The Black Economy in India: ‘Na Khaunga Na Khane Dunga’ a Non-Starter

The BJP’s rise to power was aided by Mr. Modi’s slogan in 2014, `Na Khaunga Na Khane Dunga’. An evocative slogan giving a personal guarantee of a strong leader. This was one of the many slogans like, `Chappan inch ki Chati’, `Acche Din’ and `Sabka Sath Sabka Vikas’. In 2013-14,for people reeling under rising prices the most appealing slogan was the one against corruption.

A connection was made between price rise and growing corruption that filled the pockets of the rich and corrupt at the expense of the poor. It was also linked tothe idea that much of the nation’s wealth had been spirited out of the country by the corrupt and if it could be brought back then each family in the country could get Rs.15 lakh. Alternatively, for many years citizens would not have to pay any tax. People were taken in by these propositions.

When the government initiated the Jan Dhan Account scheme for the unbanked poor, after coming to power, the common people assumed that this account was meant to put Rs.15 lakh in their accounts. But, Mr. Amit Shah, BJP’s then party President, admitted that this was a `Chunavi Jumla’, a false election promise. The opposition took advantage of this statement in the Bihar elections and won handsomely.

I. Some Recent Steps to Tackle Black Economy

The first action that Mr. Modi’s government took in May 2014 was to set up the Court monitored SIT on black money as mandated by the Supreme Court. Various other steps were announced from time to time to show seriousness about tackling the black economy. Like, passing of the Black Money bill against illegal funds held abroad and the Income Declaration Scheme (IDS). None of these steps bore any fruits and the government decided to go for a big bang in the shape of demonetization of high denomination currency notes.

These steps were taken with incomplete understanding of the analytics of black economy in India. They became political ploys to show to the public that the government was serious about tackling the black economy. Why did these policies fail?

I a. Black Wealth held Abroad

To get at illegal funds held abroad and to bring them back to the country, it is necessary to know where these funds are and how much is held abroad by Indians. Illegal funds are taken out of the country through the process of layering and shell companies are created in 6 different tax havens and funds are moved from one to the other and the shell companies closed. This way the trail of the funds is sought to be obliterated. It becomes hard for official agencies to trace these funds, even if they want to track these funds. Since there are 90 tax havens in the world, where the funds end up is not easy to discover for the agencies (See, Tax Haven (2014).

Switzerland is perhaps the earliest and the best known tax haven. When the Swiss authorities are asked for information they provide the data on the funds held legally by Indians. The other black funds of Indians having moved from other tax havens are treated as the funds belonging to those principalities. Since the largest number of tax havens are under British suzerainty, the Swiss authorities and the Swiss banking association report that the largest amount of money deposited in Swiss accounts are from Britain. Data on Indians holding illegal funds abroad has come from stolen and hacked data of entities in Tax havens. Like the data stolen from LGT bank of Liechtenstein by Kleibe and sold to German government, UBS data from Zurich branch stolen by Faviani, data hacked from Mossak Fonseca of Panama Island, data from BVI and Paradise Island. In India, prosecution based on this data has not been successful.

The information has been obtained by a group of journalists called ICJE who have in a determined way got stolen and hacked information from tax havens. German, French and US governments launched prosecution using the information obtained while the Indian government has dragged its feet. It initially refused to take the stolen Liechtenstein data from German government. It was under orders from the Supreme Court that this data was taken and later the Court monitored SIT was set up.

The double taxation avoidance agreement (DTAA) with Switzerland was supposed to help, according to official sources, in unearthing black money held abroad. But it has not (and cannot) help,since it is to do with the declared incomes and not black incomes that are not disclosed in either of the two jurisdictions. DTAA have been signed with 87 nations as of 2012. Tax Information Exchange(TIE) agreements with 37 nations have also not helped unearth black incomes since these are also about the declared incomes (See Kumar, 2017b).

How much funds have gone abroad from India was estimated by GFI (2010) as $450 billion. The government added some to it and stated that $500 billion had gone abroad by 2012 (Kumar 2012a). These figures do not tell how much may be lying abroad and in which tax havens. However, the GFI figure was partial since it did not include many elements of leakages like under invoicing of services and havala. Kumar and Chattopadhyay (2015) estimated that the opportunity cost of leakages from India between 1948 and 2012 was about $2 trillion. It was also argued that about 10% of black incomes generated annually are spirited out of the country. However, a part of it is round tripped back to India and much of what is held abroad is spent and invested so that only a small amount is left in liquid form in banks and investments. If at all, only thisamount can be brought back to India (to be distributed or not to Indians).

