The Great Indian Black Economy

Posted on February 22, 2012

By Kartikeya Rai:

Between the financial year of 2013-14, India plans to more than double its exports to around $500 billion. While absolute authenticity of the figures can never be guaranteed, it’s estimated that India’s Black Economy comprising fake and counterfeit products, spurious goods, bribery, prostitution and a host of other murky business dealings that are usually untraceable and hence unaccountable, is at around 40% of GDP, close to $500 billion. That’s already more than double our total exports. Prof Arun Kumar, author of one of the most detailed books to be written on this subject, Black Economy in India, estimates that the opportunity cost of this sin economy is around 5% of GDP growth sacrificed every year since the 1970s. India’s GDP in Public Private Partnership (PPP) in 2011 was $4.469 trillion. That means that the current size of the economy could have been around $9 trillion making us the second largest economy in the world. India’s Peripheral Component Interconnect (PCI) grew by 15.6 % to Rs 53,331 per annum in the financial year of 2010-11.

Without this existing ‘Shadow Economy’ it would have increased our PCI to seven times its existent level. Transparency International estimates that some Rs 21,000 crore annually is exchanged in the form of bribe. This amount is gargantuan and mind boggling considering it is adequate enough to provide safe drinking water to all towns and villages in the country and to relieve all farmers on their debt or to feed 90% of the hungry in the country. We could even have edged out China and U.S.A. together in terms of production vis-à-vis consumption. The Rs 1, 00,000 crore Fast Moving Consumer Goods (FMCG) Industry loses 6-7% of its turnover due to illegal imports and counterfeiting. With the standard excise rate of 8% on personal care products, the tax evasion in this sector alone is well over Rs 500 crore annually. A recent survey conducted by the Drug Controller-General of India found 0.4% of the countrywide drugs supplied by the Rs 90,000 crore Pharma Industry to be spurious. This makes the size of the counterfeit market at Rs 360 crore. With a simple multiplier effect of 10, this would exceed economic losses of Rs 3000 crore.

Black money today is created at every level of the Indian economy. The most thorough going explanation is given by Guntmann1 who attributes the following reasons for the existence of this Black Economy. Firstly, Inflation pushes the taxpayers in to higher income brackets who in turn try to push part of the inflation cost onto the government by getting ‘off the book’ income. Secondly, an immensely complex tax system requiring inordinate paper work and expense. Thirdly, a bigger Government size which leaves smaller share of national output for direct consumption by wage earners. Fourthly, the perception of the Government by the public as inefficient and wasteful making inadequate use of their hard earned money. Another reason, in developing countries, specifically could be Infrastructural shortages or capacity deficiencies. For instance, when the country suffered cement shortages in 1961-82, the amount of Black Money generated by the cement sector alone was around Rs 8 billion. However, a systematic and an endemic existence of these regular irregularities needs the existence of a corrupt business class, a corrupt executive class, consisting of the bureaucracy, the police and the judiciary and a corrupt political class, something that Prof Kumar refers to as— a Triad.

Arguably, the Black economy has its own advantages. Being entirely a cash economy, it is liquid and fast and substantially increases velocity of money. It injects the much needed Foreign exchange into the economy, increasing Money Supply and other Monetary Aggregates. In times of economic hardships, it adds to the wealth of the nations and fosters liquidity in an otherwise dehydrated market. In short, with the exception of illegal activities, it does everything that the official economy does — and, usually, more efficiently. The fact that the very existence of this Black economy (and hence, additional demand) saved us from the worse effects of recession cannot be blatantly ignored. However a true analogy of the situation in India about Black Money would be that it is equivalent to ‘digging holes and then filling them’.

Roads get washed away and pot holed at every chance of rain they get, thus ensuring that the funds allocated for new roads and constructions be now diverted to regular maintenance of existing stretches, teachers intentionally may not teach properly in class to urge the need for tuitions, the bureaucratic work is slowed down on purpose, administration intends to harass the ‘aam aadmi’ spending more of their constructive time and intellectual ability on ensuring roadblocks and inefficiencies and minting money in the process. All this has spawned a culture of ‘middlemen’ who have bellied their existence and livelihood on such means. The corrupt need the middlemen to insulate themselves from the public for the fear of being reported. It is also a convenient arrangement for the bribe giver as he never knows ‘how much to bribe’.

