5lakh of black money. So, due to surge in service sector growth, the black money economy is also experiencing explosive growth.

Sources of Black Money:
  1. Under-invoiced inventories: Sometimes the amount of inventory is under-invoiced so as to keep extra amount to sale in the black market. And the amount of sale is never reported in the account book.
  2. Over-invoiced plant and equipments: The fixed costs on plant and inventory are reported higher than the actual amount so as to generate black money. For example, companies buy for perhaps Rs 5lakhs and instead get an invoice for Rs 10lakhs to cover up Rs 5lakhs of black money.
  3. Informal sector activities including trade, films, production etc.: All the film industries in India - be it Bollywood, Kollywood or Mollywood are doing dreadfully bad, but still they continue to produce flop after flop after flop. Perhaps, it is because movies are being made simply to hide excess black money.
  4. Illegal holding of precious metals, gem and jewellery: The most favourite of the sources is hiding metals and jewellery. There are countless instances of the same in the news all the time where prominent personalities’ homes are raided and valuables worth crores are recovered.
  5. Flight of capital for investments abroad: Also, black money is used to fund investments abroad as people try to hide their incomes and put it in foreign banks which are situated in the tax haven countries.
  6. Transfer activities (like secondary share market and real estate) and buying of influence (bribe for work): Giving and taking bribe in India is pretty common in almost every day activities. Another common source of black money is real estate which is covered in detail later.
  7. Illegal activities like smuggling, drugs, prostitution, and crime: The big fishes of all of these sources are smuggling, drugs, prostitution and crime. Being illegal activities, all this money is black money as there are no records of how they are generated and used.

Methods to estimate:
Methods have been developed to estimate and evaluate the illicit amounts of money, of which, two well-established economic models are based on “Model of Capital Flight”.

The World Bank Residual model is based on change in external debt or CED. The Trade Mispricing model which is based on the IMF Direction of Trade Statistics or DOTS database. But the problem with these methods has made the task of estimators all more difficult as these methods cannot capture genuine reversal of capital flight.

The more recent and more accurate method has been developed by Global Financial Integrity. It is called as “Block Recursive Dynamic Simulation Model of Illicit Flows“. This dynamic simulation model examines the complex interactions between macroeconomic, structural and governance factors that drive illicit flow from India. Further probe into the model is out of scope of this study.

Conversion of black money to white money:
Here we see two economies with the same activities and entities. At any point of time, one cannot make out whether black money is being used by households or white money is used in the market. To an extent, black money in the financial market is limited due to compulsory legislation that one must have a PAN Card number, but the money used for daily needs do not come into picture. If a person goes to Reliance Fresh and buys some groceries using black money, it has instantly been converted into white money the moment a receipt is obtained.

Few methods followed in real life to convert black money into white money are
  1. Funding politicians:
    Suppose a businessman funds a politician with his black money to contest in the elections. When these politicians get elected, they return the favor in the form of favorable policies for the businessman which is known as “lobbying”. Finally the business man profits from their “investment” and generate “White Money”.

  2. Selling black income in form of jewellery:
    Suppose a person having huge amount of black money in the form of gold or jewellery wants to change it to white money. He goes to a jewellery shop and sells the jewellery and gives 5 to 10% of the value to the shop owner. The shop owner then gives the person the receipt on which he has to just pay the capital gain tax and then the amount turns to white.

  3. Donation:
    When a person wanting his son to get a seat in a good MBA college and uses his black money and give it off to college authorities, no one asks for a receipt. The amount one pays cannot be shown officially because the giver and taker both will face government problem. Now the son armed with his MBA degree is ready to earn white money.

Consequences of Black Money:
  1. In India, black money is that which is taxable and is not taxed, i.e. money that is hidden from taxation. However, in India, there are millions of people whose incomes do not touch the minimum income level and are thus not taxed. They also might involve in illegal activities like taking bribes which in effect must be classified as black money but are not. As a result, the value addition to the economy is actually much higher than recorded. So, what should ideally happen is that employment opportunities must increase and economy must grow because of more money circulating in the economy due to black money.
  2. However, as people actually do not spend the black money and try to just hide it, the rate of savings gets increased and as a result the multiplier reduces which leads to lesser money in circulation in the economy. This lowers the potential growth rate and the employment potential and eventually leads to the dissatisfaction of the youth.
  3. The black economy results in policy failure both because of inadequate allocations and due to ineffectiveness of expenditures. Primary schools intended to be set up do not materialize. Roads either do not get built or are of sub-standard quality needing frequent repairs. Investment gets diverted to unproductive sectors leading to shortage of savings for real investment. Scarcity of foreign exchange prevents import of essentials and technology.
  4. The black economy has many economic ill-effects. The black economy and the erosion of institutions of democracy are interlinked. The institutions of democracy, legislatures, learning centres, judiciary, police, bureaucracy, police and media, are all compromised due to the functioning of the black economy. As people’s pressure has declined, illegality has grown. The involvement of the country’s elite in illegality has eroded their commitment to work and this pervades society.
  5. The nation is not short of resources but because of the existence of black economy, a large chunk of resources are not only wasted but are either lying idle or are siphoned off out of the nation.