I b. Income Declaration and Voluntary Disclosure Schemes

The other step, Income Declaration Scheme (IDS) failed to unearth much black funds. This was announced first in mid-2016. After it failed, in November, demonetization was announced. It was bound to fail since black income generation is a result of a nexus between the corrupt businessmen, politicians and the executive – a triad. As long as this exists, black income generation is safe from prosecution. Only the opposition needs to worry about it, since it has become a means to undermining it and curbing criticism.

IDS was introduced because the government gave an undertaking in the Supreme Court after the last Voluntary Disclosure of Income Scheme (VDIS) in 1997 that henceforth it would not bring such a scheme since it is unfair to the honest tax payers. The idea behind such scheme was that the black money accumulated by the corrupt will come to the government and then get used for the nation’s development. But, in the 6 VDIS schemes announced till 1997, very little black wealth was declared compared to its estimated amount. So, while it was not successful in eradicating black income generation, it encouraged more black income generation which if desired, could safely be whitened later on.

The CAG report on the 1997 VDIS said that people are becoming habitual tax offenders since many of the same people had declared incomes in the earlier scheme and again in the 6th scheme in 1997. It argued that since these schemes keep being announced, more black incomes get generated since the opportunity is provided for whitening them later on. It also said that the honest turn dishonest since they feel they are losing out to those who generate black incomes and then whiten it by paying a negligible amount of tax. In other words, the scheme is counter-productive as it leads to more black income generation and more dishonesty. It can be likened to the government going down on its knees or prostrating itself before the black income generators.

Just as the VDIS and IDS have proved to be counter-productive, many other steps taken to check the black income generation have also failed. The reason is that they are often techno-economic steps while the cause of black income generation is socio-political-economic (Kumar, 1999 and 2017a).

I c. Demonetization

Like a bolt from the blue, demonetization was dramatically announced by the Prime Minister at 8 pm on November 8, 2016. It was supposed to destroy the black economy at one stroke, end the menace of counterfeit currency and financing of terrorism. None of these goals were achieved but it damaged the economy and especially its unorganized component (Kumar, 2017b). It led to utter chaos in the economy as the shortage of currency hit the country.

Shortage of money in the economy leads to freezing of transactions and slowdown in economic activity. A fast growing economy suddenly went in reverse gear, leading to a crisis in the lives of a vast number of people. It led to a long term trend of a decline of the unorganized sector of the economy producing 45% of the output. Since then the economy has been limping at around 1 to 2% rate of growth and facing massive problem in employment generation. This has led to a policy induced crisis in the economy.

Demonetization was carried out on the false premise the `black means cash’. The elementary distinction between wealth as a stock and income as a flow was forgotten. It was not realized that at best black cash would be about 1% of the black wealth. So, even if all the black cash could have been demobilized it would have only impacted 1% of the black wealth. As it turned out, even this did not happen since according to RBI 99.3% of the cash was returned. The 0.7% that did not come back was known to be held abroad or forgotten by the elderly, etc. (Kumar, 2017b).

The government quickly tried to change the goalpost by saying that the move would lead to a `cashless’ economy. This also did not happen and as suggested by this author one should have only expected a `less cash’ economy which was already taking place (Kumar, 2017b). For that, the draconian demonetization was not required. In fact, now cash in the economy is much higher than in 2016 in spite of the rapid increase in digitized transactions.

II. Cause of Black Income Generation

The above points to the failure of the various steps taken by the government to check the black economy and its growth. This is a result of the incorrect understanding of the black economy. One has to be able to identify the correct cause to be able to rectify a problem. So, what is the cause of black income generation?

Black incomes are generated in both the illegal and legal activities (Kumar, 1999). Of course the entire income in the illegal activity is black. It cannot be disclosed. For instance in smuggling the profit and the wages to couriers are all illegal and therefore black.

A bulk of the black incomes is generated in the legal sectors, like, industry, finance and trade. In these sectors, an illegality has to be committed to generate illegal incomes over and above the white incomes generated. Further, most of the black incomes are generated in the organized sector of the economy where taxable incomes are earned. The vast majority of incomes in the unorganized sector are way below the taxable limit so do not constitute black incomes whether reported or not. In fact, they don’t need to be reported because they are mostly below the threshold limit of reporting. It is the corporate sector that keeps talking of black incomes generation in the informal economy to divert attention from its tax evasion activity.

