A Rs 1,00,000 cr black money bonanza: Jaitley should offer a super-duper amnesty scheme

Bringing black money stashed away from abroad has been a sacred theme for the BJP for some time now. In 2009, LK Advani made it the centerpiece of his campaign. In the recent elections, the BJP promised serious efforts to bring the money back. PM candidate Narendra Modi promised Baba Ramdev he was on the job.

Well, the time has come to redeem that pledge, but, as we shall see, bringing back the money has to be seen in a more nuanced way than just sending out some tax sleuths to Switzerland, threaten some political mayhem, and bring the loot back home.

With the right incentives, the government will be able to get a flood of dollars back home even while retaining the stick for going after the recalcitrants in future. In 1997, P Chidambaram’s voluntary disclosure scheme (VDS) got the government revenues of Rs 7,800 crore by offering immunity from prosecution; now, given the much bigger size of our domestic and international illegal hoards, Arun Jaitley can easily target ten times that amount - Rs 70,000-1,00,000 crore this year. Some of it need not be government money, but funds available to infrastructure.

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This estimate is not based on any inside knowledge of the amounts stashed abroad, but by a mere extrapolation of the growth in the scale of our export-import trade between 1997 and now. Between 1997 and now, our exports have multiplied more than 15 times in rupee terms and imports more than 20-fold. Since Indians are unlikely to have become more tax-abiding people since then, it is a fair bet that the promise of amnesty will be taken seriously, especially given the resource crunch faced by corporates in India.

Cut to the present: Today’s Hindustan Times (20 June) tells us that Indian money in Swiss banks had risen 40 percent to Swiss franc (CHF) $2 billion in 2013 (around Rs 14,000 crore), up from CHF 1.34 billion the year before.

Aha, are Indians getting more brazen about keeping money in Swiss banks? Unlikely. This number is a red herring. Reason: when Swiss accounts are a big political issue here, no fool would keep his money hanging visibly in Switzerland. The bulk of the increase is likely to be legit money, or corporate funds that are legally parked there.

But the reality is there are umpteen tax havens out there (Bahamas, St Kitts, Liechtenstein, Cayman Islands, etc), including an officially-designed haven called Mauritius, where our own government has signed a tax treaty that allows funds flowing in from here to avoid Indian taxes.

Getting illegal money back from many sources thus calls for a smart approach. A bull-in-China-shop effort, full of domestic political bluster and flat-footed moves with the tax havens themselves, will not work.

In fact, if the government is serious about this, it should follow a credible carrot-and-stick approach, so that some of the money held abroad (and also domestic black money) is lured in, and the rest ferreted out in due course.

But before we get to the carrot-and-stick, we need to understand a few basics about black money, both domestic and the stuff kept abroad.

First, black money is essentially money not declared (or under-declared) to our tax authorities - either income tax or customs. The tax havens storing it abroad could not care less about whether the owners paid taxes in India or not. For them it is just money. This means the key to luring the money back will involve some tweaking of our tax regime. It is not just a police and law action.

Second, black money changes colour all the time. Tax-evaded money may be black, but some parts of it becomes white again as it flows further, even though the original amount may be black. For example, if I pay 10 percent of my house purchase price in cash, the receiver may use it to buy some things at the mall which becomes white if the mall-owner pays tax on his income. If he doesn’t, more black money gets created. So there is a stock of black money, and a flow. The aim of policy should be to shrink the flows and further creation of black money, and also make the old stock of black money available to the legitimate economy.

Third, we need to understand how black money gets generated abroad. There are two major ways - one is through the underinvoicing of exports and/or the overinvoicing of imports. The excess is clandestinely retained in tax havens abroad. And the other is the plain illegal route of sending domestic black money in rupees out through the hawala route, which then nests abroad as dollars.

Once again, this money is not just a stock; it can keep flowing in and out. For example, money stashed abroad comes in through Mauritius as foreign institutional investor (FII) money and participates in domestic markets through a route called P-notes (participatory notes, where the ultimate investor is not identified to the Indian market regulator Sebi). Thus illegal money abroad can make capital gains in Indian stocks and exit as profits without paying tax, increasing the stock of illegal wealth abroad.

In 2011, for example, a Kotak Securities report raised suspicions about the high levels of exports and FII inflows seen in 2010-11 as possible evidence of illegal Indian money coming in. The report noted super-sharp spikes in engineering exports. It notes: “Our study of exports data of major engineering companies (including automobiles and metals) shows that the increase in their exports does not reconcile with the steep increase in official exports data. In fact, the gap is quite substantial.” How substantial: maybe around $28 billion. (Read the full Firstbiz story here).

Given this backdrop, what should the Modi government do to bring black money back and put it to productive use? What is the carrot-and-stick approach that will work best?

The answer is to simultaneously announce two things: an amnesty scheme for black money coming in from abroad (and a separate one for domestic black money), and the creation of a special task force to only look at tax havens, backed up by legal, legislative and political action that promises very strong punishment for those caught holding illegal accounts after a given deadline.

Step #1: Given the government’s weak finances and the need to invest in infrastructure, the Modi government could offer zero-interest infrastructure bonds for any foreign funds brought in with the promise that the owners or their sources of money will not be questioned. The bonds can be listed, and a continuous stock can be made available till, say, 31 December 2014. The gross inflows can be taxed at 10 percent. For domestic black money, a no-questions-asked bonds with 30 percent tax can be offered.

There are moral questions involved here, for it would amount to pardoning people who held illegal wealth abroad and evaded taxes here. But one can be pragmatic or one can be purely moral and get nothing done. The government of India is no stranger to repeated amnesty schemes. As we noted before, Chidambaram had done a voluntary disclosure scheme in 1997 (in a government where the Left was part of government), and more recently there have been several schemes to pardon service tax evaders and others.

So a cash-starved government can and should announce an amnesty scheme for illegal wealth abroad and back home. But it won’t work be worth it without brandishing a stout stick.

Step #2: So, boom. The government must descend like a ton of bricks on whoever is found holding illegal accounts abroad after a declared date for amnesty. This intent must be made clear right at the outset, and some names already found to have done dark deeds can be made examples of. We already have a ready list of names from Liechtenstein and some illegal HSBC accounts, and more could be made available, if we only tried hard enough. Offenders should be picked at random and made examples of. Marching a few past offenders off to jail under a new detention law for white collar crimes will send shivers down businessmen’s spines.

This carrot-and-stick should work if the stick is very obvious. The government can ambitiously target at least Rs 70,000-1,00,000 crore, if not more if it demonstrates menacing intent.