Paradoxically, the interests of those who have benefited the most from the black economy have been hurt the most since the growth has been stunted and dynamism has eroded.

Much of the activity in the black economy is like digging holes and filling them. Many are employed but society makes little progress and remains poor. As policy fails, individual solutions are sought, which result in making the resource shortage look worse and weakens the commitment to national goals. Checking the growth of the black economy has become the single biggest task for the nation.

INDIA: Government Steps
In India, Black money refers to funds earned on the black market, on which income and other taxes have not been paid. In February 2012, the director of the Central Bureau of Investigation said that Indians have $500 billion of illegal funds in foreign tax havens, more than any other country. In March 2012, the Government of India clarified in its parliament that the CBI Director's statement on $500 billion of illegal money was an estimate based on a statement made to India's Supreme Court in July 2011.

In August 2010, the government revised the Double Taxation Avoidance Agreement to provide means for investigations of black money in Swiss banks. This revision, expected to become active by January 2012, will allow the government to make inquiries of Swiss banks in cases where they have specific information about possible black money being stored in Switzerland.

In 2011, the Indian government received the names of 782 Indians who had accounts with HSBC. Through the Investigation Division of the Central Board of Direct Taxes released a White Paper on Black Money giving the Income Tax Department increased powers.

SIT on black money.
The SC on 4 July 2011, ordered the appointment of a Special Investigating Team (SIT) headed by former SC judge BP Jeevan Reddy to act as a watch dog and monitor investigations dealing with the black money. The two judge bench observed that the failure of the government to control the phenomenon of black money is an indication of weakness and softness of the government.

“The issue of unaccounted monies held by nationals, and other legal entities, in foreign banks, is of primordial importance to the welfare of the citizens. The quantum of such monies may be rough indicators of the weakness of the State, in terms of both crime prevention, and also of tax collection. Depending on the volume of such monies, and the number of incidents through which such monies are generated and secreted away, it may very well reveal the degree of "softness of the State."”
— Justice B Sudershan Reddy

In April 2014, Indian Government disclosed to the Supreme Court the names of 26 people who had accounts in banks in Liechtenstein, as revealed to India by German authorities.

On 27 October 2014, Indian Government submitted name of three people in an affidavit to the Supreme Court who have black money account in foreign countries. Following the order, Government of India submitted the names of 627 people in the Supreme Court of India in a sealed envelope on 29 October 2014.

Double taxation agreements
DTAA is about declared (white) incomes of entities so that tax may be levied in one or the other country and not in both. Black income is not revealed in either of the two countries so there is no question of double taxation. Further, this data would not be available to either of the two countries to be exchanged. It is no wonder then that till date, no data has been supplied to India by any of the countries with which this treaty has been signed. In brief, DTAA is about white incomes and not black incomes, so it is disingenuous to say that in future no data would be given to us if names are given to courts.

Criticism of Government
Different governments have tried to stall SIT. A bank has been revealed to have acted like a hawala operator. Other MNC and private Indian banks also indulge in these activities. Why has the government not initiated action against them and hawala operators? No wonder the perception is that the government is stalling on unearthing Indian black money. In May 2012, the Government of India published a white paper on black money. It disclosed India's effort at addressing black money and guidelines to prevent black money in the future.

After a series of ongoing demonstrations and protests across India, the government appointed a high-level committee headed by MC Joshi in June 2011 to study the generation and curbing of black money.

Tax Information Exchange Agreements
To curb black money, India has signed TIEA with 13 countries -Gibraltar, Bahamas, Bermuda, the British Virgin Islands, the Isle of Man, the Cayman Islands, Jersey, Liberia, Monaco, Macau, Argentina, Guernsey and Bahrain - where money is believed to have been stashed away. India and Switzerland, claims a report, have agreed to allow India to routinely obtain banking information about Indians in Switzerland from 1 April 2011.

In June 2014, the Finance Minister Arun Jaitely on behalf of the Indian government requested the Swiss Government to hand over all the bank details and names of Indians having unaccounted money in Swiss banks.