In brief, the growth of the black economy relative to the white economy is an indication of growing illegality in the country. For illegality to grow policy makers and implementers have to connive in the activity. Kumar (1999) called this the `Triad’ underlying generation of black incomes. This then is the underlying cause of existence of the black economy. The rulers benefitting from allowing it to flourish keep making noises about wanting to check it. They also announce policies from time to time that cannot dent the black economy but make it appear that they are serious about impacting the black economy.

In the literature it is mentioned that the cause of black income generation is high tax rate and degree of controls and regulations. Kumar (1999) points out why these are not the causes of black income generation. Empirically, the highest rate of income tax was 97.5% in 1971 when the black economy was estimated to be 7% of GDP. The rates have come down systematically since then but the size of the black economy has continued to grow. Similarly, saying that controls are responsible for black income generation implies that a law is its own cause of violation. Can one argue that the existence of traffic lights is the cause of jumping traffic signals? The cause lies in the illegality being committed.

In brief, it is the Triad that needs to be dismantled to check the black economy.

III. Defining Black Incomes

Black incomes are generated in business via over invoicing costs and under invoicing revenue (Kumar, 1999). This leads to profits being under reported and wages being over invoiced. In fact the over invoiced wages become the profits of the owners of business. Most of the incomes of workers and owners of micro and small units are way below the taxable limits. So, whether they declare their incomes or not, these are not black incomes. So, it is shown that black incomes are factor incomes property incomes not reported to direct tax authorities. Property incomes should not be confused with rental income on real estate but stand for profit, interest, rent and dividend in the National Account Statistics.

This definition leaves out the `transfer incomes’, like, capital gains in real estate or share markets or bribes. These are not linked to production but to distribution in the economy. Real estate is mistakenly assumed to be the biggest generator of black incomes in India (GoI, 2012). It is only a means to transfer black incomes and not generate black incomes (Kumar, 1999).

So as not to count black incomes multiply, the final non-declaration of income is at the stage of direct tax payment. If incomes evade tax at an earlier stage like say excise or sales tax it will ultimately also evade income tax. So, it should be counted once and not three times. This is called multiple counting of black incomes. The tax authority will be interested in counting how much tax is not paid and they would do multiple counting. But from the macroeconomic perspective of how much income is missed out of national income, only the factor income not reported is to be counted.

However, black incomes are impacted in multiple ways depending on the method used to estimate the white economy. Since agricultural incomes do not have to pay income tax there is no black income generation there. However, diversion of other incomes to show them as agricultural incomes does occur but these should be counted under the sector from where they are diverted. In the case of construction, the product flow method is used and this means any black income generated will also be counted as income. In industry, output is misreported to generate black incomes so these do not get counted. And so on.

In brief, some black incomes get counted in the white economy data while some white incomes do not get counted in national incomes due to methodological issues (Kumar, 1999).

IV. Measuring Black Economy

Black incomes are not reported, nor are white incomes. They have to be estimated based on the available data and methods devised to do the estimation given the data limitations. For the white economy more data is available and for the black economy limited data is available.

The black economy leaves a trace on the white economy and using this, the size of the black economy is estimated. That is why these are called trace methods. There are four broad methods:

1. Survey approach
2. Input output approach
3. Monetarist approach and
4. Fiscal approach

Analytically the correct one is the fiscal approach since it is consistent with the analytical definition given above (Kumar, 1999). It estimates the factor incomes in each sector. Other methods look simple but often in economics simple is not so simple. The Survey approach depends on people giving honest answers. In India this has proved to be rather difficult.

The monetarist approach is the most often used approach globally. But it basically estimates transactions and not incomes. It cannot separate the factor and transfer incomes. Going from transactions to incomes proves to be difficult. The assumptions underlying it are often incorrect. Like, how to estimate the liquidity required to circulate the black economy. It involves circular reasoning and one can get the figure one wants.

The input-output approach suffers from various deficiencies – including how to incorporate technical change over time and the vitiation of the input output coefficient by the existence of black economy which distorts the coefficient. Thus, it is almost tautological (See Kumar, 1999 and 2017a).

V. Impact of Black Economy

Black economy impacts both at the macro and micro levels (Kumar, 1999 and Chattopadhyay 2018) and socially and politically.