This growing Black Economy leads to policy failures. As the ‘Parallel Economy’ is unaccounted for, the official National Income accounts do not represent the true state of the economy and given that these statistics are in turn used to formulate effective policies, and act as effective guides, the policy in itself may be erroneous. Feige has described this phenomenon as Unobserved Income Hypothesis (UIH) and suggested that systematic biases distort information systems of an economy thereby distorting our perception of economic realities. Some of the consequences of this biased economic data leading to wrong policy framework can be that first, the overall growth of the economy is understated, not taking into account the substantial financial wealth people possess in Black. Secondly, Savings ratios, Consumption ratios and Saving Functions are incorrect. Also, Capital sent abroad through Hawala Channels or otherwise does not generate output in India and hence lowers the employment potential and the level of output in the economy.

Targets for expenditures, health, food security, are not meant because expenditure in this regard is not efficiently transmitted into being an outcome. All these direct and indirect costs that the Black Economy imposes lead to unproductive investments, slower developments, higher inequity(the black money channels in the hands of just 3% of all income earners) and a lower rate of growth in the economy that would otherwise have been possible. This leads to higher costs and inflation. For instance, if a child needs tuition, family costs are higher. If a capitalist needs to pay a bribe before setting up an industry, product costs are higher.

At the social front, whenever there is an air of misdemeanour about a government, the society as a whole loses faith in the social setup and it’s functioning. Hence, the Hazare movement. At the political front, each state wants its own packages because the belief that the nation as a whole is strong enough to deliver has been dented. Each caste, community, region wants its own parties representing their narrow short sighted demands which is further stemmed by the divisive politics that is so popular with the Indian politicians. The Black economy also poses a serious threat to national security. The strong links between the Triad is leading to an increasing rate of criminalization in society. Even when the funds are channelized, a lot of the money is laundered. The public has come to acceptance and become rather cynical. All it does or is forced to do is vote for the Favourite Corrupt out of the Corrupt.

All these factors discussed so far has led India to become a high cost and low quality economy leading to the crowding out of our exports in the international market due to lack of strict surveillance and governance. It is not that the developed countries do not face this problem or do not have Black Money, but unlike India, it does not affect their daily life so their citizens do not feel harassed. They do not have to pay postmen on festivals, telephones once installed do not regularly break down, and they do not have to pay the registrar to get required documents verified, they do not pay bribes to get a Driving License, to get Gas cylinders and so on.

The way forward is not rosy and needs a brave government to enact braver reforms and stricter surveillance. It’s high time the Government stops looking at things with an ostrich like mentality and get up from their comfortable cocoons and take matters into their own hands. First and foremost, according to me, the proper functioning of any government needs four core bodies to lead the way. The CAG, the CBI, the NJC (National Judicial Council) as well as the Lokpal, the inefficiency of any of these organizations has to be avoided at all costs. We have to slowly but surely move away from a cash based economy. Next, all citizens should be obliged to file annual, personal tax returns (universal tax returns, like in the USA). This way, discrepancies between personal tax returns and other information can lead to investigations and discoveries of tax evasion and criminal activities. All places of business should be required to install over a period of time-cash registers with ‘fiscal brains’- which is a chip that saves all the trail of a transactions in the business. All registrars should be computerized: land, real estate, and motor vehicles, share ownership, companies registration, tax filings, import and export related documentation (customs), VAT, permits and licenses, records of flights abroad, ownership of mobile phones and so on. Electoral reform is required so that genuine representatives of the people enter the legislature. Criminal minds will only lead to criminal outcomes. Reform of Judiciary is required. Cases have to be speeded up and procedures simplified. The executive has to be made accountable and freed from its links with the vested interests. Taxation of business income should be based on gross profit and not net profit. Internal indirect taxes should be levied only on final luxury products. Estate duty, Gift Tax, property and wealth taxes should be revived to unearth black incomes.

We have implemented many of these suggestions, like, demonetization, voluntary disclosure, and payment by cheque, anti-defection law and citizens’ charter. However, not only have they not helped curb the menace but have often fuelled it because they have added to the complexity of the laws or turned people into habitual law breakers. No law is worth the paper it is written on if not implemented.

Political will is required which means strengthening democracy, which in turn is not possible without movements on the above issues. If all Black Money is declared by individuals, institutions as well as corporate houses, it is liable to be taxed at 30%. This would generate an additional Tax Revenue of Rs 7, 50,000 crore for the Government. The total Tax Collection for FY 2009-10 was Rs 6, 41,000 crore. Surely, the Government can make better use of this amount.

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