The Hindu Business Line : What lies beneath the economy

Every economic activity in the informal sector does not always result in tax evasion. Thus, while tax evasion may be evil, all unreported incomes and assets cannot be tarred with the same brush. says T. C. A. Ramanujam.

URBAN India is witness to a booming economy. Shopping malls have sprung up in all major cities. Over a million cars and seven million bikes have been sold in 2005. About 1,000 tonnes of gold worth Rs 49,500 crore and diamonds worth Rs 6,000 crore have been purchased in India. Stock market and real-estate prices are at an all-time high.

A 100 million TV owners and 60 million mobile-users add glitter to the India shining campaign. Over 3.2 lakh credit cardholders spend over Rs 2,00,000 each, involving Rs 4,400 crore. (Individuals who have invested over Rs 2 lakh in mutual funds totalled Rs 6,85,000 crore; over Rs 5 lakh in bonds totalled over Rs 2.31 crore, and over Rs 1 lakh in primary issues totalled Rs 60,000 crore.) It has been pointed out that 46 per cent of FII investments in India come through "participatory notes" and the stock market gained Rs 78,000 crore by this device.

And, then, there is the disturbing news that fictitious demat accounts are being used to corner public issues. Annual Information Reports (AIR) filed by the various agencies revealed that over 3,00,000 individuals deposited more than 10 lakhs in saving accounts, totalling Rs 42,000 crore in 2004-05. And, yet, the number of people with taxable income of Rs 10 lakhs and above is just 80,000.

Estimates of black money in the economy vary from 5.1 per cent of GDP to 20 per cent, from an absolute figure of Rs 36,786 crore in 1983 (the Shankar N. Acharya Committee) to over Rs 9,00,000 crore in 2005 (a study by Dr Arvind Virmani, Director and Professor, Indian Council for Research on International Economic Relations — ICRIER). The services sector alone probably contributes Rs 1,00,000 crore to the black economy.

Black money is not all that evil

Black money has its blessings too. Much of the investments in real estate would not have been possible without the informal sector participating in a big way. The hidden or informal economy operates alongside or underneath the visible formal economy and it is for this reason that it is also referred to as the parallel economy.

More than a decade back, two anthropologists from the UK— Philip Harding and Richard Jenkins — published an original work, "The Myth of the Hidden Economy: Towards a New Understanding of Informal Economic Activity". They questioned the notion that all or most modern economies are afflicted by a hidden or informal economy, operating alongside or underneath the visible formal economy.

In their view, there is no such thing as a black economy but a range of types of economic activities which should be categorised according to multiple criteria. Both the formal and the informal, the economic and non-economic dichotomies, need to be re-conceptualised as `continua' and informal economic activities of various kinds must be recognised as an integral part of the modern capitalistic economy.

It is not always the case that every economic activity in the informal sector results in tax evasion. Black economy is not wholly a curse. The problem with the parallel economy is that it upsets national income statistics because of the failure of persons operating in the underworld to report their incomes.

In the US, moonlighters and many illegally employed migrants earn income which adds to the economic development of the lower middle-class. It is for this reason that the parallel economy should be seen in a neutral sense and called the informal economy. Thus, while tax evasion may be evil, all unreported incomes and assets cannot be painted with the same brush.

Capital flight

It is well-known that capital flight has been the order of the day for well over 20 years in India. The Mauritian route for investments of the capital market was taken advantage of by India's own captains of industry to bring into the country funds secreted outside by way of kickbacks in import deals or otherwise.

Today, with the liberalisation of imports, the temptation for such re-routing has been minimised. Despite the cut in tax rates, it may not just be direct tax rates that account for the generation of black money in India.

Stringent laws regulating the financial sector and stamp duties in real estate transactions are equally responsible. It is axiomatic that black money is not a mere fund but a flow. The bureaucrat-politician-businessman nexus helps speed up the flow.

It has been estimated that candidates of major parties across 542 Lok Sabha Constituencies spend over Rs 10,000 crore, averaging Rs 5 crore per candidate per constituency. The 4,000-odd Assembly constituencies will only add to the Election bill of the nation. Most of these election funds should represent unaccounted moneys. State funding of elections, usually thought of as a solution, can be of no avail, nor will frequent disclosure schemes help.

They will only demoralise the honest taxpayer. It should not be forgotten that the Income Tax Law has a permanent provision for amnesty of sorts for voluntary disclosure without penalty at the level of the Commissioner of Income Tax.

Expenditure as base

In recent months, the Revenue Department has been gathering intelligence about the consumption expenditure of high net worth individuals. For quite sometime, the British and American economists have been seriously looking at alternatives to the income-tax levy as understood all these decades.

The idea has been floated that an individual should be taxed on his `comprehensive' income, which is defined as the amount that he/she could consume without running down the value of his wealth.

Personal income can be measured by the value of what the individual does consume plus the change in the value of his wealth. That requires a complete change in mind-set on the part of the policy framers. It will require recognition of the fact that `income' as the basis of taxation has failed.

The Budget to be presented next month will do a lot of good if it desists from measures which encourage the generation of black money and, instead, concentrates on alternative ways to tackle the problem without resorting to amendment of the tax law.

Honest taxpayers will shudder at the thought of amnesty schemes such as zero interest bonds or `no questions asked' investments. These are outdated measures. There is a need for changing the outlook with regard to the problem of black money.

(The author is a former Chief Commissioner of Income-Tax.)