Corruption: 1, Demonetisation 0. But these 3 Factors Can Turn the Tide

“…there will be a fiscal windfall both from the high denomination notes that are not returned to the RBI and from higher tax collections as a result of increased disclosure under the Pradhan Mantra Garib Kalyan Yojana (PMGKY).”---Economic Survey 2016-17 (January 2017)

The RBI Annual Report 2016-17 says that Rs15.28 lakh crore (roughly 99%) of the banned notes has been received till 30 June 2017. A quick assessment of the current state of play suggests that corruption is clearly ahead of demonetisation. The three crucial facts can turn the tide:

1. The 18-lakh suspicious accounts with around Rs2.89 lakh crore being frozen and with most of the moneys gradually finding a way to the exchequer. It is important to penalise tax evasion for signalling a high cost of for tax evasion in the future in order to have better future tax compliance.

A rise in the Tax/gross domestic product (GDP) ratio by say two percentage points in FY2018 that is sustained in the future would mean around Rs3 lakh crore of additional tax revenues each year. The Economic Survey’s expectation of a 0.5 percentage point increase in this ratio is too little especially given that the “fiscal windfall” does not seem to be happening! As mentioned in a report “ 2.A rise in the Tax/gross domestic product (GDP) ratio by say two percentage points in FY2018 that is sustained in the future would mean around Rs3 lakh crore of additional tax revenues each year. The Economic Survey’s expectation of a 0.5 percentage point increase in this ratio is too little especially given that the “fiscal windfall” does not seem to be happening! As mentioned in a report “ Tax ratio similar to Rwanda, but wants to beat China: That’s India” by Amit Mudgill (The Economic Times, 22-Jul-2017) the current tax/GDP ratio is 16.6% while the tax/GDP ratio in OECD countries is around 34.3%. Taxes are the price we pay for a civilized society.---Justice Oliver Wendell Holmes Jr. The Tax/GDP ratio is an indicator of whether we are willing to pay for civilization.

3. The currency notes of Rs2,000, Rs1,000 and Rs500 being replaced by heavy and big coins corresponding to these denominations! This would make it feasible for the poorest of the poor (or digitally-excluded) to undertake physical transactions while making it impractical for others to make large physical transactions. This is because the poor may have to deal with a few heavy and big coins however, tens of thousands of heavy and big coins will logistically difficult.

This principle has been suggested by former Professor Kenneth Rogoff, former Chief Economist of International Monetary Fund (IMG) in his book “The Curse of Cash”. This will help curb future tax evasion. Such a transition can be done gradually and need not be done at the stroke of the midnight hour given that data related to cash deposits after a transition was done at the midnight of 8 November 2017 is already available.

A not-so-easily observable sign is potentially better access to formal finance ---aided by higher adoption of digital payment ---among the poorest of the poor (or digitally excluded). In some ways the benefits of digital payments are independent of the anti-tax evasion intent of demonetisation and these benefits may be pursued independently.

The return of 99% of the banned notes almost makes it a winner-takes-all, in comparison with say a scenario in which 70% of the banned notes were returned and government takes no follow-up action resulting in partial wins for corruption and civilization in the medium term. Future inaction on the important follow-up steps would mean that the corruption mostly wins. On the other hand the government certainly has at least three ways to outsmart the enemies of civilization!

(Aniruddha M Godbole is a senior industry expert in financial services at Persistent Systems Ltd. Views expressed in this article are his personal views.)