Given the definitional aspects, the black economy results in vitiating various macro variables and ratios. For instance, black economy results in lower rate of investment but higher rate of savings. Balance of payment is impacted due to over invoicing of imports, under invoicing of exports and flight of capital. Output, rate of growth and employment are also impacted. Input output ratio is higher than actual and so is the incremental capital output ratio. These impact planning process.

In India, the black economy is concentrated in the hands of the top 3% of earners, largely from the organized sector of the economy. They benefit at the expense of the 97% (Kumar, 1999 and Kumar, 2017a). The, income distribution is much more skewed than what the white economy data reveals. It leads to higher levels of inflation which impacts the marginalized more. It lowers investment productivity and sets back development which means lesser income and employment than potentially feasible for the economy (Kumar, 2005). It leads to greater social waste and consumerism both of which impact the climate adversely and that hits the marginalized more.

The black economy leads to policy failure for two reasons. First since taxes that should have been paid are not paid, there is a shortage of resources in the budget for schemes that benefit the marginalized. Second, a fraction of the budget allocations reach the ground so that targets are missed. This is especially true for the schemes for the marginalized which, as pointed out above, anyway face cuts.

Further, to the extent taxes are evaded, the budgetary deficit rises. This has to be financed by borrowing which results in rising interest payment by the government. Interest has become the largest item in the revenue account budget and drains resources that could have been used to finance the schemes for the marginalized like, education, health and employment generation.

Black economy has social and political implications. It impacts the functioning of the political parties and the elections and thereby undermines democracy. It erodes accountability of the systems which enables illegality to proliferate.

VI. Possible Remedies

If the cause of black income generation is the existence of the Triad, technological and economic measures will not work. Kumar (1999) and Kumar (2017a) point out that hundreds of economic and technological measures have been tried since independencebut theblack economy has continued to grow. Technological measures like, digitization have not yielded results. Other steps undertaken like,demat accounts, Aadhar card, PAN cards have been circumvented in connivance with the people in charge of the schemes.

Digitization was supposed to curb illegality by making systems foolproof. Instead, new kinds of illegality have surfaced while the old forms of illegality and fraud continue. For instance, the gullible, including the well-educated, are facing phising, loan scams, hacking of accounts, theft of passwords, etc. Scamsters committing illegality are demanding payment in cryptos which are hard to track. Data is being stolen and made available on the dark web for nefarious purposes. So, the black economy, is flourishing with newer elements added to it.

The Triad has not only persisted but it has got strengthened and the black economy has continued to grow. The issue of the dismantling the Triad is a political one.Those in power benefit from it and in their self-interest they use it to make extra gains over and above their white incomes. All political parties use it to generate funds for individual leaders and the party. It enriches the leaders and enables them to run their politics. They need big sums to fight elections, maintain the party machinery, cultivate vote banks, buy out opposition leaders, topple governments and so on.

All this is true of not only national parties but also state level parties. There have been cases of disproportionate assets against a large number of party leaders. This has been taken advantage of by the ruling party to blackmail the opposition party leaders. Earlier this was more of a quiet affair but now this is being done brazenly by the ruling party to decimate the opposition. This has turned the fight against corruption into a demolition of democracy.

VI a. Strengthen Democracy

Democracy is the best check for the black economy since it brings with it real accountability of the rulers. For that a strong opposition is required. Once the opposition is weakened, accountability declines and results in more black income generation. One can give the example of a dictatorship or autocracy. Without accountability the dictators have become highly corrupt all over the world. For instance, Abacha in Nigeria, Suharto in Indonesia, Hosni Mobarak in Egypt and Marcos in Philippines.Closer home, it has happened in Pakistan, Sri Lanka, Nepal, etc. Rajiv Gandhi started his innings promising a clean government but all around him and he himself faced accusation of big corruption. The present ruling party also started with a campaign against corruption but accusations against its leaders have been growing.

Thus, the problem is structural and no magic bullet is available. The process of people becoming conscious of its deleterious effect and demanding accountability from leaders can only be slow. At present people acquiesce in their leaders corruption because they are largely feudal minded. Their experience is that they get little from general development but may get something if their caste, community, regional leader attain power. Politics has become highly competitive with every group promising gains to its followers. That this slows down general development and impacts everyone is immaterial as long as there is possibility of some gains in the immediate future. Trust in possible long term gains through national development has eroded.

