De­mon­eti­sa­tion: Flawed in plan­ning, not in prin­ci­ple

There was a short-term price but that may dis­si­pate as re­sources idled by de­mon­eti­sa­tion are re­de­ployed else­where. But are we pre­pared for this short-term pain?

Business Standard - - ISSUES AND INSIGHTS - ASHOK SAN­JAY GUHA

have con­cen­trated their fire. De­mon­eti­sa­tion, they claim, was “wit­less”, “inane”, “the grand­est hoax in India’s po­lit­i­cal his­tory”, state ter­ror­ism in­flicted on a hap­less peo­ple for no dis­cernible eco­nomic ben­e­fit what­so­ever. Their prin­ci­pal ar­gu­ment is that black money is not a stock but a flow, cre­ated when­ever tax is evaded, not nec­es­sar­ily through a cash trans­ac­tion. Even when cash is ac­quired while evad­ing taxes, it is not hoarded, but con­verted into other as­sets. To stop eva­sion, tighten tax ad­min­is­tra­tion, don’t de­stroy 86 per cent of the cur­rency.

Un­doubt­edly, de­mon­eti­sa­tion is no in­sur­ance against tax eva­sion. It does not re­place en­force­ment, but sim­pli­fies tax ad­min­is­tra­tion and com­pli­cates eva­sion. Eva­sion re­sults in un­ac­counted wealth — land, farm­houses, diamonds, BMWs, Old Masters. None of these, how­ever, has the ad­van­tages of cash. Cash is the most liq­uid of all as­sets — finely di­vis­i­ble, uni­ver­sally ac­cept­able and highly portable. That is why cash or credit — not spe­cific durables — is the favoured ex­change medium for nor­mal trans­ac­tions. This is the first lesson of mon­e­tary eco­nom­ics — one known to chai­wal­las, though not ap­par­ently to crit­ics of de­mon­eti­sa­tion. If, how­ever, we want to hood­wink the tax col­lec­tor, cash of­fers us a fur­ther boon. Un­like credit, it leaves no pa­per trail. It is vir­tu­ally in­vis­i­ble and — un­like jew­ellery or Rolex watches — does not lose value from in­vis­i­bil­ity. Cash trans­ac­tions are there­fore the pre­ferred in­stru­ments of tax eva­sion. De­mon­eti­sa­tion, re­turn of cash into bank ac­counts and con­se­quent widen­ing of the tax net re­flected in the vast mul­ti­pli­ca­tion of tax re­turns filed this year make this to­tally ir­refutable.

Of course, de­mon­eti­sa­tion can­not touch bank ac­counts in Switzer­land, Ber­muda or the Cay­man Is­lands. How­ever, ad­di­tions to or pay­ments from these ac­counts gen­er­ally re­quire mis­re­port­ing of im­port and ex­port prices. Since in­ter­na­tional prices of stan­dard goods are known, such over- or un­der­in­voic­ing in­volves the risky en­ter­prise of brib­ing col­lec­tors of cus­toms. It is not quite a walk in the park.

Un­doubt­edly, the black econ­omy will re­gen­er­ate it­self even in India. Shop­keep­ers who want cash pay­ment to evade the goods and ser­vices tax ac­quire un­ac­counted cash. But these are only thin trick­les, be­cause ear­lier cash hoards are now val­ue­less and with­drawal of new cash from banks is limited and closely mon­i­tored. So the cash cir­cuit that ear­lier en­gulfed much of our econ­omy will re­vive but slowly.

A sec­ond ar­gu­ment against de­mon­eti­sa­tion: It failed to ex­pro­pri­ate hold­ers of black money since 99 per cent of the banned cur­rency re­turned to the banks in ex­change for new notes with­out penalty. Pre­sum­ably, own­ers of vast cash hoards es­caped de­tec­tion by par­celling them out in small lots de­posited by hun­dreds of agents. How­ever, no agent per­forms such il­le­gal ser­vices with­out a sub­stan­tial cut and black­mail­ing gains over the in­def­i­nite fu­ture. The ini­tial holder of black money may es­cape de­tec­tion but only at a ma­jor fi­nan­cial cost, with pos­si­bly more to come.

De­mon­eti­sa­tion made fu­ture tax eva­sion com­plex and haz­ardous. It pro­duced another col­lat­eral ben­e­fit since al­most all pre­med­i­tated crime was funded by high-value notes. This in­cluded con­tract killing, kid­nap­ping, hu­man traf­fick­ing, bet­ting and match-fix­ing, or­gan­ised pros­ti­tu­tion (es­pe­cially pimp­ing), smug­gling (es­pe­cially of drugs and weapons) and ter­ror­ism. De­mon­eti­sa­tion turned off the tap. These busi­nesses — pos­si­bly, small busi­nesses — suf­fered be­cause their cus­tomers now lacked the means to pay. I wouldn’t shed too many tears for them.

Fur­ther, un­ac­counted cash con­sti­tuted an in­cen­tive, in­deed a com­pul­sion, for cash ex­pen­di­ture on con­sum­ables and in bars, restau­rants and broth­els. As the cash melted away, so did pres­sure for such con­sump­tion, stim­u­lat­ing pri­vate sav­ings.

Cer­tainly, de­mon­eti­sa­tion was in­com­pe­tently im­ple­mented with­out prepa­ra­tion or fore­thought. A short-run cri­sis was pre­cip­i­tated that was to­tally avoid­able had the bu­reau­cracy been toned up ear­lier. It was not — and that was a ma­jor flaw in plan­ning de­mon­eti­sa­tion, not in its ba­sic prin­ci­ple.

Fi­nally, what of the ar­gu­ment that de­mon­eti­sa­tion ru­ined the poor and the very small busi­ness­men who rely ex­clu­sively on cash? Surely these peo­ple have lit­tle to do with high-de­nom­i­na­tion cur­rency. They earn largely in ~10 and ~100 notes. Cer­tainly, the Bharatiya Janata Party’s (BJP) over­whelm­ing vic­to­ries since Novem­ber 2016 in some of our poor­est states in­di­cate that the govern­ment has not alien­ated the poor, only the wealth­ier in­tel­lec­tu­als. Or are we to be­lieve that the poor are so Is­lam­o­pho­bic that they in­sist on vot­ing for the BJP re­gard­less of the depths of mis­ery to which Naren­dra Modi has re­duced them?

FU­TURE GAIN De­mon­eti­sa­tion made fu­ture tax eva­sion com­plex and haz­ardous. It pro­duced another col­lat­eral ben­e­fit since al­most all pre­med­i­tated crime was funded by high-value notes

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