Proposals to prevent Indian black money
Current Proposals
In its white paper on black money, India has made the following proposals to tackle its underground economy and black money.

Reducing disincentives against voluntary compliance :Excessive tax rates increase black money and tax evasion. When tax rates approach 100 per cent, tax revenues approach zero, because higher is the incentive for tax evasion and greater the propensity to generate black money..Lower taxes and simpler compliance process reduces black money.

Banking transaction tax
Replacement of most direct and indirect levies with a banking transaction tax and de-monetisation of currency notes of Rs 500 and Rs 1,000 to help prevent Indian black money, ease inflation, improve employment generation and also lower corruption.

Economic liberalisation
Non-tariff barriers to economic activity such as permits and licences, long delays in getting approvals from government agencies are an incentive to proceed with underground economy and hide black money. The successive waves of economic liberalisation in India since the 1990s have encouraged compliance and taxes collected by the government of India have dramatically increased over this period. The process of economic liberalisation must be relentlessly continued to further remove underground economy and black money, suggests the report.

Reforms in vulnerable sectors of the economy
Certain vulnerable sectors of Indian economy are more prone to underground economy and black money than others. These sectors need systematic reforms. Gold trading, which was one of the major sources of black money generation and even crime prior to the reforms induced in that sector. High transaction taxes in property are one of the biggest impediments to the development of an efficient property market. Unless the real estate transaction process and tax structure is simplified. Old and complicated laws such as the Urban Land Ceiling Regulation Act and Rent Control Act need to be repealed, property value limits and high tax rates eliminated, while Property Title Certification system dramatically simplified.
Supportive measures

Public awareness initiatives must be launched. Public support for reforms and compliance are necessary for long term solution to black money. In addition, financial auditors of companies have to be made more accountable for distortions and lapses. Laws must be strengthened to encourage reporting and tax recovery.

Amnesty
Amnesty programmes have been proposed to encourage voluntary disclosure by tax evaders.

International enforcement
India has Double Tax Avoidance Agreements with 82 nations, including all popular tax haven countries. Of these, India has expanded agreements with 30 countries which require mutual effort to collect taxes on behalf of each other, if a citizen attempts to hide black money in the other country. The Agreements be expanded to other countries as well to help with enforcement.

Modified Currency Notes
Government printing of such legal currency notes of highest denomination i.e.; 1000, 500 which remain in the market for only 2 years. After a 2-year period is expired there should be a one year grace period during which these currency notes should be submitted and accepted only in bank accounts.

Remedies
One step alone cannot eradicate black economy, what needed is a joint effort at numerous levels. First of all, the Political will is needed to curb the growth of Black Money. Double Taxation Avoidance Agreement (DTAA) and Tax Exchange Information Agreements with Tax haven countries will certainly help in bringing the capital flight problem. Movements which change the consciousness of people and make them strong enough to resist the temptations are needed for a turn around. When we have sufficiently worked on the consciousness and trust issues we can look at the following reforms as a package because if handled individually, they will turn out to ineffective:
  1. Right to information, judicial, bureaucracy and Media Reforms should be encouraged which will result in increase of transparency in the system. Also, building a special task force to enforce the laws effectively will go a long way.
  2. Simplification of the tax laws should be done as it will make it easy to catch those who are fudging the accounts.
  3. The link between the politician and money power needs to be broken as this leads to the policy makers themselves resorting to sources for easy money.
  4. There should be three tier and interlinked representation in the legislatures on the same ground as party structures, which will increase the credibility of the contesting candidates.
  5. Increasing the accountability of institutions and individuals and especially of the policy-makers will act as big step in eradicating Black Economy in our country.
  6. Leaders and persons in position should file a return of their assets and incomes which should be subjected to scrutiny by a special agency created for this purpose.
  7. Lowering of tax rates so that tax evasion becomes unnecessary. Tendency to evade tax creeps in when tax rates are high.
  8. Controls, licenses, and permits should be reduced to minimum. If necessary, they should be made available without under the table payments.
  9. As recommended by Wanchoo committee, agriculture income should also be subjected to income tax as other incomes.
  10. Government should subsidies election expenditure of political parties as is done in West Germany.
  11. Heavy capital gains tax should be lowered.
  12. Registration fees in relation to property and other real estate should be lowered.
  13. All tax laws should be revised so as to eliminate loopholes.
  14. Deterrent punishment must be given to those who are found guilty of profiteering, black-marketing and smuggling.

By,
Naresh Koppu,
Current Affairs Faculty









































#Tags