VI b. Need Accountability

To break the Triad, accountability is needed of the political class, businesses and the executive. Accountability of the political class is the most important. Then the other two will follow suit. For businesses, investment in corrupt politicians and manipulable executive is highly profitable. If incorruptible leaders get elected, they will not be able to manipulate policies and make extra profits. So, businesses need to be accountable. Their board of directors and accountants must be made accountable for wrong doing by the managements. They should not merely be decorative figures on the Board or pliable appointees of the owners.

For politicians, accountability requires democracy in their political parties. There need to be democratic elections in the parties. If they do not believe in democracy in the party they are not suddenly going to become democratic when they get elected. They will remain linked to vested interests and do their bidding when in power.

Elections bring about certain accountability to the public. Thus, in the Indian situation politicians should have to face repeated elections – say every two to three years – to have some accountability to the public. This possibility is sought to be curtailed now with the move to go for `one nation one election’. In between the elections, the rulers will then be able to serve the interest of the vested interests without any hesitation and the system will become more autocratic and more corrupt.

Executive accountability will also come from political accountability. If the policy makers demand it, the executive would have to deliver. They would not be able to set up road blocks to delay action and then speed it up by taking money and sharing it with their bosses. Speed money does not speed up action. Action is first slowed down and then speeded up.

Setting up an ombudsman, a Lokpal and Lokayukt, to check corruption has been suggested. But,if the judiciary can get corrupted, as indicated by the number of cases comingto light, there is no guarantee of a Lokpal turning out to be honest. Especially, its accountability maybe in doubt if appointed by the ruling party,as has been the case regarding the Election Commission and CVC.

VII. Conclusion

To tackle the black economy, the government has tried steps like, Foreign Money Bill, Income Declaration Scheme and demonetization. These and other such steps have not succeeded since they were not based on a proper analytical understanding of the phenomenon. It is argued that without identifying the correct cause any remedy attempted would fail. The cause lies in the growing illegality fueled by a Triad between the corrupt businessmen, politicians and the executive. This nexus can only be dismantled by bringing about accountability at the top (Kumar, 2017a). The ruling party gains from this nexus and resists moves to bring its top functionaries under the purview of RTI and by weakening the whistle blowers’ protection.

Black incomes are generated by high income earners, belonging mostly to the organized sector. This sector is considerably digitized but that has not stopped it from generating black incomes via under and over invoicing. If the black economy had been dented due to the steps undertaken by the government in the last 9 years, the direct tax/GDP ratio should have risen substantially. Kumar(2023) shows that this ratio has continued to hover between 5.75 and 6.1% indicating that the black economy in India has not been dented.

It is pointed out that black incomes skew national income in favour of profit earners and result in policy failures. Further, the black economy is concentrated in the hands of at best 3% of the population. So, in every way the marginalized get more marginalized. There are important social and political implications for people’s political representation, increase in crime and growth of inequity. Thus to check the black economy, the Triad needs to be demolished and that requires people to become politically more conscious to resist. This can be achieved only via socio-political movements which change people’s consciousness and enable them to demand accountability (Kumar, 2017a).

References

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• Kumar, A. and S. Chattopadhyay. (2015). Estimates of Illicit Financial Flows Pertaining to India, 1948 to 2012. Mimeo. Paper presented at the Seminar on `Black Economy in India, its Global Dimensions and Impact on Policies’ organized by CESP, JNU and TJN, in JNU on June 26, 2015.
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(Prof. Arun Kumar, joined JNU in 1984 and retired as the Sukhamoy Chakravarty Chair Professor in the Centre for Economic Studies and Planning, Jawaharlal Nehru University in 2015. He is currently the Malcolm Adiseshiah Chair Professor in Institute of Social Sciences. He has a Ph.D. in Economics from JNU and a Masters in Physics from Princeton University USA and Delhi University. He is specialized in Development Economics, Public Finance and Public Policy and Macroeconomics. He was a part of the team to study the black economy for CBDT (1982-85). He has had visiting assignments in Pavia University, Italy and Humboldt and Leipzig University, Germany. He has delivered lectures at Yale Univ., Columbia Univ. and Carnegie Mellon Univ. in USA and UNAM, Mexico. UNAM, Mexico awarded him the Ricardo Prize in Economics for work in Development Economics. Courtesy: DD Kosambi Research Foundation – whose mission is “to seek the truth without any blind faith and find out the roots of brahminism, continuous economic drainage and strive towards a true federal, self reliant and democratic society with a scientific temper”.)