Demonetization - Putting the cart before the horse

The story of the 2016 demonetization scheme in India is similar to the cropping paddy. The plants are ripped out when the produce is ripe with no warning and the same rice is resowed only to be ripped out again come harvest season. In between they are at the mercy of natural elements, with no protection or fall back options, unless grown in a rich farmer's field, where pumped water and rich fertilizer abound for nurture. It would appear then, from all accounts of the chaos that ensued after the decision was made, that the Government in taking and executing this momentous and as the social media army call it, historic decision has put the cart before the horse.  Let’s see how.

Black money has two components. One, money derived from criminal acts like smuggling, bribery, sale of drugs etc. and the other from the evasion of taxes. Evasion of taxes is primarily a system problem. Indians are the saving kind and will adopt any means to save money including avoiding paying taxes which again has two reasons. If they pay the full component of tax they literally have nothing left in the kitty to consume or keep up with their neighbours, as what remains after paying income taxes is taxed at an extremely high level indirectly when they purchase goods and services, including strangely, a life insurance policy. The other, unlike in Western countries where too the tax component is high, the return in the form of amenities provided for the tax paid is very little.  This is evidenced by the roads, the health care system, and the education system and many other public amenities which are by and large non-existent or minimally present. All the tax money is wasted on sops for vote banks. So one can't really blame the people of the country or hold them responsible for not wanting to pay taxes and punish them. It’s insensitive of those who wield power over the taxpayers’ money! The system needs a clean-up and tax paid must have a visible return. Then things will change. Because after paying the correct taxes you probably will still have to bribe, perhaps because the system is not yet fixed, which leads us to the second dimension of Black Money - it does not really exist!

Yes it does not! But what goes around comes around….The Colour of the money depends on the hand that holds it. In the RBI's hand, like it is now post demonetization, there is only one colour, irrespective of legality - White! In one person's hand, if undeclared in an IT return or taxes are not paid on it, it turns black. Should the person holding it invest it in gold, land, or even in the purchase of white goods, or even a movie ticket, it turns white as it converts itself into a legitimate asset to have to hold from that day on! It’s not the money per se, but the process and the person that needs to be targeted or you'll be throwing the baby out with the bath water, especially if you empty 86% of the bath tub as this government has done with its rather unprovoked scheme of demonetization that should have and could have come after the many avenues for generation were tightened to a hair’s width.

What needs to be done there is twofold - strike at the root of the problem - areas like political funding, higher education professional fees, the undervaluation of land deals, the professional sector (the accounting, health care and legal sector), the government procurement and licensing sector and purchase of gold.  Each of these sectors should have first been targeted with a series of measures before demonetization. In addition, taxes should have been rationalized, reduced, exemptions eradicated and if possible, income tax eliminated altogether by piggy backing it as an expenditure tax on the GST slabs proposed.  It’s simple and easy to do. It can widen the base, eradicate harassment and lower the effective tax rate all in one go. It will also spare the poor - Please read this article (http://www.newskarnataka.com/opinion/its-time-to-abolish-income-tax-but-how) written as far back as May 2015.

Let’s see what perhaps should have and could have been done in each of these sectors prior to demonetization:

1. Political Funding:

Presently, funding below a cap of Rs: 20000 is non transparent - It is easy to change that especially with the majority that this government enjoys - No political party can argue with it as they are doing now without being labeled a black sheep. Yet not a word spoken on that either before demonetization or after. Getting political parties covered under the RTI would be the next step.

2. Education Capitation fees / Charitable Institutions:

Remove the education sector and charitable institutions from the Indian Trusts Act 1182 and Public Charitable Trust Act 1950 and move them into the Companies Act with a few exemptions. The disclosures and compulsions of the Companies Act will automatically strengthen transparency. Tax exemptions can continue to be provided to subsidize the sector however.

3. Undervaluation of land deals:

The problem with the real estate sector is the valuation, which is determined by demand and supply and fluctuates from location to location, from day to day and from every other angle possible including Vaasthu compliance.  It is not easy to determine or fix to prevent evasion by the buyer who would like to reduce his costs to the maximum, as also his desire to dispose of undeclared income he has earned elsewhere through his services in cash or through any other means including other land deals in cash.

The seller is often left with no choice whatsoever in the matter.  For example a healthcare professional, who generates undeclared wealth through his professional services rendered in cash may invest the same in the real estate sector purchasing a piece of land from a seller. Here he is hoping to convert his black money into white (through a purchase of DD in cash) / dispose it off partially (through the payment of the balance in black) even as he saves money on the stamp value. He is killing a lot of birds with one stone.  Ultimately the money starts circulating without a government record painting it black.  Although a state subject, it can be rather easily addressed if the stamp value is made inversely progressive - pay less stamp duty for higher value purchases with all properties being linked to the Aadhar no.

An additional liability is that of the Real Estate broker. For very little service, he charges a fee of 2% and demands that it be paid in cash. He does not have a professional licence, often does not have a registered office and yet makes a mountain of cash from literally nothing. This then circulates and comes around.  This must be regulated by the Real estate bill - where all such brokers are registered and licenced with an authority and have to submit annual returns to the authority concerned.

4. Professional services for cash:

This is one of the biggest areas of black money generation.  Professional services in the health care sector, legal, accounting and some other informal sectors including as bribes are largely based on cash transactions. Declaration of cash received for services is uneven and the undeclared portion as in the case of bribes in the government sector, goes to finance consumption of luxury goods and in some cases charitable causes. Eradicating these practices will prove more difficult than others, but can be tackled if income tax is abolished in its present form and it is piggy backed on the GST as an additional layered tax - there is no other way.  This will also sort out the unreported income in the rural sector.

5. Government Procurement and Licensing sector

The Times of India has reported that an engineer in Uttar Pradesh Government speaking anonymously said "A bribe is not a taboo in a government job". That perhaps sums it up.  Government has made a beginning with auctions of the resources of the country. Cannot the auction system be applied to the procurement sector too? It can is my guess, through a reverse auction or e-auction process. It is now standard practice worldwide and must be done even at the urban local bodies. Licensing and inspection must be brought down to a minimum through the streamline of various processes and the removal of discretionary powers of the concerned authorities.  Easy enough to do.

The regulatory and prosecutory mechanism too needs to be strengthened. Delays beyond 12 months must be eliminated statutorily for any deterrent to be effective. The investigative mechanism is non-existent presently. The Lok Pal Act is an example of poor execution and in the light of the haste with which demonetization has been introduced, begs the question as to why it is hanging fire. It is also noted that it has been amended recently to give added protection to the wrong doer!  Indeed the Supreme Court on 23.11.2016 castigated the government for the delay in the appointment of the Lok Pal and said it would itself act to appoint one if there was further delay, which might in the end be a good thing!

It’s only in the railways that an engine pushes the train forward from behind, but perhaps the government expected the horse to learn the tricks of the trade quickly? But while the train moves on tracks that are laid out as per a plan, the horse has to push the cart forward uphill on a bumpy and pot holed road that often disappears mid-way!