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Surjit Bhalla: Black Money in 2009=1 lakh crore

Mr. Bhalla says something interesting; that the amount of black money in the country is overrated. He complains that political parties that claim that 50% of India’s GDP is our black economy; it’s not that significant, he says. Here’s his tax calculation.

Clearly, the study of black money is an important issue. And tax evaders have to be punished. My estimate of black money in India is based on private income tax collections and details about the calculation are contained in ‘Tax Compliance and Tax Rates’ (in the book, India on the Growth Turnpike, Essays in Honour of Vijay Kelkar). And how much might total black money be in India in 2009? Only about Rs 1 lakh crore, and given our GDP is Rs 60 lakh crore, that is about 1.5 per cent of GDP. These numbers are shockingly small and especially small compared to the GFI estimate which seems to be universally accepted. The GFI numbers imply a black money flow of 7.5 per cent of GDP every year, that is, each year black money equal to five times my estimate flows into the Indian economy. Both numbers cannot be right. Which of these two numbers are closer to the truth?

(The paper he mentions is here)

First, the wording choice is deliberate and I can understand why. Surjit doesn’t say "How much total black money exists in India in 2009?" – he asks, how much of it was generated in 2009. Fine, let’s go by that definition, but it doesn’t change the assertion that 50% of India’s GDP might exist as black money.

GDP is a measure of transactions done in a year. Black money is a measure of wealth. These are different concepts. Let’s see why. He says:

The definition of black money is money that has some tax on it and is not declared. Besides personal tax, there are other forms of tax evasion — property tax, over and under-invoicing of trade, and non-declaration of corporate income. No doubt these forms of tax evasion are present but their magnitudes pale in comparison with the magnitude of income tax evasion. For example, corporate income tax collected in 2009 was Rs 2.6 lakh crore, an amount suggesting very little tax evasion.

Uhm. I’m not sure this means less tax evasion just because corporates paid 2.6 lakh crore as tax. Corporate is where a lot of the black money is generated and used. Let’s move on, though.

Some back-of-the-envelope calculations yield an insight into the likely magnitude of black money from income tax evasion. In 2009, India’s GDP was close to Rs 60 lakh crore; and income subject to income tax close to Rs 50 lakh crore. But this income accrues to the entire population, and even the poor. Only the top 20 per cent of the Indian population has incomes that make them eligible to pay tax. And this 20 per cent has 45 per cent of total income. Thus, those paying tax receive Rs 23 lakh crore as income. It is inconceivable and outright wrong to think that a third of the income received as taxable income is evasion of taxes. The average personal income tax rate in India in 2009 was about 10 per cent, that is, the government should have collected Rs 2.3 lakh crore as tax. In 2009, it collected Rs 1.3 lakh crore. Thus, the black money generated in 2009 was approximately Rs 1 lakh crore.

Okay. Good calculation, but not enough to draw that conclusion. Why?

First, the 1 lakh crore was the difference in taxes theoretically. That is, if India’s tax rate is 10%, and we paid Rs. 1.3 lakh cr. in taxes, then we "declared" Rs. 13 lakh crore in Income.

But we should have had 23 lakh crore. That’s a whopping 10 lakh crores in difference. Technically, the black money generated in 2009 was 10 lakh crores.

Let me repeat this.

  • Mr. Bhalla says black money = money which is taxable but is not declared.
  • Mr. Bhalla says that we pay, on average, 10% of our income as tax
  • Mr. Bhalla says we are short income tax collection by about 100,000 crores.
  • But Mr. Bhalla does NOT conclude that our income, to have paid that much extra in taxes, is 10,00,000 crores higher.

He leaves us to believe that black money is only 100,000 crores. Not fair.

Second, there is black money generated that isn’t GDP’ed. Cash is paid to buy a house. The seller keeps the cash in a locker. It is not part of GDP. Finito. You may think this money is small. But get this – just the amount of residential real estate under construction in India is $66 billion (or Rs. 300,000 crores). [Source: a Jones Lang LaSalle Meghraj report, referenced here] Assuming that about 1/2 of that is transacted in a year, and existing home sales are also added, we should be seeing about 300-400K crores of RE sales, and 30% of this is usually black. Just that brings in 100,000 crores in generated black money a year (though much of it revolves around, I admit)

Third, some cash is used to pay for services. That cash moves around; it is even converted to dollars as Hawala and transitioned abroad. The abroad money becomes "white" and comes back as foreign investment. The black pieces still float about in India as cash; some of it adds to GDP, the rest doesn’t. That’s wealth, in mattresses, not necessarily adding to GDP (remember, we are a high-saving country)

Using GDP as the blackboard to calculate black money is flawed; money can be generated outside standard GDP metrics.

Finally, there are avenues to convert black to white. STPI was tax free – so if you had black money, you could hawala it out, and bring it back into a software company you started, and voila. Today, SEZs have tax free income, and this kind of dirty laundering is still possible. Agricultural income is tax free; who’s to say you didn’t really sell that many onions? What is black this year can become white the next year without having to pay tax. Doesn’t change the fact that the black economy thrives.

The rest of Mr. Bhalla’s conclusions aren’t useful – that most the black money is all sitting in people whose income is less than 10 lakhs. There isn’t much data (that he provides) to actually reach that conclusion other than the flawed assumption of only 1 lakh crore being black money every year.

For the record, I agree with Mr. Bhalla that reducing effective tax-rates is the best way to ensure compliance. I think we must also dramatically improve enforcement, and cut out the above loopholes (farm net income >5 lakhs a year MUST be taxed, SEZs must be taxed, exports too).

And is it time for an tax amnesty scheme again? I don’t like the sound of it at all, as I’ve been an honest taxpayer forever and have no such "black" money (probably why I can never buy a house either). But to do a scheme where people declare their money, pay a high tax rate and get amnesty against investigation, the govt. has to massively increase enforcement and remove the loopholes. Otherwise there is no incentive to declare, if you can evade and launder with impunity.

The government is starved of money in 2011-12 – there is no 3G auction next year – so they might want to do an amnesty scheme to augment revenues. Regardless, there will be no demand for it if there is no seriousness about enforcement.

But the amount of black money in India *is* significant, it seems.

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