Seven days into the purge, it is still too early to say just how deep a wound the shadow economy will suffer. Economists and numerous studies have put India's shadow economy (deals that take place outside the tax net, practically 90 percent of all transactions) at around 20 percent of India's entire GDP.
Assuming, as Hindustan Times has done, that 10 percent of that shadow economy gets affected by the demonetisation exercise, the government would have mopped up black money worth Rs 1.4 lakh crore, roughly one percent of India's entire GDP (Rs 135.76 lakh crore in current fiscal).
There is no guarantee that the target will be met. But there are enough indications that the parallel economy has taken a major hit. Reports have emerged of cash being burnt by the sacks, decommissioned notes sliced and washed down the drains, I-T authorities conducting raids on jewellery outlets and bullion traders with abnormal sales spike post 8 November, black money hoarders pressing into service the poor as money mules. A picture emerges of the still invisible Loch Ness monster steadily leaking blood.
There have also been reports of Maoists, majorly inconvenienced by Narendra Modi's drive, forcing villagers to exchange cash as extortion funds dry up or become useless. In absence of terror funding from across the border, stone pelters have fallen silent and school arsonists have taken a break in Kashmir.
And yet such a massive exercise will not ensure the death of shadow economy. Sure, the cost of hoarding black money will be raised, the risks of conducting untaxed transactions would spike but even if we assume that the government succeeds in mopping up most of the untaxed money that is floating around (by no means a given), that would still amount to little beyond the amputation of a limb for the parallel economy.
The reason is simple. Apart from the cash that has already been converted into asset classes such as real estate and bullion or stashed away abroad, political funding remains the major source of unaccounted money. Unless the Modi government follows up the demonetisation exercise with much-needed reforms in funding of political parties and elections, the shadow economy will continue to thrive.
It won't, of course, be easy. The Prime Minister may face opposition from within his own party. When it comes to transparency of funding structure through tools such as the RTI, political parties have repeatedly set aside their differences to thwart such moves in unison.
Take the case of Congress.
In 2013, a full bench of the Central Information Commission (CIC) in a landmark judgement brought all six national parties (BJP, Congress, CPI, CPM, BSP and NCP) within the RTI net. And yet the parties refused to honour the applications seeking details of donations. In June this year, the Congress told the CIC that it is neither a court nor a competent authority to exercise plenary jurisdiction and the order (to bring parties under RTI) is "arbitrary and illegal." Congress counsel KC Mittal told a full bench of the Commission that an application has been moved to quash CIC's order bringing political parties under the RTI Act, according to a PTI report.
Or take the BJP, for instance.
In August last year, the government submitted an affidavit in Supreme Court, opposing the plea to bring political parties under the ambit of RTI Act. “If political parties are held to be public authorities under RTI Act, it would hamper their smooth internal working, which is not the objective of the RTI Act and was not envisaged by Parliament. Further, it is apprehended that political rivals might file RTI applications with malicious intentions, adversely affecting their political functioning,” the affidavit stated, according to a report in The Indian Express.
Why are all political parties desperate to avoid RTI glare? Because they are loathe to repulse a major source of funding which comes in hard cash and bears no transactional footprint.
In his blog, journalist and author Vivek Kaul writes: "If as a citizen I need to show my identity card while depositing my old notes to the bank, people making donations to political parties should also be made to do the same. This will make the accounts of political parties completely auditable."
Kaul points out various legal loopholes that are frequently used by parties to stay outside the tax ambit. He cites a research paper by Sandip Sukhtankar and Milan Vaishnav on funding pattern of political parties. An excerpt from the paper states: "…Corporations and parties are only legally required to publicly disclose political contributions in excess of Rs 20,000. This rule allows contributors to package unlimited political contributions just below this threshold value completely free of disclosure. Indeed, in 2014 the Association for Democratic Reforms (ADR) reported that 75 percent of the income of India’s six major parties comes from undocumented sources.”
Kaul's blog also highlights the huge gap between money spent by the government in funding the elections and the actual expenses incurred by all the candidates. This humongous gap is filled almost completely with black money and funds are usually sourced from the real estate sector. The entire exercise stays below the tax radar.
In an encouraging move, the Prime Minister on Tuesday raised the issue of state funding of elections and simultaneous Lok Sabha and Assembly polls during an all-party meeting just ahead of the Winter Session. Modi wants a debate on Parliament on whether these could be used viable tools to cleanse up the system in conjunction with the demonetization exercise. Though old, these are good ideas to reduce poll expenditure and make it less difficult for candidates to raise funds. But there is a reason why these 'good ideas' have remained canned in 'non-implementable' bottles. There is no incentive for political parties under the current structure to even debate these reforms.
The Prime Minister has hinted that benami properties might be the next area where black money fight will rage but he must also adopt a carrot and stick strategy. One way of making more people pay income tax is to bring down or regularize the rates. The rampant avoidance of stamp duties on real estate transactions, for instance, is also caused by abnormally high rates.
As economist Surjit Bhalla says, the government must "decrease the onerous and prohibitive tax rates on purchases of houses. With GST, there should be no such thing as a stamp duty on land at any of the stages of “sale”. That is a relic of the British, and the Congress, and should have no place in a GST India."
A combination of these steps will ensure victory over black money. Else despite the sacrifices of so many Indian citizens and commendable political resolve from the PM, the battle will be half won.