The black money scheme is badly designed

V Kumaraswamy | Updated on January 24, 2018 Published on July 22, 2015

Money laundering That's the name of the game OLAF SPEIER/SHUTTERSTOCK.COM

Wealth-owners are attached to their hoard and may not succumb easily to carrot-and-stick measures

The anti-money laundering laws have come into effect. The voluntary period of compliance is set at September 30. Those who want to escape punishment and prosecution have to declare their income, pay 30 per cent as tax and a further 30 per cent as penalty in return for immunity.

Behavioural economists would dismiss this as amateurish. From the ‘incentive to act’ angle, it looks like the weakest attempt to mobilise black money since Independence. The government has to decide what is more important — punishment of the guilty or mobilising money for growth (even if it does not give up on either). If it is the punishment that’s more important, our legal systems provide enough loopholes for the guilty to escape and effectively prolong the delivery of justice. Even death penalties are not a deterrent.

The current scheme amounts to a 60 per cent tax on ‘accumulated wealth’. Higher tax on current income is easier to recover than a similar tax on wealth. Supposing we shift from taxing the current year’s income to recovering taxes after four years — will the compliance be better?

Unrealistic tax rate

Definitely not, and this is one reason why most governments have shifted to ‘pay as you earn’ systems. Most such stashed income is in the form of assets (even if it is in the form of cash); the ‘owner’ tends to get attached to it, and this only increases with time. This is part of what behavioural economists call the ‘endowment effect’. Even in commercial establishments, an invoice or debt is best recovered by the seller within the credit period or reasonable extension therefrom. It would almost be impossible to recover it after two or three years.

Some may be paying the current dues even while keeping the older ones in dispute, or keep raising issues to delay payments in the hope some favourable ‘settlement’ will be feasible. This is one reason most MNCs insist on writing off overdue debts beyond the current accounting period and blacklisting the counter party.

Recovering a high tax of 60 per cent is almost impossible. They will use every legal recourse to fend off the payments, including migration, filing appeal after appeal, or playing ‘catch me if you can’. And they can afford much better legal advice for much longer than the government can ever afford.

Alternative approach

A far better approach would have been to recover the same indirectly. Suppose the government taxes such income at, say, 10 per cent of the declared amount and asks the owner to invest the declared income in GOI bonds at 3 per cent interest and repayable at par in 15 years. The ‘endowment effect’ will be far easier for the owner of ill-gotten wealth to swallow at 10 per cent than at 60 per cent and he will more likely pay the tax and declare his income. If the ill-gotten assets are already in the form of cash and bank balances it is even more likely.

If the bonds so created are made tradable, many of them may be willing to finish the declaration and sell off the bonds (immediately or over time) at discounts and redeploy the proceeds in their business at better returns. In which case they don’t even have to keep dealing with their ‘regret’ over 15 years; they can dismiss it as a one-time nightmare.

For the government, the net present value of such an arrangement is the same thing — ₹60 net of taxes, if discounted at 8 per cent which is the Union government’s current rate of market borrowings for similar term. It is essentially the same thing but ‘frames’ the question or problem differently in a manner more palatable to the taxpayer.

The other penal provisions can remain the same without any dilution whatsoever, so the Union government is not seen as bending to the interest of law-breakers and accused by an aggressive opposition.

It would be interesting to see how the current scheme works. Let’s wait till September 30, 2015.

The writer is the CFO of JK Paper and the author of ‘Making Growth Happen In India’

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Published on July 22, 2015
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