Union Budget 2017: Critics are wrong, shocking tax evasion figures alone justify demonetisation

Demonetisation has attracted a lot of criticism since inception. Motivated, non-motivated, justified, unjustified, economic, political. Leaving aside political disapproval which is aimed to serve a specific purpose, there are still enough rational voices who are raising reasoned critiques. Director of Centre for Contemporary South Asia, Professor Ashutosh Varshney, for instance, in a recent column in The Indian Express has called Prime Minister's currency swap a patently "political move without an economic rationale."

But are criticisms like these well-rounded?

During a DD News program on Thursday evening, Arun Jaitley made an interesting point while discussing the budget with author Chetan Bhagat, the host. In reply to a question that came up on India's pathetic tax compliance, the Union finance minister said that though Indians are generally conservative in nature and "god-fearing" in their beliefs, they do not see tax evasion as a moral problem. According to the the finance minister, Indians by and large do not consider tax evasion as "cheating", but rather an attribute of "smartness".

Taking the argument forward, this skewed public belief has led to a situation where tax-compliant citizens are perceived as "foolish" and those who evade taxes are considered "clever". And because tax dodging is not considered an immoral act, an otherwise law-abiding society as a whole incentivizes dishonesty and discourages honesty. This places an unfair burden on compliant taxpayers who are forced to pick up the tab for evaders.

The extent of this problem can be adjudged from India's poor tax-to-GDP ratio and the shocking figures that the finance minister revealed during his budget presentation on Wednesday.

"As against estimated 4.2 crore persons engaged in organised sector employment, the number of individuals filing return for salary income are only 1.74 crore. As against 5.6 crore informal sector individual enterprises and firms doing small business in India, the number of returns filed by this category are only 1.81 crore," said Jaitley.

Union Finance Minister Arun Jaitley. PTI

Union Finance Minister Arun Jaitley. PTI

"Out of the 13.94 lakh companies registered in India up to 31 March, 2014, 5.97 lakh companies have filed their returns for 2016-17" of which "2.76 lakh have shown losses or zero income, 2.85 lakh have shown profit before tax of less than Rs 1 crore. 28,667 have shown profit between Rs 1 crore to Rs 10 crore, and only 7781 companies have profit before tax of more than Rs 10 crores," he said in his speech.

Further, "among 3.7 crore individuals who filed the tax returns in 2015-16, 99 lakh show income below the exemption limit of Rs. 2.5 lakh per annum, 1.95 crore show income between Rs 2.5 to Rs 5 lakh, 52 lakh show income between Rs 5 to Rs 10 lakh and only 24 lakh people show income above Rs 10 lakh. Of the 76 lakh individual assesses who declare income above Rs 5 lakh, 56 lakh are in the salaried class. The number of people showing income more than Rs50 lakh in the entire country is only 1.72 lakh," said the finance minister.

He drew a contrast between disclosure of income by Indians and their expenditure. In the last five years, he said, "more than 1.25 crore cars have been sold, and number of Indian citizens who flew abroad, either for business or tourism, is 2 crore in the year 2015."

If this is one data set, there is more. Post demonetisation, bank collection of old currencies show that "during the period 8 November to 30 December, 2016, deposits between Rs 2 lakh and Rs 80 lakh were made in about 1.09 crore accounts with an average deposit size of Rs 5.03 lakh. Deposits of more than 80 lakh were made in 1.48 lakh accounts with average deposit size of Rs 3.31 crores," revealed Jaitley, though he steered clear of putting absolute numbers on the value of money that has returned.

These are outrageous revelations. Allowing for the fact that India's per capita income is still low (expected to cross Rs 1 lakh in fiscal 2017), it bears testimony to Jaitley's contention that we are "largely a tax non-compliant society and the predominance of cash in the economy makes it possible for the people to evade their taxes."

What sort of problems do non-paying of taxes pose? In an economy hemmed in by lack of private investment due to corporate debt burden, NPA-ridden banks and exports running into global protectionist headwind, non-compliance makes it that much harder for government to meet its revenue targets, which in turn makes it difficult to maintain fiscal prudence.

As IIM Ahmedabad Professor TT Ram Mohan, in a column in The Hindu, wrote how this raised "the big question whether Jaitley can meet the revenue targets for the coming year. He does not have the benefit of falling oil prices and higher excise duties any more. And the target of Rs 72,500 crore for disinvestment looks challenging when compared with receipts of Rs 45,500 crore in 2016-17."

Critics please note, this is exactly where demonetisation comes to the government's aid. By forcing the burgeoning (and largely non-tax-compliant) unregistered sector to join the formal economy, Narendra Modi has substantially widened the tax base in a very short amount of time. Now this will, in the short to medium term, create contraction in the economy. The extent of the contraction only proves just how much of India's GDP was reliant on the unregistered sector.

As Saurabh Mukherjea and Ritika Mankar Mukherjee of Ambit Capital pointed out in this Firstpost article, "the increased focus on tax compliance is likely to mean that the non-tax paying informal sector in India will shrink at a rapid pace. This, in turn, will entail a degree of demand destruction as the informal sector accounts for more than 40 percent of India’s GDP and provides employment to close to +75 percent of the labour force."

Critics have highlighted this part, but have ignored the fact that this temporary transition will result in a much more compliant and healthy economy wherein increased tax revenues will enable the government to direct the spending towards achieving greater social equity.

To quote Professor Ram Mohan's article in The Hindu: "Prime Minister Narendra Modi’s instinct about the demonetisation may thus turn out to have been spot on. It’s not just the long-term gains that will be material. At a time when growth is faltering, the demonetisation could hold the key to realising more taxes and maintaining fiscal stability in the immediate future."

Moreover, as Jaitley's budget speech revealed, the government is now in possession of big data and it could go after the tax evaders with gusto using data mining and initiate tough action. If evaders are caught, tax net is widened and the eventual benefit redistributed among weak sections of Indian economy, demonetisation would have met its purpose. Naysayers should take a break.

Updated Date: Feb 02, 2017 16:20 PM

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